Acquiring an already established small business is a quicker way of starting up compared to establishing one. Nevertheless, cautious consideration will save on expensive errors and regrets. This guide points out the key considerations prior to signings of any agreement to buy a small business.

Essential checks before purchasing a small business

Financial health and hidden liabilities

Examine at least three years of tax returns, profit and loss statements and balance sheets. Find stable patterns of revenues, rather than a single good year. The financial checks to be carried out include:

  • Profit verification: Compare internal books with tax returns, large differences will indicate hidden income or overstated costs.
  • Debt assessment: Determine all the outstanding debts, leases or accounts payable to the vendor that come with the purchase of the business.
  • Customer concentration: A loss of a client which comprises a quarter of the revenue is unacceptable risk.
  • Accounts receivable age: Unpaid invoices of old age are not assets, discount them heavily or do not include them in the deal.
  • Cash flow reality: Find out the discretionary earnings of sellers not only reported earnings to get the real earning power.

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Operational dependencies

An over reliant business on the owner is likely to fail upon sale. Assess the operation of the business in the absence of the seller every day. The checks to do are:

  • Key person risk: Determine whether or not the business would be put out of market when the owner (key person) ceased working there tomorrow.
  • Supplier concentration There is one supplier of key material which poses vulnerability to the business in the event that the relationship is broken.
  • Retaining employees: Major employees can quit following a change of ownership; be ready to retain them.
  • Standardized processes: The business can be run by a new owner; the undocumented knowledge is out the door.
  • Vendor agreements: Review supplier agreements, under which termination is required in the case of a sale.

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Seller motivation and transition plan

The motive behind the sale by the owner influences the terms of the deal and success in the future. The transition is difficult because a reluctant seller or unrealistic expectations make the transition difficult. The checks to be done with the seller are as follows:

  • Reason for sale: Retirement is not the same as burnout or dropped sales; the latter is an indication of deeper issues.
  • Training period: Negotiate two or four weeks of seller training upon closing in order to get to know how to operate.
  • Non-compete agreement: Don’t allow the seller to install a competing business next to the premises after the sale.
  • Seller financing: The seller retakes a portion of the purchase price, thus has an incentive to reveal issues.
  • Transition timeline: With little time to transition, the buyer is left saying goodbye too quickly; demand plenty of transition time.

Conclusion

The acquisition of a small business must involve keen research on financial matters, business operations and motivation of the seller. Any rush with passing of these checks may lead to the inheritance of unseen ills that drain time and money. A proper due diligence will distinguish between a good investment and a costly one.