So you’re thinking about buying an operating business! That’s great because small business ownership can be one of the most self-satisfying and personally rewarding things you can do. But don’t make the same mistakes that many others have made when buying a business. Don’t take the unnecessary risk of turning your dream into a financial and emotional nightmare!
Although most business brokers are ethical intermediaries, some are only interested in closing the deal, no matter what the consequences are to either the buyer or the seller. Remember, for a broker, if there’s no deal –there’s no commission! No matter how nice a business broker is or how helpful he seems to be, remember, it’s the seller who pays the broker and it’s the commission from the sale price that pays his bills. The higher the sale price, the bigger the commission. And if no sale takes place, no commission at all.
If you think the broker’s going to hold your hand through the process, you’re absolutely right. He’s going to hold your hand all the way to the bank. The more the broker can convince you to pay for a business, the happier he’ll be. Don’t forget, whether or not the broker feels that you can succeed in this business or make a profit at it doesn’t necessarily affect him. So what can you do to avoid making possibly the biggest financial mistake of your life? Get as much information as you can so that you’ll know what to watch for as you negotiate to buy a business. Don’t believe anyone without checking the facts and independently verifying them (the due diligence process).
Here’s some of the key things you should know before buying an existing business.
A Business is worth only if someone is ready to pay
Valuing the business is not as hard as you think, but you should never rely on a broker’s or seller’s estimate as to what a business is worth. Remember that buying a business is fundamentally an investment and consequently the business is worth only as much as its ability to generate a profit for you based on how much money you must put into it. If you’re going to work in the business as most people do, then the business should also pay you a fair wage in addition to the profit that it produces. The best way to determine a business’s value is to work backwards from the available profit that a seller can prove to you. This will at least get you to a point where serious negotiations can then take place.
Most sellers stretch the truth or downright lie about unreported cash sales
One of the biggest problems in valuing small businesses for sale is the frequent claim by the sellers that they are taking large sums of unreported cash out of the business and therefore, the “profits” won’t support the asking price of the business. Ignore all claims of unreported cash income! How do you know the seller is telling you the truth? It’s your money and time you are about to risk — don’t risk it foolishly.
Always assume there are skeletons in the closet
Other things that you must watch out for are the ‘skeletons in the closet’ These are hidden problems that many businesses have and which may be motivating the seller to unload. You’ll have to be sort of a detective to find them.
Here is a list so you get the idea of what to look for:
- Credit problems with banks and/or suppliers
- Personal affairs of the seller that may affect his ability to sell the business (e.g., divorce, death of a partner, argument with a partner, etc…)
- Historic downward business trends in the seller’s particular industry
- Downward business trends for this business in particular
- Expiring patents, licenses, franchise agreements, etc…
- Changing franchise terms that will increase operating expenses
- Major new competition (such as a new shopping center)
- Increasing difficulty or expense in getting raw materials, products, or services
- The potential non-renewal of a major sales account
- Significant increases in rent to be expected (if the business space is leased)
- Unapproved existing variances in violation of zoning regulations
- Leases that are non-assignable or non-renewable
- Legal claims, encumbrances, and liens against the business
- Pending litigation against the business
- Poor management of capital assets requiring near-term replacement
- Obsolete machinery, overvalued inventory
- Partner and/or shareholder who may not concur with the seller’s desire to sell
- Unpaid taxes
- Product obsolescence
- Potential major increase in product liability insurance
- Potential labor union or other employee related problems
- Non-compliance with environmental and/or safety requirements