What to Look for When Buying a Small Business

On the surface it seems like a sure-fire winning formula for an aspiring entrepreneur: Buy an existing profitable business and the money should keep rolling in, right? Not quite. Experts remind aspiring small business owners that past performance is no guarantee of future profits no matter how great the acquisition target seems to be.

“The first rule of buying a business is due diligence,” said Frank Rosenbaum, Fiducial’s director or national accounts. “The second rule is to see rule number one.”

Due diligence is an umbrella encompassing an enormous amount of information that would-be entrepreneurs need to gather before they even make an offer to buy a business.

“The critical thing a buyer needs to ask is can they run this business?’ ” Rosenbaum said. “Do they have adequate training, the right kind of background, skills and the right chemistry to get involved?”

Prospective buyers need to take an in-depth look at the financial picture of the company they want to acquire, going back as far as seven years, if possible, to spot any financial trends occurring.

“If all of a sudden we see a blip of changes within the last couple of years to groom the company for sale, we want to delve into those and find out what happened,” he said.

Skeletons in the closet Buyers need to analyze financial trends and that means getting all the tax returns, federal and state, as possible from the company and pouring over them. Enlisting the aid of a tax professional can help them sift through the sea of data otherwise they’ll make a costly decision without having all the facts. This can often be dangerous, especially when they don’t know what skeletons companies have hidden in the closet.

Unless there’s a very beneficial reason for buying the corporation, Rosenbaum says buyers are much better off just purchasing the assets which is much more advantageous tax-wise.

“If it’s a franchise opportunity, any goodwill that’s purchased can be written-off over 15 years,” he said.

Basically, when someone wants to buy a business it behooves them to do everything in their power to ensure they have not overlooked any detail because once a deal is done it’s very difficult to untangle a poorly structured acquisition. Rosenbaum noted that he’s been called in a number of times over the years by clients after the deal was completed but by then it was too late.

“You really have to be there at the beginning of the process reevaluating and restructuring,” he said. “When people don’t bring a professional on early in the process and the deal is structured incorrectly, they lose an enormous amount of tax breaks.”

Often times, the success a business enjoyed was largely due to its owner and when the proprietor leaves after the sale is made, Rosenbaum says the business walks right out the door with them.

“We’re really cognizant of the fact that the business really has to be tangible,” he said.

Put yourself in the seller’s shoes It’s important for the buyer to have a team of qualified advisors including a business counselor, banker and an attorney standing by so they can provide the right counseling from a tax, lending and legal standpoint.

“It may cost you a few dollars going in but it will save you thousands,” he said.

Another aspect to consider is to look at the environment of the business itself. If it’s a restaurant, are there any plans to close the road in front? Are there any environmental issues on the property? Is it contaminated? Are there going to be laws or regulations that could affect the ongoing business? All these questions need to be addressed before a buyer signs on the dotted line.

In one area that’s sometimes overlooked, key employees have to be treated with respect and handled with care. Buyers have to be upfront with employees and let them know how the change of ownership is going to benefit them and improve their careers. New owners need to work with staff to get them through the changes which are always difficult and stressful so that they remain with the business.

Obviously, it’s a very detailed process when considering buying a business.

“You literally have to put yourself in the seller’s shoes and find out what is driving this business and what makes it run,” Rosenbaum said. “You have to be in a position to replicate that process.”

Don’t spread your business too thin Georges Leopold, a business development manager in Fiducial’s New York City headquarters, maintains that buyers with an existing company should look at potential synergies at the targeted acquisition that could reduce some of their costs. These include the potential for growth through complementary product lines along with ways to expand both vertically and horizontally with the acquisition.

“In addition, look at the possibility for geographic locations of where you are and where you are not,” said Leopold, a former investment banker. “Does it make sense to expand or target certain areas?”

The prevalent strategy for a small business owner is to be strong in one geographic area and expand later rather than going out all over the place which requires more coordination and resources, and a better integrated platform.

“As a small business you grow locally and afterwards try to expand geographically beyond the local area,” he said.

So what should a small business owner consider when considering growing their business?

According to Leopold, they have to find a good balance on a case-by-case basis between organic growth where the business grows itself and external growth where they expand by acquiring an outside company.

But external growth may also represent a significant challenge for a small business to achieve since they need to have access to the external financial resources necessary to carry off the deal.

“The risk is basically not to spread yourself too thin by only growing through acquisition because if you don’t have the balance between organic and external growth, you might not be able to manage it in the long-term,” he said. “It could backfire.”

Getting the deal done Asked what types of businesses are prime acquisition targets, Leopold says those companies founded by passionate entrepreneurs are usually good bets, regardless of the industry.

“People are successful because they do what they do with passion,” he said.

Leopold also recommends that entrepreneurs ready to buy a business should have a circle of trusted advisors at hand such as an accountant and lawyer to assist them through this painstaking, emotional process.

“Advisors basically make the difference between emotions and what needs to be done to get the deal done,” he said. “For a small business owner who puts so much of his heart and time in the business— the long hours and private sacrifices—it’s extremely important that this person is well-advised so that his interests are better protected and emotions don’t take over.”

Rosenbaum added that Fiducial advisors take the acquisition process from an emotional to an analytical event.

“We bridge that gap, analyze the numbers and the market to make sure that the buyer knows what they’re getting into rather than dealing with emotion,” he said.

‘You can’t wait forever’

Another avenue to thoroughly explore before making an offer is checking whether existing employees have a non-compete agreement so buyers don’t purchase a business and all the employees leave and set up a similar venture.

“In that instance they take the clients and you pay for them,” said Dale Ellery, district manager for Fiducial’s Detroit, MI, region.

Ellery cautioned buyers to have their professional advisors dig extensively into the businesses’ tax returns because the financial statement presented showing prior years aren’t necessarily what was filed with the IRS. He cited an example of an entrepreneur who bought a company but their business broker is now being sued since they didn’t go into the depth required on the taxes.

“You’d be surprised at what you find on the tax returns,” he said. “I’ve seen it happen when we acquire or get a new client and their records from the other accountant are different.”

Perhaps the best rule of thumb for buying a business is to purchase a company in an industry that you know something about.

“If you’re an accountant, relate it [the buy] to how many tax returns you did last year,” he said.

Among the riskier enterprises to buy are restaurants and bars because embezzlement thrives in an atmosphere where things are going out the door that customers aren’t charged for. For instance, waitresses may collect tips from patrons instead of actually collecting money for food or beverages served.

Buyers also have to be aware of what the competition is doing in the industry where the company they want to acquire is doing business. Each company has its own tricks of the trade so make sure that those remain part of the deal.

“Check on whether there’s a special patented process where you could take the formula,” he said.

With many first-time entrepreneurs exiting from the corporate ranks and going into business for themselves, Ellery pointed out a recent survey indicating that 65% of small business owners would tell a friend to launch a new venture now rather than wait another year.

“You can’t wait forever,” he said.



To learn more about this author, visit Stephen Parezo's Website.

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