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source by: businesstown.com
Key Considerations in Buying a Business
The advantage of
buying a successful business in comparison to starting a new one can
be overwhelming. Perhaps the biggest plus is that a huge amount of
risk and uncertainty is eliminated. There are not only existing customers,
but a track record of what is selling and what isn’t.
And, since the basic business infrastructure is already in place, you
can focus on improving the existing business, rather than on reinventing
the wheel.
Customers
The most important asset you may acquire in buying a business are the
customers. Even with a great product or service, building clientele
can take time. Be sure the customers are satisfied and that they will
remain loyal to the business after the current owners have sold out.
Employees
Identify and assess the value of all key employees. Arrange to meet with
them. Ask yourself: How critical are the current employees to the business?
Do the salespeople have strong relationships with key customers? Would
a particular engineer’s or designer’s talents be difficult
to replace? How important is the role of the current owner? You might
even consider offering incentives to certain employees to assure that
they will remain with the business at least through the transition
period.
Facilities
Leases are not an integral part of the balance sheet yet they can be
a tremendous hidden liability. Find out if the current owner personally
guaranteed the lease(s) and ascertain whether or not the landlords
will insist you personally guarantee them as well.
There are important regulations to consider as well. Environmental legislation,
in particular, places the burden of polluted property cleanup on current
property owners and in some cases leaseholders. Find out if the property
was ever owned or leased by a manufacturer involved in activities that
created hazardous wastes that could have contaminated the soil. Find
out whether or not any clean-up action has already been taken.
Financial statements
Don’t take historical financial statements at face value, especially
if they are not accompanied by a satisfactory audit letter from a CPA
firm. Don’t confuse a compilation (basically adding up the numbers
provided by the client) or a review (a compilation with a few ratios
figured out) with an audit. Only an audit requires that a CPA test financial
information. If the seller offers you projections, don’t even look
at them!
Receivables
Chances are, if the business has receivables, their value is overstated.
Carefully examine an aging of the receivables and determine what amount
is outstanding past normal industry practices (nominal stated terms
are often ignored). Then assume that an appropriate amount of receivables
that are still current will also become bad debts.
Inventories
The market value of the inventory is almost certainly going to be a lot
less than what was paid for it. While even larger businesses tend to
have a fair amount of slower- moving items in inventory, many small
businesses are even more hesitant to write down or sell off obsolete
items.
Competitors
Be sure that you are not walking into a competitive mine-field! Is a
price war beginning? Are your competitors slashing their margins to
the bone? Did the current seller hear advance reports of a powerful
international corporation entering their market niche?
Attorneys
Much more so than in buying a house, you need to consult with an attorney
familiar with small businesses before signing an offer to buy. This
is particularly important because of the many hidden liabilities you
may be taking on, such as contracts, employment obligations, pending
litigation, bills to vendors, leases, and more.
Confidentiality
You need to have a firm agreement with the current owner as to with whom,
at what stage of the negotiations, and under what conditions you can
discuss your interest in buying the business. Telling key customers
that you are considering buying a business that is not yet publicly
for sale can pose a risk to the business and expose you to potential
litigation from the current owner.
Valuation
Start by carefully
estimating the net positive cash flow for the next five years, after
subtracting a good salary for your talents—one
in line with your market value if you were employed in a similar management
capacity elsewhere. Then determine the appropriate multiple of earnings
to use to arrive at a fair valuation. The appropriate valuation should
reflect the amount of risk inherent in the business and the importance
of your efforts towards making the business succeed.
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