There is much more to consider when buying a business than simply doing your due diligence or negotiating a low price as possible. I had a call today from a business owner and his question was “what do I need to do about due diligence?” for a new business he is considering. Great question.
When buying a business:
Firstly, take off the rose-coloured glasses.
So often people who are considering buying a business get caught up in the excitement of it all. Sometimes the seller (or agent) is great at selling and you find yourself really wanting it. Don’t. Leave emotion at the door and base this decision on the cold, hard facts.
Do your due diligence. This will include Googling the business and seeing if it’s got any bad publicity.
Also, review the financials for the last 3 years as well as BASes for the last year. Ensure the BASes substantiate the financials. I did see one set of financials a few years back that had been ‘creatively enhanced’ (you get my drift) and so don’t assume what you see is true – get the seller to substantiate. Look at margins, who the clients are, marketing plans, prepaid advertisements, leases, client contracts, recurring business, employment agreements – just to name a few items.
On this note, if they say they have lots of cash work and the figures don’t reflect the true value of the income, don’t factor this into your decision.
If they can’t prove income, then as far as you’re concerned, it didn’t happen. The sell price should reflect this. (If you’re considering selling, this is important for you … by not declaring income, or claiming absolutely very little thing, you’ll be putting yourself into a position of a lower sell price.)
Check out some of the critical expenses.
For example, some businesses have exceedingly high insurance, so talk to your insurance broker and ensure that the pricings are right. Perhaps the premise lease is high and it’s about to have a huge increase?
Do a budget.
That’s right, before you even consider buying a business, do up a budget of projected income and expenditure. Work out how many hours you’re likely to be working in the business and then do your maths to work out what your average hourly rate will be. Let’s say a business turns over $200K, but after expenses, the net profit (before tax) is $20K p.a. Now, let’s say you’ve worked out you’ll have to work 60 hours every week on this business (including operations, admin and marketing), at least 50 weeks of the year. You’re hourly rate would be $6.67 an hour (before tax). Doesn’t seem worth it to me!
A contract is critical.
If the person is selling via an agent, then they will have a contract. A contract doesn’t just protect both parties, but it covers off on things like who pays any staff accruals’ holiday or long service leave. It will clarify who covers the debt of the existing business. Even for a small price business, you want to ensure you are clear what you get to have, what you will own and what you’re taking on. Contracts ensure that what is promised actually happens. Ensure any promises or agreements are added and built into the contract. If it’s not in writing, it wasn’t said.
Finally, consult a professional.
After you’ve done your own due diligence, if you are interested in proceeding, see your solicitor to have them run through the figures and ensure you have a qualified solicitor to handle the contract and legal side of things. Do use professionals where possible.
I know a lot of what I have said is pretty concerning, but far better to do a business purchase right than to end up regretting the decision for years (or decades) to come. Particularly my last point, consulting a professional is absolutely important. Good luck!
P.S. If once you’ve bought a business and new to business yourself, contact me for some pricing on business coaching. I have various packages including an affordable entry package suitable for most new business owners.