Do You Want to Buy a Business?
Dec 19th, 2019
Do You Want to Buy a Business? What do you need to know and do prior to signing a purchase agreement?
Whenever someone is interested in purchasing a business, there is always a term that is used which bears describing; that term is “due diligence.”
Due diligence is “a comprehensive appraisal of a business, undertaken by a prospective buyer, especially to establish its assets and liabilities and evaluate its commercial potential.” While the definition of due diligence is concise, the work required, prior to making an offer to purchase, can be considerable. The purpose of this blog post is to provide some necessary tips on how to go about making that required work a bit easier.
Many times, it may be easier and more cost effective to purchase an existing business, rather than creating one from scratch. It may also be easier to attain financial backing from investors or lending institutions for an established business, rather than a start-up.
Knowing your strengths, interests and passions will assist you in choosing a business that is suitable for you. If you are going to be an onsite operator/manager, then you must know that the business is something that you will enjoy so you can look forward to a productive future as its owner.
Businesses are also purchased based solely on profitability and future growth, not on personal interest. Know what your motivation is when looking to purchase an existing business.
You will need a team to support your quest. All the people on your team will assist in your due diligence. The team will be comprised of the following:
YOU, the Purchaser
You are the most important team member. Making sure to do your due diligence could mean the difference between success or failure. An informed, educated decision can provide you with the basis from which to make your decision to purchase or not.
Whatever business operation you decide to purchase, make sure the business has a strong customer base, sales that continue to increase, excellent staff and customer reviews. If possible, arrange to meet with customers, suppliers and even the Better Business Bureau to determine if there have been any complaints about the current operator that have gone unresolved. The more knowledgeable you are about the business you want to purchase, the more prepared you will be should you decide to purchase.
Establishing a relationship with a commercial/business lending banker is one of the first steps you need to take. Knowing your banker and understanding the criteria the bank will require will provide a sense of direction with regards to purchase price, payment schedules, interest rates, etc. Creating a relationship allows the lender to get to know you, what your business aspirations are and how you plan to make them a reality. This relationship can aid you in securing the required financing. You are now an identifiable face, not merely an account applying for credit online.
A realtor is working for a commission on the sale, so make sure you know and trust the realtor to have your best interests in mind. Never feel pressured to put in an offer.
A realtor can advise you of any businesses for sale. They can also request financial statements, assist in determining a fair market price and present an offer to the seller. A realtor has access to previous commercial sales, thus allowing them to provide comparable asking prices. Realtors also know of upcoming opportunities which may be exactly what you are looking to purchase.
Ask your realtor questions, including:
- Why is this business for sale?
- What is the outlook for the future? Why?
- How has the business changed over time? Different products? Services? Clients?
- How does the business obtain customers? What is the marketing plan?
- How long have the employees been there? Are there any key employees who would be hard to replace? Why or why not?
A realtor will either find the answers to your questions or will arrange for you to meet with the vendor so that you can understand the motivation for the sale. You must know that all your due diligence is completed prior to making an offer. Sale prices are always negotiable. A business owner always places higher value on something they have owned and operated than anyone else would. Remember that in your negotiations. The best way to arrive at a price you are comfortable offering is to make sure that you have a clear understanding of the finances of the business, which are best provided by the next team member, the accountant.
An accountant can advise you on the financial statements that are provided to the realtor. A minimum of three years of financial records should be made available. If necessary, a Non-Disclosure Agreement (NDA) can be signed to protect the interests of the seller. An NDA assures the seller that the financial information will not be shared with anyone other than an agreed-upon accountant. There is a fee for the services of an accountant; financial expertise comes at a cost, a cost that is well worth paying.
An accountant can help you understand the Income Statement, (also known as the Profit/Loss Statement), Balance Sheet, and Statement of Cash Flow. It is necessary to know about the assets and liabilities of the business. An accountant can review all the statements and provide answers that will help you decide if purchasing the business is advisable. The following is a small sample of questions that will be answered in a review:
- Is there a positive cash flow? If so, for how long?
- Is the owner making any money from the business? Is the owner able to take a consistent living wage and have a net profit at year-end?
- Is there enough profit to cover the cost of financing?
- Have sales increased yearly?
- Have inventory levels changed: increased or decreased?
- Have the costs increased substantially and, if so, which costs are driving the increases?
- What are the percentages of product sales to costs, labour and materials?
- Are the capital assets valued at the depreciated value in the sale price?
- Are there areas where costs could be lowered to increase profitability? Would investing in marketing increase the bottom line?
Any purchase of a business, whether it’s a private sale or done through a realtor, needs to be transacted through a lawyer. Your rights, as well as the seller’s, will be clearly outlined by your legal representative. An offer to purchase is a legally binding document in which the terms of the purchase are listed. Any equipment, inventory, smallwares, buildings, land, etc. must be listed in the purchase agreement. When a decision has been made to purchase a business, your realtor can submit an offer to purchase. In the offer, the purchase price will be listed along with all the other requirements of the sale. If you are buying a business that is not listed with a realtor, then your lawyer will assist in detailing all the items to be included in the sale. If there is a deposit required, then the realtor will place that in trust with the lawyer.
The amount of due diligence required is directly influenced by whether the purchase is stock or an asset sale. A stock purchase means the buyer is taking on the seller’s debts and liabilities. Asset sales are much easier than stock sales. Stock sales involve shareholders, a board, and a potential third-party approval of the sale.
A business consultant can be an excellent resource to assist in determining whether the business you are interested in will be a good prospect.
Knowledge is the upmost necessity in making any business purchase. Make sure to protect yourself and your future by assembling a team that will work for your best interests.
The staff at Aurora Project are experienced business advisors and can work with you to make the best decision possible.
Do you have ideas for a business? Are you a Permanent Resident? Would you like information about business in Canada? Would you like to have an advisor at your disposal at no cost to you?