What to know before buying a business
Posted by Northadvisory on November 25, 2020
As business accountants, we regularly meet Australians who are interested in buying an existing business. This type of business ownership can be both exhilarating… and daunting.
Buying an existing business differs from establishing a start-up – because someone else has laid the foundations. They’ve done the market research, launched the product or service, created the brand. They have a story to tell… and that story has a value attached to it.
And while buying an existing business has its challenges, it can be less risky than setting up a new business.
To make the right buying decision, you need all the key information about the business. You need to do a detailed review of the business’s financial performance, operations, reputation and industry as part of the ‘due diligence’ process. So, before you plunge into buying a business, here are some questions you should ask.
How did the business decide on the asking price?
A business is worth what a buyer is willing to pay – and although there’s no exact science behind it, most will sell for a multiple of two to four times their earnings (after wages).
There are three basic criteria that affect the business value:
- circumstances of the sale
- tangible versus intangible assets
- years of operation.
Other things to consider when valuing a business are:
- strong relationships with key customers or suppliers
- brand value
- management stability
- intellectual property ownership.
Tip: Ask an independent business valuation expert or business accountant for their review of the asking price.
Have you done your due diligence? Financial statements, tax records and assets
You – and your business accountant – will need to see detailed financial reports, including:
- last two financial years’ accounts (Profit and Loss and Balance Sheets)
- current year financials
- last four quarters of Business Activity Statements (BAS)
- last income tax return
- listing of every asset the sale will include (and copies of any lease agreements for assets leased).
Questions to ask:
- Are there new or increased costs you should anticipate?
- Are there any cash flow or debtor problems?
- Are you buying the accounts receivable/debtors?
- If inventory has been sitting in the business for some time, ask why.
- Are there any one-off sales in the numbers that won’t be recurring? If so, what is the impact on the business profitability?
Tip: You should physically inspect the assets during the sale process and record the valuation of the assets… as well as making sure the assets are insured until settlement of purchase.
Tip: Don’t rely on financial statements generated by the vendor’s accounting system. You need to be working from certified copies of financial statements produced by a business accountant.
Who are your customers and suppliers?
Let’s talk about the 80/20 rule… you know the one. 80% of your business comes from 20% of your customers. So, you need to know who they are… what, when and how they spend.
Your customer database is central to the sale of the business, so make sure it is stored in an appropriate CRM system you can access or import into your preferred software package.
You need to be able to extract:
- a list or database of all customers and contact details
- meaningful reports on customer activity, including a history of transactions and sales.
You’ll also need to access:
- sales contracts to see what future business is guaranteed and to check if any major contracts are about to expire.
And where possible, it’s always a good idea to get feedback from customers and suppliers on the business.
Do you know the reason the business is being sold?
Is the business being poorly managed? Is the owner selling because it isn’t making enough money? Or is it simply being sold so the owner can retire, travel or look for other opportunities? The answers to these questions may affect your decision moving forward.
Try to understand what the current owner’s motives are by asking:
- How long has the business been operating?
- How many owners has the business had?
- How long has the business been on the market?
- How many offers have been made?
- What’s the owner planning to do next?
Tip: It’s a good idea to speak to customers, suppliers and competitors for information about the business and its problems.
Do you know your legal rights and obligations?
As business accountants, we regularly advise our clients to seek legal advice on their rights and obligations. This might include government regulations, licences and permits, worker entitlements, workers compensation premiums, patents, trademarks and registrations. Has the business owner ever been taken to court? Has there been any record of unlawful trading? The answers to these questions could save you in the long term.
Do you know who your competitors are?
Understanding your market is important… but understanding your competitors is crucial to your success. You’ll find some of this information from industry associations, government departments and the Australian Bureau of Statistics… and you can also seek specialist advice from industry bodies, consultants and business brokers.
Some things to consider when investigating your competitors:
- Look at your competitors’ market – their growth, strengths, weaknesses and threat to you.
- Check with the local council to see if new competitors are planning to start up.
- What is happening in your industry? What are the trends? What are the profit margins?
Will you retain existing employees?
Is a particular employee critical to the business’s success? If so, will you be able to retain that person in your employment?
Generally, the current business owner will terminate the employees’ contracts on the last day. The new owner may then choose to offer new contracts to the workers.
Experience tells us existing employees are the glue that binds the business sale together. If the existing employees have long-term relationships with key customers, will those customers take their business to their new employer?
Tip: Be prepared to deal with the ‘people’ issues that come with changing business ownership. Communicate with employees to put them at ease and try not to rock the boat early in the handover period.
What is the trial period, and do I need one?
The existing owner of this business will have built relationships with clients. This is classified as goodwill. And, depending on the nature of these relationships, this goodwill (and future revenue) can disappear if the owner walks away from the business.
We generally advise a transaction and training period stated in the contract.
This will provide an opportunity for you to be introduced to the existing clients as well as have the owner on hand to answer any questions you might have about the business.
Finally, reduce your risk through research
Congratulations – this is an exciting time, but it pays to be well organised. Reduce your risk by doing your homework and due diligence. Research well, and remember we are business accountants, and we’re here to help you every step of the way with buying a business.