What to look for when buying a Business
In any business transaction we need to be careful and take precautions before making a commitment. When buying a house we get a property inspection, when buying a car we arrange for the vehicle to be inspected before purchase. So naturally it is wise for us to have an expert check-out the business before buying.
The big difference here is that building inspectors and motor mechanics become very familiar with the items being inspected and know what to look for. With businesses it is not so clear what potential problems or issues should be looked at and checked out. Here are a few things that we have found you need to watch out for when assessing a business:
- Potential. When someone bases their offer to you largely on potential, remember that the potential for the business to improve is matched by the potential for the business not to improve.
- Cash. When someone sells a business and advises you that there is much more cash income in the business than the books suggest, don’t believe them. If they lie to the taxman, there’s a fair chance that they’ll lie to you too!
- Profit. Be careful when looking at business profit. Check to see if it includes owner’s wages, if it excludes depreciation, interest, or if it is real – or a “projection”. We discuss how to interpret profit in more detail in this article.
- Projected Earnings. Business value is based on historic earnings, not future profits. If you buy the business you will be the one doing the work to realise the projected earnings, so you should be cautious of paying for that privilege.
- Leases. Property leases can have “demolition clauses” and all sorts of potential hidden problems contained within them. Be careful, get an experienced lawyer to check a lease thoroughly before putting your name on it.
- Staff entitlements. There are laws and legislation that require staff entitlements to continue through a change of business ownership. Make sure that the Seller has made provision for these entitlements and passes this on to you at settlement.
- Work In Progress. Many businesses will have orders in hand, and unfinished work “in progress” at the time of settlement. There is a “standard condition” that deals with this in the Business Contract, but you will need to consider this and negotiate with the Seller as to how you wish to deal with this. The point being, that this can be an extra expense.
- Equipment condition. When you buy a business, unless otherwise stipulated, it usually includes the equipment required to operate the business. The equipment is sold in an as-is condition. It is recommended that just prior to settlement, an audit of the equipment be completed to ensure all equipment is working. If something is not working it should be fixed by the seller before settlement. This process also establishes that everything is working at settlement, so that there are no ongoing issues after the transaction is completed.
- Future advertising. It is possible that a business owner planning to sell will cut-back, or cancel future advertising (in order to save money), knowing that the business will be sold. Check that future advertising (such as Yellow Pages) is in place prior to settlement.
- Stock. The usual practice with stock is to pay the “landed invoiced cost” price for stock – or the wholesale price. You do not pay GST on stock, as it has already been paid by the Seller when they bought it. You do not need to pay for damaged or out-of-date stock. You can also limit how much stock you are prepared to buy with the business, by negotiating the Business Contract accordingly.
- GST. When buying a business, you do not have to pay GST on the purchase price – as long as it is deemed to be a “going concern”. Be careful! There a few potential traps here. For example, a newly franchised business is not a “going concern” and will attract GST. Another tricky situation can exist if you acquire a property with the business. If there is no lease between the owner of the land, and a tenant in place, it will not be a “going concern” and will attract GST. This could be a significant extra cost.
- Debtors. Sometimes when buying a business the Seller will require that you “buy the debtors” from them. This has the advantage of tying the client to the new owner, and allows you to acquire an immediate client base. The down side is that you have no idea about what these clients purchased to create the debt, and how quickly they will pay the debt. If you agree to “buy the debtors” it is a good idea to negotiate a discount.
- “Key” Staff, Products, or Clients. Nearly every business is going to rely heavily upon either “key” staff, products, or clients for its income. This is not a bad thing, it’s simply something to be aware of, and to allow for when assessing a business.
- Interest Rates. Rates of interest will cycle up and down every few years, as they have over the past 150 years. Be aware of this and allow for fluctuating rates in your budgeting and business plans.
- Underestimating the cost & overestimating your capacity. This simply means that you should consider all the establishment costs and how much you can really afford to spend to acquire a business, before you get started.
- Client audit. When buying a business it is a good idea to talk to existing clients of the business to ascertain the perceived strengths and weaknesses of that business. The challenge here is that you will often enter into a confidentiality agreement with the Seller. Under such an agreement you are not allowed to talk to staff, clients, suppliers, etc without the express permission of the owner. Most owners will not allow you to do this until the sale is “unconditional” – by which time it is too late.
These tips are offered to assist you to be aware of the types of things that you should look out for and consider as a part of the whole process. It sounds like a lot of areas where things can go wrong, but it’s similar to a car. When you break it down into the components there seems to be a lot of things that can go wrong, but it’s the sum of all these parts that you need to consider.
It also reinforces the need to have professional advisors working with you to properly audit the business and ensure that all is in order.