Most articles I see focus on providing information and guidance to those who want to sell their business, but not as much on those who are first time buyers of a business. If you were looking to buy a larger business, you should engage a Mergers & Acquisitions professional who will work on your behalf for a fee and help you in assessing whether a business you want to buy is worth what the owner’s asking price. Unfortunately for smaller businesses, there is not that much help available, as in most cases the focus of most business brokers is working on behalf of the seller.  Business brokers are governed by the real estate board and typically help smaller businesses find buyers for their business. There are some that will work for the buyer, but in many cases buyers are not prepared to pay someone for this function, so the main focus is on selling.

If you are dealing with a business broker as a buyer and have been contacted by a business broker on behalf of the seller, as with a real estate transaction, they are not working for you, they are working for the seller, so it is up to you to make sure that you do your due diligence. Just because a business is listed at a price, it does not mean that the business is worth that price, so it is up to you as the buyer to understand what you are getting into.  As with a real estate transaction, the business broker wants to sell his/her client’s business as high as possible as in most cases, their fee is a percentage of what they get for the seller, depending on what other services they provided the owner.

What Is The Value of The Business I Am Buying?
There are professionals that are Business Valuators (Chartered Business Valuator, CBV) who can be hired to come in and assess what a business is worth, and if you are buying a business that is over a a few hundred thousand dollars, it would be highly recommended that you engage their services. You are going to pay a few thousand dollars in most cases, but if you are going to make that large of a purchase, it is well worth the money and peace of mind.  If you choose not to go that route, here are just a few things that you need to look at and find out about the business before you sign on the dotted line:

  • You should get at a minimum 3 and up to 5 years of compiled statements prepared by a professional accountant (minimum of a Notice to Reader).  If the seller is not providing this to you, than you should have some level of suspicion, as you should never take the seller’s word of what their revenues are as well as their expenses. You want to look at their net income (revenue-expenses before taxes) and in particular, pay attention to any shareholder and related party transactions. These can turn into red flag items very quickly.
  • If you are purchasing the assets in the business, such as equipment, you are going to want to understand the age of the assets, what it would cost to replace them, and determine ongoing maintenance costs required.
  • If you are purchasing buildings with the business, you are going to want to have an inspection done on the building just as you would if you were purchasing a house, to understand if you are going to invest in upgrades.  If you are taking over the lease of a building you will want a copy of the lease and have a corporate lawyer look at it before you take on the responsibilities and understand if there are possible lease increases or requirements that would differ than what is listed as rent expense on the owner’s financial statements.
  • Look at what is listed under accounts receivables as an asset and find out the aging of the A/R. Anything that is over 90 days is most likely not collectible and therefore will not be an asset that you should pay for.
  • Verify the costs of the operating expense items that are fixed such as utilities or any other large expenses.
  • You will want to verify if there are any potential liabilities related to customer issues that could result in lawsuits or costs that company could incur.
  • If you are purchasing a business with inventory, you will want to understand the valuation of the inventory and know the age and the value, as you do not want to take the seller’s “word” for it.  There could be inventory that is obsolete and should have been written off that is sitting on the balance sheet as an asset.

Though you can get a valuation of a business, at the end of the day, a business is worth whatever the buyer is willing to pay. Current owners almost always overvalue their business. Most buying decisions are emotional and do not always focus on the true valuation at the time, but you want to make sure that you know what you are getting into and do not sign an agreement to purchase before you have done some level of due diligence.

You want to engage the right professionals to help you make the right decisions and make sure that you have individuals working for you and are not taking the word of the owner or business broker who is working on behalf of the seller.

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