How To Buy A Profitable Business Without Losing Your Shirt
You may finally be in the position to fulfill your life-long dream of owing your own business and feel that buying an existing profitable business offers many advantages to starting from scratch. That may or may not be true. An existing profitable business will have customers, employees, established product lines and the existing equipment necessary to run the business. But buying an existing business is a lot different from buying a new house or car. There are lots of things you must be aware of or your dream could turn into a nightmare.
The seller is more than likely represented by a professional. If you do not have expertise in , your first step should be to hire professional representation. If you are going to spend upwards of half a million dollars on a business, it only makes good sense to spend a few thousand dollars on a highly competent professional looking out for your interest.
The seller will have taken great pains to present the business in the best light. The business can look like it is an ideal acquisition. The thought of owning your own business can generate strong emotions. So the second thing you must do is temper your emotions. As the Godfather said, “It’s just business.” Do not get emotionally attached to owning any business. Stay totally objective about the business. Being emotionally attached to owning any business can color your judgment and allow you to make a poor decision.
The structure of the transaction is probably as important as the purchase price. Get competent advice on how to properly structure the transaction. You should never buy the stock of a small closely held company. You may end up being liable for undisclosed liabilities. An even more serious problem could be potential income tax liabilities for prior year returns.
The following is a general list of things you should examine carefully. This list is general in nature and is not intended to be all inclusive. In any particular acquisition, there may be specific problems not covered by this list.
- The company financial statements probably have been restated to reflect certain add backs, generally owner’s salary and owner’s expenses. Do accept this as economic reality. Often the owner is the most important employee of the business. It will often cost as much or more to replace him.
- Understand the income drivers of the business. What really drives the business? Too often it is the owner and the relationships he has build up over the years.
- The may present a set of income projections. Pay more attention to the assumptions than to the numbers. Always ask yourself if the assumptions are optimistic or realistic. Often they are best case numbers. Never buy on best case numbers.
- Often the owner or broker will list a few things that have the potential to increase the profitability of the business. Never pay for potential.
- Never assume that you can operate more efficiently than the owner has been operating. Actually expenses will probably rise somewhat. Don’t plan on cutting cost.
- Be sure to analyze the income statements for non-recurring income items. This might be sale of equipment, a one time job or something of that nature. You are buying an income stream. Make sure that all the items in the income statement were from normal recurring operations.
- Is the business cyclical? What is the income trend? Be sure to do trend analysis on major income and expense items. Be cautious of sharp spikes. Sharp spikes can often be temporary.
- Look for hidden deferred maintenance. If the business has a lot of machinery and equipment, there may have been some deferred maintenance. Be sure to check the maintenance records.
- If the business has a lot of property and equipment, be aware that the taxing authorities will often re-appraise the taxable base upon a sale. This could increase operating cost significantly. Also some of the property and equipment may be under insured. Another chance for cost to go up.
- When you are doing your income projections, do not overlook the income tax impact.
- Pay particular attention to the employment staff. How long have the people been with the company? Are they likely to stay as employees? Are they expecting salary adjustments? Are the key employees under employment contract?
- How important was the owner to the daily operation of the business. Very often the owner is the business. Be extremely cautious of where the owner was the center of the business. When he leaves it is very difficult to predict the total impact.
Buying an existing profitable business can cut years off the painful process of growing a business. You already know there is a market and you have an established base. If is much easier to build on an established base than to start from scratch. Just be careful. Do your homework. Do your due diligence. If you do, you should be able to buy a profitable business and still keep your wardrobe intact.