Buying a business is obviously a serious investment with major financial ramifications. If you’re in the process of vetting a business for purchase, make sure you take all of the pertinent factors into account – including the finer details that could be easily glossed over.
6 Things You Absolutely Must Consider
If you’re buying a used bicycle from Craigslist for $50, you can afford to take the seller at his word and buy the bike unseen. But you’d never buy a pre-owned Ferrari without first having it inspected by an independent mechanic, test-driving, and doing thorough due diligence.
The same goes for a business. Whether you’re investing a few thousand dollars or tens of millions, this is not a purchase that you want to gloss over. Careful analysis is an absolute must. And here are a few things we highly recommend you consider before pulling the trigger on any deal:
1. Business History
Just like you would never marry someone before getting to know their past, you should never purchase a business without taking a deep dive into the company’s complete history. You want to find out:
- How long has the business been in operation?
- Has it ever operated under any different names?
- Are the current owners the founders?
- Has it had any different business models in the past?
- How long has each employee been with the company?
Every detail is like a puzzle piece. The more pieces you have, the clearer the picture becomes. Gather as much information as you possibly can to ensure you have every chance to be successful.
2. Existing Customer Base
As you get further along in the due diligence process, make sure you become intimately familiar with the existing customer base, who they are, and how they comprise the revenue “pie.” In other words, who are the largest accounts, and what percentage share of revenue do they represent?
It’s helpful to know where the revenue is coming from. Are there 1,000 clients spending $100 each per month? Or are there 50 clients spending $2,000 per month? (That’s an extreme example, but it’s something you’d want to know as you plan ahead for some attrition during the transition.)
3. Existing Team
You’ll obviously want to know who is on the current team, as well as who would be staying on if you purchased the business. You might have some of your own people you want to bring in, but it’s always helpful to retain at least a couple of existing employees so that there’s some sense of continuity and experience.
4. Skeletons in the Closet
Every business has some skeletons hiding in the closet. However, some skeletons are a lot bigger than others. The problem is that they can be difficult to find, which is why you want to hire an experienced business broker to help you conduct proper due diligence in every nook and cranny.
Examples of common (but dangerous) skeletons include error-ridden books, incomplete contracts with clients (such as handshake agreements), past lawsuits, existing liens, sour industry relationships, or even a declining market.
5. Financial Mileage
If you study successful companies, you’ll discover that they’ve all figured out a profitability formula that allows them to operate efficiently and at scale. As you evaluate businesses for purchase, consider their financial “mileage.”
A company’s financial mileage is basically its profitability track record. You shouldn’t be worried about any one quarter or month. You want to look at the trends and study the long-term. Are things improving or declining?
6. Legal Agreements
Always study the current contracts that exist between the business and its customers and suppliers. You’ll want to have an attorney carefully review each contract to see if/how they’ll transfer in an ownership change. The same goes for legal documents pertaining to insurance policies and employment agreements.
Adding it All Up
Every business is unique. And while it’s certainly possible to lump different types of businesses into similar categories, every deal is going to carry a unique set of circumstances and challenges. By digging in and analyzing every aspect of the deal before signing the dotted line, you can ensure there are no dangerous or surprising factors hiding behind closed doors. This doesn’t guarantee success, but it does provide significant downside protection. Ignore at your own peril!