10 Questions You Need to Ask Before Buying a Business
As an entrepreneur, you may find yourself in a position to purchase an existing business. Many times this can be a great business opportunity that gives you a chance to build up an already-existing business or help to rehabilitate a business that might be struggling.
However, as with any type of business venture, there are risks. Below are 10 questions you should ask yourself before buying a business.
1. Why Do You Want to Buy This Business?
The answer to this question might be simple. It could be one of your favorite businesses, you could have a great interest in the industry or you could see it as a great investment. Take this self-examination a bit further and make sure that the business falls in line with your strengths.
For example, if it's a retail outlet, do you have the wherewithal and patience to deal with vendors and customers? You also want to be sure you have some knowledge of the industry, and you certainly don’t want to overpay.
2. How Will You Make Sure You Are Successful?
This might go hand-in-hand with why you want to buy the business. Your business acumen might lend itself to marketing, accounting and budgeting, which will make much more of an impact than simple cosmetic changes. Make sure you have the qualities and resources to make the business successful, especially if it's being sold out of dire financial concerns (which we'll discuss later).
3. How Much Capital Do I have Access to?
Aside from the money you’ll need to purchase the business, you’ll also need working capital to cover expenses like payroll, inventory, utilities, rent and more. Analyze your current cash flow and determine how much money you’ll have to devote to the operation of the business. Review the accounting ledgers of the current owner and talk to him or her about their current monthly and annual costs.
4. How Much Is the Business Worth?
This will be important for you to know in order to determine a fair asking/selling price. There are a few different methods you can use to conduct this value analysis, including:
- Capitalized Earnings Approach: This looks at the expected return on investment.
- Excess Earnings Method: This looks at the return on investment, but separates asset returns from other earnings.
- Tangible Assets Method: This looks at the value of the business based on its tangible assets.
5. Ask to Speak With the Current Owner
Part of purchasing a business is speaking to the current owner to gain a better understanding of the business’ strengths and weaknesses. After you’ve identified a business you’re interested in buying, you should:
- Send a letter of intent to the owner outlining your proposed price and the terms and conditions of the sale.
- Sign a confidentiality agreement that assures the current owner you will not use the information they share for anything other than to make a decision.
6. Ask to See the Business’ Current Financial Statements
You’ll want to be sure you have access to their statements from the last three to five years, including tax returns and any current contracts or leases. Make sure that these statements have been audited by a reputable accounting firm. While it would be nice to be able to trust a business’ own financial analysis, it’s best to be sure the forms have been vetted by accounting professionals.
If the company's financial statements have not been reviewed, ask for the current owner's permission to conduct an independent audit of your own. If the owner refuses, he or she may have something to hide, which means that you might want to walk away from the sale.
7. Have a Candid Conversation with the Current Owners
You want to have a clear understanding of why they’re selling. Here are a few important questions to ask:
- Why do you want to sell?
- How many hours do you currently work per week?
- What is the current cash flow?
- Are you currently paying yourself? If so, how much and how often?
- What are the lengths of your leases?
- Do you have a business plan?
- Do you have a marketing or advertising plan?
- Do you have any past, current or pending lawsuits?
Answers to these questions will help you decide if the business is worth buying, and how much work and capital it might take to get it running smoothly.
8. What Happens After the Sale?
Check in with the owner and ask what he or she plans to do after the sale of the business. Ask if he or she would be willing to aid in the transition. Check in with the employees and determine what will happen to them once the sale is final. Will you be keeping all of the employees? Will you keep some and let others go? It’s also best to speak with the employees once it appears the sale will happen and answer any of their questions regarding the sale and the business’ future.
9. What Are the Business’ Current Prospects?
If the business has one, ask to see its current client list and inquire about the status of each client account. You want to be sure that the current owners are leaving you with a portfolio of workable accounts that have the potential to turn a profit.
10. What Is My Exit Strategy?
The hope is that you’ll buy this business and have a long, successful and lucrative career. However, there is a chance that at some point you’ll want to sell the business as well, or at the very least retire. Take a look at the business and evaluate what you’ll need to do to get the operation to a point where it is either profitable, sellable or a combination of both. Know what your exit strategy is at the start so that you can always be planning toward the future.
As always, make sure you’re consulting with an experienced business lawyer throughout the process. It’s best to find one that specializes in the sale of the type of business you’re interested in.
When making a big purchase such as a business, and especially when you’re inheriting someone else’s infrastructure and client list, doing your homework is the best approach. Lawyers will call this due diligence, but for many business owners and entrepreneurs, it’s really just common sense.
Should you decide to buy a business, one of the biggest choices will be whether to draw money from your business as needed or to pay yourself a regular salary. To help you decide, look at ways you can pay yourself based on tax, business structure and more.