Red Flags to Look For When Buying a Business

Buying a business is generally safer than starting a new one.  An existing business has established its presence in the market.  It has regular customers or clientele who are aware of the products or services the company offers.  It has employees who know how the business operates.  You can review its financial and operational history and project how the business will perform in the coming years.  There are downsides or risks, however, as pointed out by this article at Find out the real reason why the seller is putting the business for sale on the market.  Do not believe what the seller says entirely – do your own investigation.  Here are other factors you should carefully study when conducting the due diligence process.

Demographic and political changes: Go to the local Planning and Development Office and see if there are any proposed zoning law changes that would change the “permitted use” at the business location.

Owner’s Discretionary Income, or ODI: This is what the seller is taking out of the business after paying his suppliers, his employees, his rent, his overhead expenses and his taxes. If you can’t live on the current ODI, or if ODI has been declining for several years, watch out! The business is going downhill. If the ODI seems healthy, get the seller to put it in writing, and hold back on naming your purchase price for a few months so you can confirm the seller’s ODI numbers are accurate.

The location of the nearest big competitor: If you’re looking to buy a retail or service business, chances are there’s at least one franchise or “big box” competitor that will wipe you off the map if they ever come to town. Where’s the nearest outlet or franchisee?

Sales taxes: When you buy the assets of a business, you avoid responsibility for the seller’s debts, obligations and liabilities (other than his lease and other debts you expressly agree to assume and continue paying). Except . . . for sales taxes. If your seller has been underreporting his sales taxes, and the state tax authority finds out about it, they can come after you for everything the seller owed. You can sue your seller, of course, but by then he’s fled to Timbuktu and can’t be tracked down.

Don’t pay a penny for a small business until you know the seller has filed all state and local sales tax returns.

Local business reputation: Don’t rely on just “hard data.” Go to the library and skim the local newspapers going back at least five years. Go to the local police station and ask if there are frequent complaints by or against the current owner.

Spend some time talking to the locals–hang out at the local library, senior center, coffee shops and public parks and talk to the “old timers” who congregate there. …

Photo by Caston Corporate

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