5 Things to Look for
When Buying a Business
Not all businesses are created equal and not all businesses are ready to be purchased and managed by an outside entity. Just because a business has a recognizable brand, a popular product/service, or good cash flow / operating income, does not necessarily mean that business will make a good investment for an outsider or strategic buyer. Here is a list of 6 things to look for when assessing the purchase of a business:
1. The company has recurring revenues from ongoing customers vs one-time product or service sales revenues: the costs of maintaining or upselling a current customer are typically far less than acquiring a new customer. Therefore, when seeking to buy a business, look for companies that have established and ongoing relationships with customers who pay for products or services on a monthly or recurring basis. A company with recurring revenues has much more stable revenue and growth prospects than a company that relies on one-time sales to generate revenue and bottom-line growth.
2. The operations of the business do not rely on the daily efforts of the business owner: most business owners start out as technical experts and then develop leadership and managerial skills over time. However, if the business is too dependent upon the ability of the owner to sell, to maintain customer relationships, or perform technical services then it will be very hard for a potential buyer to operate the business if they do not have those same selling skills, customer relationships, and technical abilities. When looking to buy a business you want to find companies that have developed repeatable processes that can be written down, learned by new employees, and executed in a reliable and high-quality manner WITHOUT the daily involvement of the owner. A business that can operate at a high level without the intimate involvement of the owner is a much better investment than a business that cannot effectively function without the leadership of the owner.
3. A corporation that has filed a Sub S election vs a “C” Corp: without getting into the weeds of state and federal tax law, a corporation that is organized as a Sub S is in a much better position during a sale for two reasons: 1) the owner can sell the shares and/or assets of the business and claim most of the benefits of the federal long-term capital gains tax laws thus reducing overall taxation after the sale 2) the buyer can claim the entire asset purchase as a step-up in basis which will reduce the long-term tax liability even if the previous owner fully depreciated the assets of the company. A stock sale will result in the buyer taking the existing basis, which is typically much lower.
4. Solid financial statements (accrual based), a history of budgets and a comparison to actual operating results: a company that does not have its financial documents in order is an indication of poor management and increased risks during and after the sale. A business seller should be able to support their revenue, expenses, cash flow, net income, etc. claims with solid financial statements, including tax returns, for at least the last three fiscal years. If the internal financial statements are not supported or in line with the tax returns then the buyer should beware as future tax liability / penalties could be required. Finally, the business seller should have several years of operating budgets to show the buyer that the budget and the corresponding actual operating results make sense so that the potential buyer can understand the nature of the business and the predictability of company revenues and expenses.
5. A good workforce backed by solid HR documentation and/or employee contracts: this point relates back to point #1, which is the company should have experienced and skilled employees who do the majority of the work in the business vs the business owner. As the new owner, you will not necessarily have the industry knowledge and relationships that the previous owner had, therefore, you want to look for companies where that knowledge and those relationships are held and maintained by the employees who will continue to work for you as the new business owner. The seller should be able to provide solid HR documentation for each employee including contracts, non-compete agreements, HR training, and signed acknowledgement from every employee that they have received the employee handbook and agree to its terms.