Buying a business for sale is a multi-step process and each step is important. Many times you may not proceed to the next position until you complete the preceding step and you should never be tempted to short-cut the process at all. Adequate preparation and time spent revealing everything there is to know about the business will be well spent here and will help to ensure that no horror stories are uncovered once you take the helm.
Before you even start to talk to a prospective seller, a great deal of information can be revealed. One of the most important questions you must ask yourself before you go forward is what kind of enthusiasm you possess for the type of business you have your eye on. Is the industry that you are looking at of particular interest to you and do you really want to get actively involved in everything that it represents? Unless you intend to be a completely “hands-off” owner and are therefore taking considerable additional steps to ensure your safety, it is far better for you to be involved in an industry that you have a good feeling for, if not a considerable level of enthusiasm.
A process of due diligence requires you to inspect all kinds of documentation:
* Financials: these documents will include balance sheets, payroll records, tax reports, reconciliation documents and profit and loss statements. Be wary if the seller says that there are a lot of “cash sales,” as unless these have been declared to the tax authorities, you cannot count them and they should be ignored.
* Employee records: including information on individual behavior, attendance, length of service and pay scales.
* Licenses: these will include county, city, state and federal licenses, as well as any certification you need to operate the business. Be prepared to consult records independently to see if there have been any discrepancies or problems in the past.
* Equipment records: detailing the age, cost of replacement, any required inspections and associated results and details on maintenance investments.
* Inventory records: including turnover, condition, and re-saleability.
* Supplier contracts: are they transferable, do you have alternatives and is there goodwill?
* Property records: are any rental agreements transferable to you without any problem, as this can be particularly important.
If you find that all records, licenses, contracts and agreements are in order and are workable for you going forward, you may be wondering how to arrive at a good value when you buy business assets. There are many different ways of looking at this. Some of the methods used to calculate include:
* Asset-based multipliers, where assets are totalled and value is determined.
* Rule of thumb, where industry benchmarks are used to establish the value (not recommended).
* Revenue-based multipliers, are where a percentage or a multiple of the monthly or annual revenue is used. Again not recommended.
* Cash flow multiplier – where the business owner's profit is added to the salary and realized perks, with a number of expenses deducted. This method is most commonly used to determine the value of a business.
Any number of documents and figures can be used by the owner to back up a claim and it is up to you to take these at their value and determine the appropriate conclusions. What is the age and reputation of the business, the level of competition expected, its physical location in many cases, the legal structure of the business, the quality of the premises and/or the difficulty in obtaining a new lease. When looking at a business for sale, take everything into account as you determine whether you should buy a business like this.
Richard Parker is the author of the How to Buy a Good Business at a Great Price series. As President and founder of Diomo Corporation - The Business Buyer Resource Center, his materials, seminars and consulting have helped thousands of business buyers realize their dream to buy a business.