When buying a business, what are some basic questions you should ask? One of your key objectives is to become educated about the business and the process, so that you can make an informed decision. This will minimize the risk, risk which is inherent in purchasing a business, starting a business, or undertaking any new venture.
One of the best ways to ensure that you are getting more in depth information is to choose businesses which are represented by professional intermediaries, vs. being for sale by owner. Some of the latter will have a reasonable amount of obtainable information, but most business owners are not in the business of selling businesses, and simply will not know how to package and present the information you will need in an understandable format. Most professional Business Brokers will have an information package available to you after you have signed a Non-Disclosure or Confidentiality Agreement, which protects the seller and new buyer’s interests from damage done when proprietary information is made available to the wrong parties.
These types of questions, at a minimum, should be answered in the initial information package, and/or at the first meeting. If you are working directly with a seller, you still need this information to start evaluating the business. I will say only a little about each question, and take them each in more depth in future posts.
1. Why are you selling your business?
Some reasons are better than others. You may not want to buy a business that the owner is struggling to grow, unless you have skills and experience that he does not. Is the market saturated with too many competitors and/or insufficient demand? Is the product or service in the decline phase of its life cycle?
2. How many years have you been in business?
A business that is only 1, 2, 3 years old is still a start up; it does not have enough history to determine trends, and may not even be profitable yet. This will lead to more questions, such as why are you selling so soon? Often, new business owners have failed to calculate adequate working capital for the business, and will simply be running out of cash.
3. How many years have you been in business at the present location?
A business that is location-dependent, that has recently changed locations, is like a “new” business. Do you have enough history to see how it is performing in the new location? How has this changed the expenses for the business, especially rent? Did all the employees make the transition?
4. Did you create the business or did you buy it from someone else?
It is important to understand the history of the business and know where any past owners may be now. Is the last non-compete from the first owner about to run out and create a big competitor for you?
5. Are you a sole proprietorship, partnership, or S or C corporation?
There are advantages and disadvantages of each type of legal entity, and different tax considerations in the sale of assets. One of your acquisition team members should be a small business accountant, and one should be a small business attorney with expertise in small business sales. Your team will advise you on setting up your own legal entity and financial books and records. Between them and your business intermediary/broker, your team can determine the optimum deal structure that will work for you and the seller.
6. Do you have tax returns and financial statements that my CPA can look at?
No one should buy a business without these. No one can get financing without these. If the seller cannot provide them, and you want to pay cash, you need to devise a way to prove the revenue, expenses, and profit of the business, and plan to perform very deep due diligence.
7. What types of insurance must your business carry?
This will inform you about some of the risks of doing business in that particular industry. Some kinds of insurance can be difficult to obtain, particular if the business has a poor loss-run history and you do not have direct experience in the industry. Recent hikes or high worker’s comp rates will tell a story of the risks you may be taking on.
8. What licenses are necessary to own and/or run this business?
Many businesses are subject to licensing requirements beyond the usual business license in the jurisdictions in which the business has locations. Trade licenses may take years of in the field practice and state testing to obtain. You need to know who has these licenses at the business. They will NOT transfer to other individuals. You may be able to employ the seller for a transition, but that is typically only a short-term practical solution.
9. How many hours do you work per week in your business?
Good to know what you are in for, right? Is the owner doing most or all of the key work in the business? What happens when he leaves?
10. How many employees do you have?
This helps you to understand what human resources infrastructure is in place to support a successful transition. If there are key employees in key positions, doing their jobs, and not likely to leave, you have a greater success of making a smooth transition post-sale.
11. Do family members work in your business?
Many small business are family businesses. This may (or may not!) be working well. The more family members there are, the more complex any transition will be. Are they being paid above fair market value for a comparable employee? If so, it will be very hard to cut their pay post-sale. If “mom” is working for free, you will need to pay an employee to perform her tasks post-sale.
12. Will the family members stay after the sale?
How many people will be leaving and need to be replaced? Sometimes the answer to who will stay is impossible to answer because it will depend entirely on how everyone gets along with the new owners and how well they can work for someone who is not their family—and under what terms. Again, more digging will be required to satisfy yourself that you know the risks.
13. Are you willing to take a note and be paid over time instead of all at once?
Seller financing is a part of the large majority of all small business sales. Sometimes, it is only a small percentage, (say 10%) with the majority coming from third party financing. In many cases, the business will not be financeable by a third party lender, and a buyer will need to pay cash or have seller financing. The seller will (very rightly) assess the risk of financing each buyer on a case by case basis and the parties will agree to financing terms that work for both.
14. Will you stay and work for a while after the business is sold?
It is typical for a business seller to offer transitional training for about 2-4 weeks, which is included in the price of the business. Normally, this is sufficient. If a buyer needs a seller for longer, terms are negotiated. Be careful what you wish for: often the seller will not work well under the buyer when he used to be boss. Employees will also be conflicted, and not know whom to respond to when instructed. Carefully consider post-sale employment agreements.
15. How is inventory controlled?
In businesses where inventory costs and controls are key to making a profit, a buyer needs to look hard at the actual count, the turnover ratios, the percent of the inventory that is truly sellable and not outdated, and the internal control systems. You will also need to consider how inventory will be counted for the sale, as third party counting services can be expensive.
These “Good Questions!” will get you started in your initial business investigation.
