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WHAT TO CONSIDER BEFORE BUYING A BUSINESS

Updated: Feb 16, 2023


Buying a Business


Most articles on mergers and acquisitions provide more information and guidance to those who want to sell their business versus first-time business buyers. If you are looking to buy a business (over $5M), you should, in most cases, engage a Mergers & Acquisitions professional. They will work on your behalf for a fee and help you assess whether a business you want to buy is worth the owner's asking price. Unfortunately, for smaller companies, there is only so much help available. In most cases, most business brokers tend to work on behalf of the seller. Business brokers are governed by the real estate board and typically help smaller businesses find buyers for their business. Some will work for the buyer, but in many cases, buyers must prepare to pay someone to help with this function, as the main focus is selling. We have worked with several where this is not the case, but consulting fees are attached.


How a Business Broker Works With Buying a Business

Suppose you are dealing with a business broker as a buyer. A business broker has contacted you on behalf of the seller. Keep in mind that this is with a real estate transaction. In that case, they are not working for you; they are working for the seller. It is now up to you to do your due diligence. As with any real estate transaction, the business broker wants to sell their client's business at as high a price as possible, just as with any real estate sale. A company is listed at a price does not mean it is worth that price. It is up to you as the buyer to understand what you are getting. The broker's fee is usually set as a percentage of what they get for the seller, depending on what other services they provide the owner.


What Is The Value of The Business I Am Buying?

Two types of professionals can provide you with a business valuation. Many CPAs, lawyers, and other professionals have taken additional business valuation training and perform valuations for smaller businesses. For a more extensive or complex business, there might be a requirement by the buyer for further due diligence. In this case, you may require a Chartered Business Valuator (CBV). You will pay at least fifteen thousand dollars minimum for this due diligence. Still, if you make that large of a purchase, it is well worth the money and peace of mind. You want to rely on something other than a business valuation provided by the seller, as the discount rates from the owner's perspective are quite different from the one purchasing. Other professionals, especially for smaller businesses, can provide a fundamental valuation based on financials and questionnaire for under $5K. It will not include the professional coming in and going through your business records as required by a CBV. It is based on the information you provide.

Before Signing on the Dotted Line

If you choose not to get a business valuation, here are just a few things that you still need to look at and find out about the business before you sign on the dotted line:

  1. You should get at least three and up to five years of compiled statements prepared by a professional accountant. It is highly suggested that they are a Review or an Audit and not a Notice to Reader. Notice to Reader statements only includes information given to the accountant by the owner. You should be suspicious if the seller will not provide this to you. It would be best if you never took the seller's word for their revenues, expenses, assets, and liabilities.

  2. You want to look at their net income (revenue - expenses before taxes) and key financial ratios. In particular, pay attention to any shareholder and related party transactions on the Balance Sheet. These can turn into red-flag items very quickly.

  3. Suppose you are purchasing assets in the business, such as equipment. You will want to understand the age of the asset, what it would cost to replace it, and determine ongoing maintenance costs.

  4. If you purchase buildings with the business, you will want an inspection performed. This is the same as buying a house to understand if you must invest further.

  5. Instead, you might be taking over the lease of a building. You will want a copy of the lease and have a corporate lawyer review it before taking on the responsibilities. You will want to understand if possible lease increases or requirements differ from what is listed as the rent expense on the owner's financial statements.

  6. Look closely at what is listed under accounts receivables as an asset and determine the ageing of the A/R. Anything over 90 days is likely, not collectible and should not be considered an asset for buying the business.

  7. Verify the operating expense costs fixed items, such as utilities or any other large expenses.

  8. Verify the cost of goods/sales and generate enough revenue to cover variable and fixed costs.

  9. Verify if there are any potential liabilities related to customer issues resulting in lawsuits or costs to you down the road.

  10. If you are purchasing a business with inventory, you will want to understand the inventory's valuation and age. Do not take the seller's "word" for it. There could be an obsolete inventory that should have been written off, which is still sitting on the Balance Sheet as an asset.


What a Business is Really Worth

Though getting a business valuation is recommended, at the end of the day, a business is worth whatever the buyer is willing to pay. Current owners almost always overvalue their businesses. Most buying decisions are emotional and do not always focus on the accurate valuation at the time. Still, you want to ensure that you know what you are getting into and only sign an agreement to purchase after you have done some due diligence. These few tips will help you identify areas you should assess when buying a business.

Summary

Engage the right professionals, such as an M&A professional or business broker, and involve your lawyer and accountant. We suggest you get a business valuation, which is one of our services performed by our partner, a CPA. Suppose you require more in-depth due diligence or buy a business over $5M. In that case, we can refer you to a Chartered Business Valuator.

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