Six Questions to Ask Before You Buy a Small Business

Buying an existing small business can be a shortcut to expanding your current business or taking on the mantle of business owner for the first time. Someone else has already done the legwork to get the venture up and running. They laid the foundation. They’ve built a client base. They have an established physical presence and grabbed some market share. They have staff in place. They’ve proved the business model. Your acquisition allows you to build on that foundation.

Of course, as with everything else in business, not all acquisitions are created equal. There are worthwhile businesses you could acquire pick up and there are duds. Taking the time to conduct thorough due diligence will help you determine which side of the coin your potential purchase lies on.

@toddemaus via Twenty20

Buyers need consider tangible and non-tangible aspects when eyeing a potential business. Here are a few questions you need to ask yourself before taking the plunge:

What’s its reputation?

The internet is a great place to start your research. Check out your potential new business’s online reviews and social media pages. If you’re planning on keeping the existing name and branding assets, the reputation attached to them is also part of the package deal. Are you inheriting goodwill and happy customers, or will you need to win over a disgruntled market? Don’t limit your search to online ventures. Also, reach out to the local Better Business Bureau and the SBA office. Scan the local media outlets for news items related to the business and talk to the members of the community.

How’s the competition?

Everyone has competition. Before you jump into the water with this business, take a good look at how deep the pool is. Is this a crowded marketspace? Will it be hard to differentiate and stand out? Are there a number of competitors also looking to divest themselves of their business? If yes, dig a little deeper. Why are owners in this market looking to leave it? Take a closer look in the other direction also. Is the competition in this space sparse? Why? Is there no demand in this area for the business model? Do local ordinances or taxes make it difficult to turn a profit? Does a big box competitor have plans to move into town?

What does the deal include?

Before you close the deal, be clear about what assets are included in the asking price. Businesses have three different types of assets:

  • Capital Assets/Fixed Assets, which include tangibles such as property, vehicles and equipment.
  • Current Assets, such as cash, inventory and accounts receivable.
  • Intangible Assets, which include client lists, branding, patents, supplier contracts and staff.

Don’t just look at the assets, of course. Pay attention to the other side of the coin too. What debt will you be assuming with the business? Are there outstanding account deliverables or bills that will become yours? Are there leases or franchising agreements about to expire, and will the renewal costs be higher than the current negotiated rate?

How’s the cash flow?

Money moves in and out of your business. You have expenses (rent, franchising fees, staff, inventory, taxes, etc.). Money moves out to pay for those items. You also have income – the money others are paying you for products and services. It’s possible to be making a profit but have a negative cash flow.

For example, you may be waiting for your customers to pay outstanding invoices and you may simultaneously need to pay for inventory to cover future sales. Your books show a profit based on those pending accounts receivable, but you don’t yet have the cash in hand to cover the expense of new stock. Negative cash flow is one the biggest reasons startups fail. Before you purchase your new business from its existing owner, take a close look at cash flow and understand what the answer means for you.

What’s the current owner discretionary income (ODI)?

After the current owner pays her bills, after she pays her staff, after she pays taxes, after she invests in new inventory or business tools, what is she paying herself? This figure is the ODI. It’s what the current owner is taking out of the business as personal income. If you can’t live on that figure or if that figure has been in decline, think twice about this purchase.

What’s the asking price and how did the seller arrive at that number?

Buying a business isn’t like buying a new piece of great tech, a car or even a house. It’s a lot more complicated than that. There’s not a simple sticker price that comes attached to a company. There are different methods to derive a business valuation. Understanding the process the seller used is as important as knowing the asking price.

You need to understand the financial and operational value of the company, as well as any potential hiccups before you settle on a negotiated price. At Peek Advisory Group, our buy-side services can ensure you have all the facts before you sign on the dotted line.