I met the husband and wife owners of a small retail shop recently. The business was running at a $65,000 (approx) annual loss. They had purchased the business over 12 months ago and had been steadily losing money. I looked briefly at their books and realised they had paid too much for the business. On top of that, both of them had no retail business experience and they had decided to cut out all of the advertising that the previous business owner had been running – due to cost reasons only.
I asked them how much research and due diligence had they conducted before buying the business. I was shocked by their response…
“We asked the solicitor who was performing the business settlement service if the business was a good buy.”
In other words, they had already committed and signed a contract for sale.
Talk about throwing $$$ away. Needless to say, they no longer have any available capital to invest in marketing or anything else. The outcome will be to close up shop and accept the loss, and the lesson.
So how do you actually avoid this type of business disaster?
Ask yourself these questions…
1. What do I want from being in business?
- For lifestyle – to work fewer than 40 hours per week, more time with family, the freedom to go on holidays whenever you choose?
- To make a healthy profit by building the business up (increasing sales and/or profit)?
- To generate more income than a 9-to-5 job?
If your reasons are not listed above – don’t buy the business. If you want to be involved in what the business does (manufacturing, retail, services, etc) out of personal interest, it’s much less stressful and safer to be an employee.
2. Why am I buying this particular business?
- It’s in a prime location.
- It has a massive customer database which is not being used to its full potential.
- You’ve created a specific plan to massively grow the sales revenue using knowledge you’ve accumulated from being an manager in a similar business, or from a previous business(es) owned.
- The business has ‘something’ (intellectual property, branding, contracts, etc) that you cannot easily duplicate or purchase.
- You can buy the business at a price much lower than the market value. The vendor is highly motivated to sell.
3. What will be my exit strategy to get out of the business?
- Sell the business for a profit (find a business broker FIRST that can sell this type of business)
- Sell the business to a major shareholder or shareholders and become a silent partner (this could be a current employee)
- Pass the business down to a family member
4. What skills do I have that will make me successful in this business?
Please don’t think that all that is required to ‘improve’ the business is cosmetic – by changing some of the products, re-designing the store interior, etc. These ‘improvements’ won’t double sales.
Only very good marketing, a good sales team and good systems will increase sales significantly. Think MARKETING, SALES and DELIVERY of the product or service (using systems).
5. What skills will I have to “hire in”?
6. What cash flow do I need?
What’s my break-even cash-flow (to cover expenses, wages, etc)?
7. How much working capital do I have access to?
8. Will this business suit me i.e. hours, type of operation?
To ask the vendor who is selling the business…
9. How long has the business been operating?
10. How long have they had the business?
11. Why are they selling?
- Worn out from working long hours for little money?
- Couldn’t make the business work (perhaps in its current location)?
- Actual legitimate reasons such as long illness (either them or a family member they need to care for), retiring, moving to another state or country, or looking for another challenge in another business?
12. What is the cash flow and profit (gross and net) for the business?
13. What is the business owner paying him/herself?
14. What do the last 3 years of financial accounts show?
15. How has the business been valued?
Using the ROI method – based on ‘current’ profit of the business? Certainly not priced on what effort & money the current owner put into the business over the years. Only profit counts.
16. Who are the key customers, suppliers, staff?
17. What are the terms and length of any leases?
18. Will the current owner stay on and assist for a period of time?
Ask them to put this period in WRITING!
19. What areas of the business are systemised?
20. Is there a business plan?
21. How many hours a week does the current owner work in the business?
22. When was the last time the current owner took a holiday?
23. What are the marketing systems like? Do they make money for the business?
Review all advertising material, the customer database, the POS systems (if applicable), any loyalty programs, special promotional material, etc.
24. What facts support the “story” of the business?
25. How secure is future income i.e. contracts with customers and suppliers?
26. How dependent is the business on the current owner?
27. What will it take to grow the business so I can sell it for a profit?
Before you make an offer!
1. Get your accountant to check the financial accounts
Obtain actual lodged tax returns with the government, not the business owner’s printout or handwritten bookkeeping summary.
Your accountant will ensure that the business has cash-flow and is not over-capitalised.
2. Hire a solicitor who is experienced in buying businesses like the one you are looking at.
Your solicitor will ensure that the contracts with suppliers, the landlord, etc don’t have any surprises.
3. If you are spending over $250,000 on the business, or even if you want to be extra careful, pay for a business valuation.
Pay a licenced valuer to come in and audit the business. Even if you have to spend $7,000 for the valuation, it’s still much better than paying $50,000, $100,000 or more than you should have to buy the business.
You could certainly ‘use’ the valuation to negotiate a better price.
Homework always pays off in business. Buying a business on emotion can lead to regrets – especially if you end up paying too much!
It’s unlikely that the vendor will have competing bids, so do your best to get the right advice and find a business that has an upside potential and is a good fit for you.