Buying a business is an opportunity to skip the growing pains of launching a startup. It’s a chance to start with a proven model with customers and cashflow. How can you tell if the prospective business is a genuine investment opportunity or a disguised escape route for a burnt-out owner?
The following is a list of the top five things to consider when prospecting a business purchase – and some red flags for each category so you can recognize trouble a long way away. This list is no way exhaustive and there are many other issues to consider when buying a business. However, nailing these will tip the odds of success in your favor. Here are 20 red flags for buying a business you should look out for.
1. Why the Business is For Sale
Before you fall in love with a business, make sure you understand why it’s for sale. You’ll want to interview the owner about their experience with ups and downs, their efforts to course-correct, and what tactics have been most successful.
Above all, you should be checking to see if you have what it takes to take the business to the next level and why hasn’t the previous ownership attempted this course. It’s not just about if the company could be a profitable investment– it’s about verifying the fit with your skills and resources.
- The owner is burnt out or seems to be filling multiple roles
- A toxic culture and/or high employee turnover
- A poor business plan that can’t compete with costs or competition
- An industry that is contracting or being disrupted by technology.
2. Perform Due Diligence
Due diligence will occur after your Letter of Intent has been accepted. It’s a comprehensive process, taking anywhere from 45 days to 9 months. This is the most critical step in the acquisition process. This is your chance to get “under the hood” and see how the business operates and to validate what you have heard from the owner in the prior discussions.
Due diligence includes:
- Verification of sales and cashflow
- Key employees
- Concentration risk – clients and key suppliers
- Financial/Tax Review
- Asset Consideration
- Legal Review
- Operational Efficiency
- Company debt
- Real Estate status – lease expiring, property owned by the owner.
- Inventory – obsolescence, turnover
- Environment Concerns
- Findings are significantly different than similar companies
- The business model is overly complicated
- Report results seem unlikely
- Cultural concerns
3. Financial Review
Although briefly discussed in the previous section on due diligence, this is where you will determine what the financial opportunity of acquiring this business will be. It’s critical to partner with an independent and qualified CPA / financial professional to ensure that the story the numbers are telling are accurate. It is your responsibility to verify the results being provided to you.
You’ll want to dig into:
- Profit and Loss (P&L) Statements
- Balance Sheet
- Cash Flow Statements
- Tax Returns
- Accounts Payable
- Accounts Receivable
- Sales history
- The owner claims that the company makes more than the books reflect
- Customer concentration
- Equipment will need to be replaced soon (significant early expenses)
- Account receivable and Accounts payable aged past 90 days Lack of budget and rolling 13 week cash forecast.
4. Get Clear About the Industry’s Future
You’ll also need to research the future of your new company. Is growth likely? What are the barriers to entry? Competitive landscape? Is the industry fading in relevance, being disrupted by technology, requiring significant product development to stay alive?
Access to industry research and speaking with industry experts is important. Talk with future competitors under the guise that your are considering becoming an investor in the industry. Seek out recent transactions and what the multiples are. How have the new owners faired post-acquisition.
- The owner claims to have little competition
- Inability to adequately explain declines in sales or margins
- The owner reports having a hard time keeping up with established competitors
- The owner mentions continuous new competition
- The industry isn’t flexible to modern innovations
5. Reputation Matters
A good reputation isn’t just nice to have– its value is measured in dollars. Companies with a good reputation benefit from higher profits, free marketing, and better hiring ability.
Clean branding has never been more critical in an age of consumer determination to buy socially, ethically, and environmentally friendly. With social media and reviews in the driver’s seat, it’s crucial to work with intact brands.
Remember, brands don’t get a redo just because ownership changed.
- Poor social media or news coverage
- Significant poor reviews
- Mistrust in target consumer base
Buying a business is a long, in-depth, detailed process. Contact us if you want professional help navigating your business investment with a qualified exit planner. We’ll help you get what you need with confidence.
Point One: Why the business is for sale
Point 2: Due Diligence
Point 3: Review Financials
Point 4: Industry Future
Point 5: Reputation