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Diligence needed in buying business

May 11, 2014

We have seen an increase in businesses for sale recently, and I am sure it is partly because of the baby boomer generation of business owners wanting to cash out and transition their business to someone else.

Buying a business can be an exciting and apprehensive task. An existing business usually has a solid customer base and can provide immediate cash flow. Systems and procedures are mostly developed. Employees are most likely well trained and have good knowledge of their customers and business operations. These things are already in place that someone starting a new business would have to build or create.

As exciting as this seems, there may be some unanswered questions. Is this business right for you? Why is the owner selling? Are the financials accurate as presented? Will there be hidden land mines that you as the new owner will have to face?

Most of these questions can be answered by doing what is called due diligence, or looking into and understanding important areas before you buy the business. Below is a discussion of some things to consider.

Find the Right Business

It is important to find a business where you have knowledge of the industry and an understanding of its critical success factors. It is not often a small business can be purchased and turned over to a hired manager and operated successfully. It takes the involvement of the owner who knows the business and industry.

As in starting any business, try to understand whether the business is right for your personal circumstances. How many hours are necessary? Will it involve heavy physical work? Will you have the support of your family? These are examples of some of the questions you should be asking to see if there is a personal fit.

Analyze the seller’s numbers

To accurately assess the financials of the business, secure current and the past three years’ financial statements. These statements include profit and loss, balance sheets, along with accounts receivable and accounts payable aging. Also secure copies of the business tax returns. Ask the seller questions and have a CPA or other consultant help you review the numbers. This analysis will help determine if you are comfortable with the asking price or if you should negotiate it further.

In most cases the value of a business is a combination of the value of future cash flows, the value of the assets being purchased and an amount of goodwill over the value of the assets. This “goodwill” is what the seller feels entitled to by selling you that customer base, trained employees and other sweat equity. Valuation of a business can be a complicated issue. Getting professional help in this area is important. Overpaying for a business can result in future financial problems.

Another area you may look into is the reason the seller wants to sell. Looking into the past financials may indicate the industry is struggling or the seller has lost interest and the business is declining as a result.

Are there any claims on the business?

Doing your due diligence also means making sure there are no claims on the business. Check with the State Comptroller’s office to see if the business owes back sales or franchise taxes. Check with the appropriate office to determine if there are liens on any assets such as the equipment you are purchasing. Ask to see any employment contracts. Visit with the landlord if you will be assuming a lease to make sure that will be possible. If the lease will be up soon, consider asking that a new lease be negotiated so you will know what your rent will be in the foreseeable future.

These are just some areas of due diligence when purchasing a business. Conducting due diligence will help ensure your excitement with purchasing the business will not be dampened by unforeseen problems. There are many professionals you can use to help in this process such as brokers, CPAs and attorneys.

Advisers at the Small Business Development Center can assist in many areas of purchasing a business, including help with preparation of a loan proposal to take to a lender if financing is needed.