Buying an established business is a common practice for many entrepreneurs looking to expand their income streams. There are many advantages over starting a new business from scratch. These range from tapping into an existing customer base to enhancing other businesses owned by the entrepreneur.
However, due diligence is necessary when looking at purchasing any business. There are many potholes you will need to avoid when buying an established business. Often, these require special attention from you, your bookkeeper, and your accountant. To assist any budding entrepreneurs, we have created this guide to buying an established business.
Why buy an established business?
Buying an established business has many advantages over starting a new business from scratch. To begin with, if the business is in good shape, buying an established business means immediate cashflow. You will begin to see a return on your investment far earlier than you would have been when starting a business from scratch. This is a major positive for entrepreneurs looking to boost their personal cashflow.
With an established business there will also be existing customers and plans and procedures in place. All the difficult start-up work has already been completed by previous owners allowing you to instead focus on growing the business. The existing customer base will offer a basis to grow the business forward. Of course, you may have to make improvements to these plans and procedures in order to achieve this growth.
When you purchase a new business, you gain the expertise and experience from existing employees and managers. They can not only help you improve the business itself, but if you own related businesses, this expertise can be used to boost them. Often acquiring experienced talent can have advantages across many of the businesses you own, expanding their capabilities.
How to avoid business buying pitfalls
Before you purchase a business there are a few factors that you must look at. You should know everything about the business, having run through all the financial data with your bookkeeper and accountant. Here are 8 tips to avoiding common pitfalls when buying a business.
1. Find out why the business is being sold
There is always a reason why the owners are selling their business. You need to make sure it is the right reason. Finding out why the business is being sold is a good precaution to avoiding financial headaches. Often the reason will tell you whether the business you are buying is good or not.
As most businesses are sold due to bankruptcy, the owner needing cash, the owner is retiring, or declining income, it is extremely important for you to find the reason for the sale. Sometimes the owner may not give you a straight answer, retiring could be an excuse to bail out of a failing business or its success could have enabled an early retirement.
Check for relevant trends, social changes or new government regulations that could have led the owner to want to sell. Businesses that are being sold due to a declining income or mismanagement should be avoided. If the owner is retiring and the business is in good shape, then you have found a great opportunity.
2. Learn the businesses sales process
What does the business sell? How relevant is it now? What technologies are coming that could disrupt it in the future making it irrelevant? Researching trends surrounding a business’ products could transform the entire acquisition. With technological innovations moving at a breakneck pace you could discover new opportunities that the existing owners are missing, increasing the value immensely of the acquisition. Looking at trends and relevant marketing campaigns will give you an idea on how the businesses products are faring and whether there is any new potential into the future.
You should also look into the sales process itself. Who are the customers? What terms are the products or services sold on? Look at the sales staff and their performance. Look at how accounts collection is handled. Ask your bookkeeper to investigate the business’ cashflow and determine whether it is healthy or not. You do not want to purchase a business that is having cashflow troubles that are spiralling out of control.
3. Learn the businesses operational costs
What is the business spending money on? What are the costs? Take a closer look at where the business’ money is going. You may find that you can decrease costs and boost profitability if a business has significant unnecessary costs.
Uber very recently found that by switching from helium balloons to stickers for each of its employees’ yearly anniversary it would save $200k per year from its San Francisco office alone! Is the business you are purchasing blowing money on unnecessary expenses?
There could also be a lot of operations that, when streamlined, could dramatically reduce the operational costs of the business. Before you purchase the business have a look over the business’ operational costs with your bookkeeper. Form there you can go into the sale knowing what you will do to reduce costs and boost profits.
4. Study the balance sheet
Dive right into the balance sheet with your accountant and bookkeeper before you buy any business. What assets does the business have? There may be a lot of issues here. There could be old A/Rs that are almost worthless, extensive buildings that are expensive to maintain, or unproductive facilities. Look closely at each asset, you could be able to sell some and improve a business’ productivity and efficiency.
Take a deep dive into the business’ inventory. Are they stacked with unsellable products? This could cause problems. Run through any debts the business has with your accountant. They may be due soon with the business being unable to pay them. Ensure that you investigate every detail with your accountant and bookkeeper so that you know what you are purchasing.
5. Look at the structure of the business
While you can always change a business’ structure later, it is important to understand how it is being run now. Does the business structure suit you? What is working and what is not? If you do want to change up the structure do some research into the current structure and how effective it is. A restructure can be expensive so go in with a plan.
6. Talk to the people in the business
You should get to know those who are in the company, they will be your employees after all. Talk to them about the company, learn the culture, the working dynamic and trends. These are the people with firsthand knowledge about the company, so have a lot of valuable information.
Talk to them about their tasks, workload and pay rates. If they are being underpaid that could be a huge red flag. They also may have some valuable information about the business’ structure and could provide you with good ideas on how to improve the business. Each employee has been hired for a reason so why not find out why?
7. Learn about the industry
Look at the industry as a whole before purchasing the business. Learn industry trends and look for any potentially disruptive innovations incoming. While some industries are generally seen as stable, no industry is safe from digital disruption these days. There are also industries that become obsolete very quickly like entertainment crazes, electronic devices and fashion fads. Business’ in these industries may require extra work to remain relevant.
Check legal and ethical implications that may affect the company. Changing ethics and awareness campaigns may paint the business in a bad light, such as those that pollute or rely on animals. You should also check incoming government legislation that could restrict the business further.
8. Terms of the sale
What are the sale terms? What can you expect from the seller in the handover? Are you buying full or part ownership? These are all important facts to be aware of when you purchase a business. They could completely transform the perceived value of the company. Why would you pay a large sum for only part ownership? Asking questions and running over the sales terms is vital. You should also bring in your solicitor at this stage to look over the terms and the business to ensure there is nothing that could land you in hot water.
How much pressure is the seller under? Maybe you could use this to your advantage, allowing you to negotiate. Find out whether there are other interested buyers and what time pressures you may be under. Negotiation is important to buying a business, so ensure that you can get terms that you are happy with.
The trick to buying any business is to come in with a plan. While the difficult start-up may have already been completed for you, it is still up to you to grow the company into the future. You should figure out what you want to do to the business into the future based off research done on the business, discussions had with employees and those in the industry, and advice from your accountant and bookkeepers.
Every successful business needs an expert bookkeeper by their side. Link Strategies is all about growing businesses with innovative bookkeeping techniques. Find out how we can help your business and business purchases here.