Jonathan Jay teaching how to buy a business

What to Look Out for When Buying a Business

When you look at a small business with a view to buying it, you have to make sure you know what you would be getting into. If ever there was a case of buyer beware, this is it!

There are several reasons why caution is advised, including that this is likely to be one of the biggest investments you ever make and you want to be confident you are buying the right business for you. Also, things might not be as they are represented to you. That’s not necessarily because the current owner, or a business broker, is being untruthful – although that might be the case – but because people often don’t know what’s happening in their own businesses. Strange but true, and especially so when it comes to the financials.

So, everything needs to be scrutinised. Lights need to be shone into dark corners, carpets need to be looked under, stones need to be turned. That way, you can be as sure as you can be that you understand what you are buying, you know what the value of the business is, and you are confident you are paying a fair price for it.

Performing Comprehensive Due Diligence

The due diligence process can be long and painstaking, and it’s one for which you will need the help of professionals – like your accountant and solicitor – to be sure you haven’t missed anything. It’s essential if you are to establish the market value of an established business.

The three major areas of focus are financial due diligence, legal due diligence, and commercial due diligence.

Financial due diligence, as you would expect, takes a deep dive into the numbers. It’s usually conducted by your accountant and will investigate historical financial statements, and financial forecasts. Balance sheets, profit and loss statements and cash flow statements will be subjected to scrutiny, as will financial liabilities and tax returns.

Your solicitor will undertake legal due diligence. Contracts will be checked out, as will intellectual property, trademarks, etc. The first task will be to make sure the person selling the business has the legal right to do so. Check out shareholding – there might be partners you weren’t aware of who can influence the deal.

Commercial due diligence seeks to gain a thorough understanding of how the business works: how it delivers its products and services, who the key suppliers and customers are and so on.

Due diligence looks for faults and it isn’t unusual for purchase price and terms to be renegotiated based on what it finds. If there are still things you aren’t entirely happy about or clear on, you can make sure to include indemnities and warranties in the sale and purchase agreement. Also – word to the wise – make sure there are non-compete and non-solicitation clauses in there too.

While the three areas mentioned here are the most common and will need to be investigated for every existing business, there are other areas you might also need to look into. For example, business assets, including real estate, might need to be investigated. For more information, see our Due Diligence Checklist: A Comprehensive Guide.

Analyzing Financial Performance

This is one of the most important things you will do in a business acquisition. Once you have signed heads of terms – and likely a non-disclosure agreement (NDA) – but prior to full due diligence, ask the business owners to see things like the bank statements and latest accounts. They will give you an idea of how cash flows within the business, and an overview of sales and profits, assets and liabilities. It’s an overview of the financial health of the business. What you see here can give you the confidence to push on with the deal – or might raise a red flag that makes you step away before spending more time and money on it.

Full financial due diligence will seek to establish financial performance. As mentioned above, financial statements and forecasts will be examined, and accounts receivable, payables,outstanding debts and more will be put under the spotlight. This all feeds in to business valuation.

Verifying Business Registered Status

Companies in the UK have to be registered with Companies House. For free information on the registration status of a target business, plus the registered office address, details of directors, filings history, accounts and more, search for the company’s name or registration number in the Companies House database.

Exploring Legal Obligations

Check contracts to see whether there are any clauses relating to change of business owner. You don’t want to lose a contract on acquisition, or have to renegotiate and end up with potentially less favourable terms than the previous owner, if a change of ownership renders a key contract null and void.

Is there any ongoing litigation? Staff disputes, issues with customers or suppliers, or anything else that has not been resolved could be potentially costly and harmful to reputation.

Are there any liens or judgments against the business? Are there any legal issues connected with any member of the management team? Make sure you know where you stand.

Understanding Business & Industry Trends

A business reliant on one key client is in a precarious position; the loss of that one client could see the business collapse. Even if there’s a handful of clients, that’s still potentially perilous. If that is the case, does the market offer more opportunity for growing the customer base? Do you have marketing strategies you can put into operation quickly?

The financials will give you an indication as to whether the business is growing or contracting. Does that reflect the overall market trend? Are any competitors looking to set up in the area? Some research here can pay off well.

Does the business have some form of competitive advantage? Is it being fully exploited?

What do customers think of the business? If the owner doesn’t conduct research into customer satisfaction, have a look online and see if there’s anything there. Talk to other business contacts and your network about it; do they know anything?

These things can give a more holistic insight into a small business, and also help you to gauge the likely accuracy of sales forecasts. This has an impact on valuation, and also on how lenders are likely to view the business.

I want to give you access to my complete Business Buying Toolkit so you can discover:

Assessing Operational Efficiency

How well does the business run, day-to-day? Get under the bonnet and aim to understand and evaluate things including work flow, efficiency of systems and procedures, supply chain, working capital requirements, and capital expenditure.

Can you introduce efficiencies? For example, if you have an existing business, can you combine admin functions and so reduce staff – and maybe move everything into one premises?

Identifying Assets and Liabilities

While assets and liabilities will appear on the balance sheet as numbers, here you want to get some specifics. The business owner should be able to provide you with a list of debts and responsibilities, and also details of the assets. Remember assets aren’t always tangible, so don’t forget things like intellectual property, trademarks and patents.

Considering Reputation

Do a deep dive on past news articles, review sites and social media to see what people think about your potential new business. A poor reputation can have implications for value and profitability. It might be that a name change will help – or things might run deeper than that. You need to know, because business reputation is important. Get informed and stay informed.

Ensuring Compliance & Confidentiality

Is the business up to date with HMRC and Companies House filings and requirements? Is there a data protection/GDPR policy, and is it being adhered to?

Depending on the type of business, you might also need to be compliant in other ways – licences, permits, staff training and certification, confidentiality agreements and more might be required. Make sure you understand what is needed and the business is on top of everything.

Checking Environmental Compliance

Again, depending on the nature of the business, there might be environmental obligations to be met. It’s also a good idea to be proactive regarding the environment – not only is it wise, but it can be attractive to both customers and staff.

Conducting Employment & Tech Reviews

Review employee contracts. Are they legal and up to date? Do you wish to change any of the terms and conditions? Are you keeping all the staff? Will training for new ways of working be required? Know where you stand and have plans ready to be implemented when the business becomes yours.

Also, check the status of the technology. Are machines and equipment adequate for the job they have to do? Is there a programme of planned maintenance and replacement? What about IT support and cybersecurity measures; are they in place and sufficient?

Reviewing Supplier and Vendor Relationships

Some businesses have informal arrangements with third parties based on the relationship those parties have with the business owner. What happens to those when you are the new owner? Say a supplier offers preferential terms because they have known the seller for years; they don’t know you, there’s no formal agreement, so where do you stand?

You need to get to grips with these sorts of things because they can affect the profitability of the business.

Seeking Professional Advice and Support

No matter how much experience and knowledge you have, you can’t know everything. Also, why take on enormous quantities of work, potentially holding the deal up while you slog through it, when there are experts who could do it in a fraction of the time?

One of the key things about being in business is knowing when to delegate, and when to call on professional help. That starts with the acquisition process. Gather a good deal team around you, and trust them to do their job. They know what to look for, they recognise red flags and they have the expertise to avoid making potentially costly errors. You have enough to do as it is.

Conclusion

There are lots of things to look out for when you are a business buyer. You have to have a grasp of a range of different issues. You don’t need to know about all of them in depth – that’s where your deal team comes in – but you do need to be able to take a big-picture view of the process. You also need to be able to walk away if anything that represents a red line appears. Remember, you want a motivated seller, you don’t ever want to be a motivated buyer, determined to have a particular business at any cost!

It can be a huge bonus to have someone with years of experience in business mergers and acquisitions on your side. Jonathan Jay has helped more than 3,000 people buy successful businesses and become acquisition entrepreneurs, and he has put together the most comprehensive FREE package of business buying resources available today. To get started on your acquisitions journey, download your FREE Business Buying Toolkit now.

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