1) Why are the current owners selling? If the business is all the broker cracks it up to be (profitable, relocatable, minimal owner input, strong customer base, etc…) then why wouldn’t they simply hire someone to run it and enjoy the profits while retaining the asset? The are many legitimate reasons why someone might sell but it is important to consider their motives. Remember there are always two reasons for everything: The first is always the good reason (the one they tell you is the reason for the actions) and the second is the real reason (this one is the one they don’t tell you about, but the one that is crucial to understand). I’ll explain this with an example – your daughter wants to go to a friend’s house for a study group which is a good reason and you will most likely agree and say yes….the real reason however is that the study group is actually a group of friends getting together and one of the friends is the boy she likes. Make sure you understand the real reason they are selling and don’t simply believe the first good reason you are given.
2) In the famous words of Ronald Reagan (which he learnt from a Russian proverb) – Trust, but Verify. When analysing the accounts (which should automatically form part of your due diligence, anyway) make sure you verify the important numbers. For example, a couple ways you can verify turnover numbers would be to 1) pick a month and add up each individual invoice for that month, potentially verifying those invoices by calling the customers and confirming the goods were received, or reconciling the invoices with the bank account. 2 ) Check the VAT and tax returns for each year; people are unlikely to pay VAT on turnover they don’t have (unless it is an elaborate con) and the same goes for the tax they pay on profits. Any inconsistencies here should be a big red flag.
“In God we trust, all others bring data”
3) Don’t pay for the seller’s mistakes. If the business sells physical products and carries stock, they WILL HAVE bad/dead stock. Do not buy this stock. Every business selling products gets it wrong at some point or another, make sure you don’t pay for those mistakes. Verifying this means you need to review unit sales numbers by product for the last few years and compare this with stock holding. The issues will be easy to spot. Negotiate to get this stock for free or on a consignment basis and make sure it is removed from any calculations that might include stock to determine a portion of the business sales value.
I have seen sophisticated business people with expertise in this area, make this exact mistake, buying millions of unsellable stock because they get caught up in the excitement of the “deal” and all the great things the seller tells them about the business. Spend your time on this and get it right.
4) Understand potential “contingent liabilities” that might not appear on the balance sheet. In other words, are there any potential claims that could be made on the business in the future, that you would effectively be buying with the business that aren’t obvious when looking at the financials or prospectus? Examples of these might be employee bonus or share incentives, retailer rebates (a percentage of the sales made to a retailer that they are able to claim back at the end of the year either as a matter of course or because of purchase targets they have met), retailer “sale or return” agreements. Retailer “sale or return” agreements are important because if retailers are contractually allowed to return unsold stock to the business, you need to fully understand this mechanism and what stock these retailers might be holding of the businesses’ products – if they return it, chances are it will be a large volume and that there isn’t a market for it. This would mean you would have to write it off. Other contingent liabilities might be product warranties (be especially wary of newer businesses where products are now getting to an age where there might be claims and businesses where the product is complicated.)
5) The broker is representing the seller. Their incentives are the commissions they earn and therefore their priority is to sell the business for the highest price possible and not to make sure you are getting a good long term investment. Because of this, they will want to avoid any deal structure that isn’t 100% cash up front, this however, doesn’t mean you have to accept their terms or can’t push for a different deal structure with the seller. Especially if you are unsure or if there is a large purchase price, look to see if you can structure the sale with profit warranties or earn out periods. This way, if the business does what they say it will the seller will still earn the full sale price while at the same time you reduce your risk. You could incentivise this by allowing the seller to effectively sell the business for more money in the long run if it hits certain profit numbers but this is often a more prudent way to approach it.
Brokers will tell you many amazing things about the business but then always put the onus on you to verify them and not take any responsibility for the accuracy of any information they share. Buyer beware.
Bonus point – Don’t get caught up in the hype! Humans are easy to fool and often the easiest person to fool is yourself. Buying a business is really exciting but don’t get caught up, you need to evaluate it properly and look a both the pro’s and the cons.
As a closing comment, the important stuff to look for is the stuff that is not there. This sounds a bit ridiculous but anything that might negatively affect the price or the business will not be put on the prospectus or sale document, you need to ask the right questions and understand what is not on the sale documents. Also a quick Google search of the sellers and brokers will be worth its weight in gold, take any search results with scams or unhappy clients seriously. A last note – if the business claims to hold any Intellectual Property or patents ensure you have a lawyer look into these and make sure they are water tight and that the IP is actually protected.
If you would like help completing a due diligence or advice with regards to a newly purchased or business you are contemplating purchasing please get in touch. We offer a free initial consultation with absolutely no obligation – info@consultsme.co.uk.