How to Find and Assess the Business Part 2
The particulars also normally give some very brief information about the trade - turnover, gross profit and net profit. There should be figures for at least two, and preferably three, years, unless it's a newer business. At your first meeting you will not want to go into great analytical depth about the trading figures, but you will want to have a general chat about them. At the first meeting you only need a superficial knowledge for general questions, which that section will give you.
Has the business been offered at a reasonable price?
At this preliminary stage, however, you cannot go into that much detail, but you can sometimes work out a ballpark figure for a leasehold business by multiplying the weekly sales by a given number of weeks. It must be emphasised that the value this produces is very rough and ready, and assumes that profitability is at normal average levels for a business of that type. It can be used for picking out businesses that seem to be worth looking at more closely, and for preliminary discussions with the agent and vendor. However, you will need to do the proper valuation exercise covered in the next chapter before agreeing a price with the vendor. There could be many special reasons why any particular business is offered at a price widely different from this ballpark figure, but knowing the ballpark figure at least enables you to open a general discussion on how the vendor assessed the price he is asking for the business.
If it is a freehold business, then there is also the question of the property value to be considered and added to the ballpark figure.
Although you are not going to undertake a detailed examination of the trading records at this stage, the only way that you are going to be able subsequently to verify the accuracy of the trading information you are being given is by looking through the annual accounts and daily books kept by the business. The first key question, therefore, concerns the quality of the detailed accounting information you are going to receive in due course, and it is strongly recommended that you ascertain this before going much further. However attractive a business may seem at this stage, you are not going to buy it if you have no confidence in the truthfulness of the accounts.
All businesses have to submit annual accounts to the taxman, and this is normally done for the owner by an accountant or professional bookkeeper. Like all professionals, accountants and bookkeepers vary widely in competence and integrity. They have to include in the accounts a certificate of what they have carried out in preparing the accounts. If they have not been given all the reliable information that they would have liked, they should normally say so in the certificate. If the business is run through a limited company, the rules are laid down in the various Companies Acts and for larger companies a full audit is required. A good accountant will not put his name to accounts that he is not satisfied are genuinely accurate.
The annual accounts will have been prepared from the bank statements and bookkeeping records maintained by the business throughout the year. Obviously the annual accounts are more likely to be completely accurate if the daily records are well maintained than if paperwork is just tossed into a shoe box for the accountant to sort out later. It is also important to you that the bookkeeping records are good because annual accounts are likely to be at least ten months out of date, and possibly much more, and you will have to rely on the bookkeeping records to verify how trade has continued since the date of the last accounts. Before you commit to buying the business, it is going to be essential to satisfy yourself that the trading information on which you are basing your decision to buy the business is accurate. You don't want to waste lots of time looking at potential businesses only to discover that the trading records are poor, so before going any further I suggest you ask the agent:
• How recent are the available annual accounts?
• Who prepared them?
• How good are the bookkeeping records?
Having decided to proceed to the next stage, prepare for the meeting with the owner.
A few key figures will have been included in the agent's particulars. Are sales going up year on year? If they have gone down, ask why? Have a look at the gross profit. This should be shown as a percentage of sales. Is it normal for that type of business? If not, ask why not. This question should be raised even if the gross profit is better than the norm, because you need to be certain that the unusually high sales prices can be maintained in the future.
Make a list of these general sorts of questions to ask the owner. It may sound pedantic to say 'make a list", but this is important for two reasons. Obviously you're bound to forget something if you don't but, equally, it is much harder for the seller to drive the conversation towards areas he wants to talk about, and away from those he wants to avoid, if you have a list you keep coming back to.
The other important issue you will need to discuss with the owner is the risks the business faces, and how well he has placed it, in so far as he can, to face those risks.
Is the business well placed to handle the risks it may face?
Some of the risks arise from external factors outside your direct control, and others from internal factors, which you may or may not be able to control. Prior to meeting with the owner, consider what risks could be involved, and add appropriate questions to your list. To assist you, listed below are some of the most common risks that could be relevant.
In any type of business where the general public comes to you, the location is critical, but not always from the same point of view. Consider the location issues that apply in your case. Here are some examples to start you thinking.
1. Is visibility important? People will not come to your shop if they do not know it's there, or they just don't notice it. If you are a general retailer of some kind (flower shop, card shop, convenience store) you have to be very visible. When you have worked in retail, you quickly realise just how difficult it can be to get the public to see things. Often being just round the corner from the main road is enough to get overlooked. Check the footfall (footfall in this context being the term used by retailers to mean the volume of pedestrians walking past the front door).
2. Parking is likely to be important. People will not walk far these days, especially with bags to carry. If you are a post office it will be sufficient that you are very close to parking. If you are a television repair shop it will be important that people can stop right in front of or behind the shop.
3. Are there likely to be changes in planning that could adversely affect the business? It's important to consider this. Measures such as pedestrianisation, one-way systems, ring-roads, traffic-calming, etc., can devastate individual businesses. You will be able to judge from the general nature of the area whether such measures could be possible. If so, ask the owner, but also ask around in the neighbouring shops and bars (obviously be discreet about why you are asking), and approach the local planning department. A very successful privately-owned convenience store not far from New York was sold a few years ago to one of the smaller chains. Two months after they had taken over they were banned from allowing cars to cross the pavement to park in front of the shop. This was because it was close to, a pedestrian crossing and it had become very dangerous. The trade dropped to a trickle, because the nearest car park was two hundred yards away across a busy road. Whereas being able to park outside had previously made it a very convenient shop, it was now considerably less convenient than other shops in the town. Needless to say, the previous owner had known this was coming, but obviously the chain did not carry out the right checks and suffered as a result.
This heading will not apply to the vast majority of businesses, but if your potential business relies heavily for its survival on technology in some way, there are a number of angles that could be relevant to consider.
Is the technology used in your potential business likely to be phased out in favour of newer technology, or even completely replaced? If so, can the business adapt? For example, a television repair shop once dealt in valves, but without adapting to electronics skills, could not have survived to the present day. In the future, many technologies will be completely replaced at an ever-increasing pace.
If your business depends on costly machinery, is it up-to-date? Small garages are a good example. These days more and more cars on the road rely on electronic diagnostics and tuning, and the small independent garage cannot undertake much of the repair work on these cars that it once was able to do.
Printing machinery, or machinery in small engineering works, can easily be out of date, possibly meaning that it is difficult, if not impossible, to produce work to a high enough specification for the modern client, or at a competitive price. If you are looking at this type of business you need specialist knowledge.
You will need to know what competition the business is facing now, and what you could face in the future, Consider competition in terms of:
• Existing local competitors.
• Potential for new competitors to come into the area.
• New alternative products.
Is the business a passing fad? Basically it is the entertainment type of businesses that are vulnerable here. Have karaoke machine sales peaked? How long will karaoke bars be popular? Be very wary of coming in at the end of a fad. Bars and pubs become the place in town to be seen, only to be overtaken by the new one that opens.
Internal risks are much more under your control, but you will want to discuss them with the current owner in order to assess the degree of risk, and how the risks are controlled by him.
Control of cash and stock
Obviously this is vital in all cash businesses with employees. Bars and cafes are particularly vulnerable, and breweries have gone to great expense to have sophisticated stock control systems to enable checks to be maintained.
Apart from the risk of theft already touched upon, there are a number of other stock risks that your business could face.
Buying the right stock
To what extent is it necessary to understand what your customers will buy? Is this the type of business where you could finish up with thousands of dollars of unsaleable stock because you bought the wrong items? A small newsagent's and tobacconist's shop may not be particularly problematic from this point of view, but greetings cards or gifts, and worse still, toys, could be a different matter. How does the current owner face this?
Sourcing stock well
Can the current owner introduce you to a range of suppliers who offer good products and good prices? When we cover the detailed verification process, because it is most important to satisfy yourself before proceeding whether the current owners have excellent supplier relationships. As a new owner of a business, in the early days you will rely on being introduced to good suppliers to get you going.
Stock price risk
Is your business one where the value of stock can drop? A small computer shop, for example, would be very wary of carrying more stock than necessary, because today's highly desirable state-of-the-art processor chip will be overtaken (and therefore devalued) within weeks.
If your business stocks perishable items, how much is thrown away, and are the best measures taken to minimise loss? For example, a flower shop with a cold room will throw away fewer blooms than one without.
Reliance on larger customers/suppliers
Obviously a business that gets a high proportion of its business from a few large customers is inherently more risky than one with a broad spread of clientele.
The same can be said about suppliers. However, it is usually less of a worry to find alternative suppliers than it is to replace large customers who are lost.
This risk has been left until last because it is not normally relevant to the vast majority of retail or catering types of businesses - usually it applies only to business-to-business type trades. If the business sells on credit then you will have debtors. However, debtors could be a critical aspect of the business's viability. In order to assess whether it is worth taking matters to the next stage, at this first meeting you will want to ask a few questions about how debtors affect the business and are controlled:
How many customers does the business have, and what proportion of trade do the largest represent?
In this type of business you are interested to know how well the business is spread across its customers. At this stage you should ask for a general indication of how many customers there are, and how much of the trade comes from the largest few. Clearly, a business with 100 roughly equal customers is less at risk than one where three customers provide 75 per cent of the business. In the latter case, what happens if one of the major customers goes elsewhere or goes bust?
How do they decide how much credit to give to individual customers?
Would your bank lend you $1 million unsecured without making checks? There should at least be a system for taking references, and possibly credit insurance.
What length of credit do they offer?
Thirty or sixty days, and occasionally ninety, is normal.
What length of credit do they take?
How good are the customers at paying on time, and what procedures are in place to chase-up late payers?
Meeting the owner
Remember, most owners will not have told their staff that they are selling, and are paranoid lest they find out. This confidentiality must be respected, so don't rush up to the counter and, clutching the agent's particulars in your hand, ask to see the owner, making it obvious why you are there. Be tactful!
The owner may be reluctant to talk when staff or customers may overhear. He may suggest that you pretend to be from the insurance company or something similar, but such covers usually will not work well, and anyway limit your ability to ask searching questions. Therefore it is best to resist this suggestion. If there is nowhere private on the premises, it is better to offer to visit after hours, or to go to a nearby cafe for a coffee or lunch. That way you will be able to have a much more relaxed and informative conversation.
Make it clear that you would like a general chat, but that you have a list of questions that you will wish to cover. Most business owners are keen to talk about their business, and why they think it's an exceptional opportunity that has probably been undervalued by the agent. You should be able to slip most of your questions into the general chat.
Look for any inconsistencies in what the owner says. Make a note for later of any points that strike you as important or in need of further investigation.
Why is he selling? Normally owners will say that it's due to ill health, or retirement, or to spend more time on the rest of their business empire. It's a question that people always feel they should ask. Intrinsically, it doesn't matter to you, as long as it's a good business opportunity at the right price. That is not to say you shouldn't ask, but sellers are not likely to tell you it's a decaying business that can't survive when Macy's is open down the road! You may get a feeling that the truth isn't being told but, quite honestly, assess the opportunity on its own merits, based on detailed and careful research, and largely ignore the answer you are given.
More relevant questions are:
• How long has the business been on the market?
• Is anyone else interested?
Be very wary about businesses that have been on the market for a long time, or where there are no other interested parties. It may be that the business is a dud, or it could be that the owner is simply asking too much for it.
In the latter case you may wish to take the conversations further of course. However, be patient about it, because it rarely pays to get into a price discussion at this early stage. All business transfer agents will tell you that business owners frequently convince themselves that their business is worth far more than it really is, and certainly far more than they would be willing to pay for it themselves if they had come along to buy it.
The problem is that vendors are usually very difficult to shake from this view, and they are certainly not going to change their mind in a first discussion.
If in all other respects the business looks appealing to you, raise the price issue with the agent when you go back to discuss your concerns with him. He will know the likelihood of the seller being willing to compromise. Obviously, you will not be able to take a final view on the value of the business until you have gone back for another meeting to go through the valuation and verification process described in the next chapter, How to Assess What a Business is Worth. However, if it is clear from these preliminary discussions that the price is far too high, there is no point in going through a more detailed and time-consuming exercise, or spending money on a professional valuer, if the agent indicates there is unlikely to be any substantive movement from the seller. In this case, move on. Do not be tempted to overpay.
After the first meeting
Having carefully prepared yourself beforehand, you will have probably managed to glean most of the information you need to judge whether or not it is worth taking further. However, when you sit down to think about it there are almost bound to be further questions that spring to mind, and possibly concerns that you would like to discuss in more detail. Speak to the agent - he will probably call you for your reactions anyway. A general chat with him will probably answer many of your concerns, and he can ask the seller for any additional information that you require that he does not have to hand.
Let's assume that at this point you have decided you like the business and, provided it checks out and the price is reasonable, you would like to proceed.
Before going further, you will need to have a feel for what a reasonable price for this business would be. At this stage you will need to call for the detailed accounts to enable you to undertake this exercise.
Obviously, once you have put a value on the business you will be in a position to make a verbal offer, subject to contract, and the negotiations can begin.