Buying an existing business is an exciting opportunity to leverage an already established brand and pay yourself on day one. It can also be less risky than starting a business from the ground up. But how can you be sure the business you want to buy is a good business? Doing your homework is essential and the list of things you need to look at can be quite daunting. We’ve put together a list of some of the most common items in this article. If you’re a business owner, know that these are some of the things an interested buyer will be eager to look at and be prepared to provide documentation/answers.
*Before we get started, it’s important to note that the suggestions in this article are best practices but by no means is this a comprehensive list. Every business is unique and due diligence items vary depending on the business. *
Before you buy a business, you’ll want to perform what is commonly known as due diligence. Due diligence is a fancy term for researching and confirming that what you’re buying is what you think you are buying. In most business transactions, diligence isn’t performed until after you’ve submitted a non-disclosure agreement (NDA) and the seller has accepted your offer (an Indication of Interest (IOI), Letter of Intent (LOI), or a Purchase and Sale Agreement). Diligence can last a few days to a few months.
Getting into the financials is one of the most important parts of your research. You need to evaluate how viable a business is, whether its profitable, and if there are any red flags or inconsistencies that may exist. At a minimum, you want to see the last three years of financials i.e., tax returns, income statements, cash flow statements, and a current balance sheet. For larger businesses, ask if the financial statements have been audited by a Certified Public Accountant (CPA) for further comfort that the numbers are accurate.
Pay attention to whether a significant percentage of a company’s overall revenue relies on a single or a small group of customers. A business with a high level of customer concentration is a riskier investment if you are concerned that any of those customers may decide to leave after you buy the business. Likewise, if you are looking at a business that relies heavily on any one supplier and a disruption (like a pandemic or the supplier closing) occurs, that could have serious business impact. Industry concentrations are a little less concerning than customer or supplier concentrations, but there is still risk anytime you have a large number of eggs in one basket. Lenders are also not as likely to approve a loan on a business with those dynamics.
The reputation of a business is one of the strongest measures of its success. When you buy a business, you will inherit their reputation. You can manually perform searches by using a business’s name on search engines or social media sites and learn if they are perceived favorably or not. This may also help you decide if you want to keep the name of the business or change it after the ownership transfer.
Know a business’s outlook before you purchase it as well as whether the overall industry is expanding or contracting. Understand the customer base and satisfaction, buying habits, who the competition is as well as what their strengths and weaknesses are. Ask the seller why they are selling. By doing your research on these key areas, you will know what it takes for the business to be successful and can make better growth decisions once you own it.
Familiarize yourself with how the business operates. In other words, look at everything a business is doing daily to keep running and make money. Dig into the systems, polices, procedures, staffing, culture, etc., to ensure things are running as the seller says they are. You wouldn’t buy a house without an inspection; you shouldn’t buy a business without inspecting it either.
You can find information on any business entity by performing a search on the Secretary of State’s website where the business is registered. There may be a small fee associated with the request but there is peace of mind knowing that a business you want to purchase is in good standing and the owner has the legal right to sell it.
Find out if a business’s assets are being used as collateral in some type of secured transaction, usually a loan or a lease. As part of the sale agreement, a seller will typically take care of those obligations prior to closing (or make arrangements for the buyer to assume them), but a buyer should still ensure that the assets being transferred are free and clear of any seller liens.
Something that can easily be overlooked is whether a business’s licenses and permits are intact. If those aren’t secured and maintained, it could disrupt the continued operation of the business after you purchase it. By verifying that licenses and permits are up to date, and easily transferable, the business can continue to operate without interruption.
The offer to purchase agreement should outline in detail all the assets being included in the sale. Assets include tangible goods, such as vehicles, real estate, computers, office furniture, and other fixtures, and intangible items like intellectual property, such as a patent, brand, trademark, or copyright.
There is a lot involved in vetting a business to buy and this article gives you a few ideas of things to look into. Buying a business is a complex process and working with professional advisors who have transaction experience – an attorney, accountant, and a business broker/merger and acquisition advisor – will help you to feel confident that you have adequately analyzed all the components of a business before you buy it and are making a good decision. Contact us to learn more about our support for buyers in the due diligence process.
