Common errors when evaluating a business to buy
When it comes to selling a business, it’s never a bad thing to be too careful. In fact, according to Forbes’ contributor Richard Parker, 50 percent of business acquisitions fall apart during the “due diligence” phase, where many current and future obligations exist. With such a high rate of deals that fall through, what are the most common reasons that business acquisitions end up failing?
Learn About Business Obligations Pre-Purchase
One of the many reasons a business deal breaks down is due to either the seller not being transparent or the buyer discovering things about the business’s existing obligations, such as the level of debt or a full accounting of outstanding bills.
This brings up a larger concern of how to determine if a business is a good fit. First, generate many questions to ask. This includes finding out details about the business structure, the company’s outstanding bills, agreements and client contracts and how each of these items will be addressed. For example, if there’s a lease, will it be transferred and renewed as part of the business sale? Is the building’s owner on board and part of the contract to renew the lease after the sale and transfer has completed?
Another consideration, echoed by Parker, is to determine how many customers the business currently has and what the company will be doing to keep developing clients. Is the business on time with bills or are there vendors with outstanding invoices that might be holding back product, thus preventing existing customer orders from being fulfilled?
Parker uses the example of looking at a company and how the majority of its revenue comes from a single government contract. As long as the company has ongoing marketing and sales efforts to gain new clients to expand its client base when that contract ends, it can make reasonable budget and staffing projections depending on how fast new clients are acquired. However, if such efforts are not implemented, a lack of new clients can put a squeeze on future cash flow.
Other considerations include understanding how the new ownership will affect existing and future obligations. For example, have all existing debts and business correspondence been disclosed to the potential buyer? If there’s an indemnification clause in the purchase contract for the business, and the business is subject to collections from an unpaid vendor or is later sued, if the indemnification clause is not fully understood, the new owners might contest indemnifying the previous owner.
An additional consideration is to determine how the business’ ownership is structured and how it will impact unforeseen events. Depending on the business entity, creating a fair operating agreement that sets expectations for all owners can minimize many issues, especially for businesses with more than one partner.
One example of an important clause for business owners is how major decisions are made. Are these decisions made unanimously or are they made with a majority of partners? Without a clear set of expectations for how major decisions will be made, partners could walk away with hard feelings, looking to sell their ownership share unexpectedly.
Our outsourced CFOs, have experience buying and selling businesses and can help you with an evaluation. We also specialise in strategic and financial planning, managing your finance function, raising capital and providing commercial advice. We look forward to hearing from you.