When buying a business part of the process is managing risk. One way to manage risk is to uncover everything you can about the business your are considering acquiring.
The best way to start is to either sit down with the owner or his/her agent and interview them. The interview would consist of mostly questions on your part and be as open ended as possible. Sometimes this will lead to information you would never have uncovered if limiting questions to facts.
Additional information can be obtained from business documents such as financial statements, tax returns, leases, etc. You can also gain information through observations or by talking with employees (if given permission by the seller).
Communication with the seller is important so if there is a broker involved get them onboard for a meeting with you and the seller. The seller provides invaluable experience and knowledge that you need in order to make a decision about purchasing the business. The seller also has a great deal of knowledge that would be beneficial after transfer of ownership.
This information may be a bit bias, so keep that in mind. The seller likely has invested much time, energy, and money in the business. A tactful approach to the information-gathering process can benefit you during the negotiation phase.
The following checklist from the SBA is not an exhaustive listing. Rather, it should serve as a starting point for your investigation. In addition to information you obtain from the seller, you must also consider how changes under your ownership would influence operations and cash flow.
Don’t ignore red flags; remaining objective while you learn about the business is critical as you decide whether to move forward with the purchase.
A prospective buyer should request access to business financial records. This financial information is key to understanding past profitability of the business as well as projected future success.
If the seller cannot provide adequate information, you must make the decision whether to move forward at your own risk. If bank financing is involved, the lender will require adequate financial information.
Obtain the proposed selling price and determine what is included in the sale. How much of the selling price is allocated for real estate, goodwill, equipment, inventory, etc.? What is the actual market value of those assets?
Determine the type of sale. Will it be an asset or stock purchase?
Establish whether or not the buyer will assume any business obligations or debts such as unpaid balances of accounts payable. If so, obtain all current loan terms, documents, etc.
Acquire business balance sheets and income statements (at least three year-end statements and interim for current year), and federal business tax returns (at least the past three years). Confirm that all past taxes (state and federal) originating from the business are paid.
Determine whether additional working capital will be needed to conduct business operations after the sale.
Business and Operations
Obtain a business history. What kind of reputation does the business have? How long has this business been established? Include the development/progress of the business and ownership structure.
Determine whether upgrades are required and identify needed changes to business operations. Are any leasehold improvements, equipment purchases, or general updates to the business necessary? What would be the costs of these updates?
Obtain a copy of the franchise agreement, if applicable. Will another franchise fee or a transfer fee have to be paid?
Obtain a copy of the proposed buy/sell agreement (unsigned) or information in writing about the proposed terms of the buy/sell transaction.
Request an explanation of seller’s reason for selling the business.
Investigate any business leases for equipment, property, etc. Are leases transferable? Investigate zoning laws to ensure compliance.
Determine whether or not the buyer will be able to continue utilizing the firm’s intellectual property such as business name, patents, trademarks, trade secrets, product names, and any other proprietary information.
Research any licenses that may be required to maintain business operations. What are the costs?
Determine whether or not the seller will offer a non-compete agreement after transfer of ownership.
Investigate whether there are any customer product warranties issued by the company that may be future obligations.
Learn about staffing requirements and key employees. Analyze the roles and salaries of all employees in the business. Will you keep existing employees and/or key management during the transition? Do you have the experience and expertise to manage this new acquisition?
Obtain a copy of existing employee contracts and benefit packages, if applicable. Determine the likelihood that existing employees will stay with the business after the transfer of ownership.
Establish whether or not the seller is willing to stay on for a period of time after ownership transfers in order to provide knowledge and support.
Market and Industry
Identify the products/services the business provides. What is the current pricing system? Do you plan to alter the product/service mix? Are existing inventories and supplies included with the sale? What level of inventory will be in the business at the time of transfer? Does inventory consist of high quality saleable inventory or predominantly old inventory that will be difficult to sell?
Acquire a list of competitors, suppliers, and clients/customers, if possible. Can you retain customers and sustain revenues? Will existing vendors offer the new owner the same terms as the current owner? Will you forge new relationships with different suppliers or continue with current operations?
Determine the market area of the business and method of distribution. Fully understand the business’s customer geography and target market. How large is the current customer base? Is there an opportunity to grow the customer base? Research the industry. Is this industry growing? What are its strengths and
weaknesses? Are their any emerging opportunities or threats? Gather information on current demand, seasonality, buying patterns, etc. Consider changes in the business environment which would affect operations and profit potential. The seller may have access to industry journals and information. In addition, outside industry research will likely be necessary.
Richard Roberts, ABE, SVA
Richard is the founder and managing broker-intermediary at AEGIS Business Brokers, LLC. You can reach him at 800.246.1660 Ext 11 or firstname.lastname@example.org