If you have a business in mind that you want to buy, you will need to perform your due diligence before going through with the purchase. Owning a business can be the fulfillment of a lifelong dream, but if you get into the wrong business, this dream can turn into a nightmare.
Before you agree to buy a business, there are several important questions that need to be answered. Here are seven of them:
- How is the Business being Valued?
You will want to make sure you are paying a fair price for the business, and that you are not overpaying. But determining the true value of the business is not always as straightforward as it seems. Businesses are generally valued based on several factors, the most important being:
- Income/Revenue: The value of some businesses is based on a multiplier of annual net revenue. For example, if the average yearly net revenue in recent years has been $250,000, its value might be three times that amount, or $750,000. These figures should always be verified by an accountant.
- Market Value: The value that comparable business in the area have sold for recently.
- Asset Value: The value of the assets owned by the business (such as real estate, equipment, vehicles, etc.) minus their liabilities.
These factors are usually given a certain weight by a business appraiser, and one factor may be more important than the others based on the type of business you are looking at. For example, if a business owns expensive real estate (such as an office building or factory), that will be an important part of the valuation. On the other hand, if the business leases a commercial space and only has some computers and equipment, then asset value will be far less important.
- What is the Seller’s Motive?
It is very important to know the reason why the seller is getting out of the business. If the business is going smoothly and earning good profits, then it is not likely that an owner will want to sell; unless they are retiring, have a health issue, need to move out of the area to take care of a sick relative or another personal reason, or they have another good reason they want to give it up. Ask clarifying questions of the owner to determine exactly why they are selling, and to ensure that it is not to get rid of a problem.
- Will the Seller Remain in the Business?
Somewhat related to the previous question, is the current owner willing to stay on for at least a little while to help ensure a smoother transition for you? Another important thing to consider here is that, in many instances, the owner is the face of the business. The owner often has a personal relationship with important customers and clients, as well as with employees. This is why it is usually in your best interests for the current owner to remain in the business. You might even want to go a step further and propose to make the sale at least partially contingent on how well the business does in the near future. This would provide financial incentive for the owner to help you succeed.
- Will Key Employees Stay with the Business?
Employees are critical to the success of a business. When you are looking at becoming the new owner, you need to know that, at the very least, the key employees are on board. Find out about each employee, what their role is in the business, and whether or not they will be staying on. And of course, treat your new employees well and do everything you can to help them transition to new ownership.
- Are there any Outstanding Tax or Legal Issues?
This is a big one. Some businesses appear to be healthy on the surface, but there are underlying issues that present a threat to their stability. Among these include any pending litigation the business may be involved with. Another area to check out is whether or not the owner is current on their payroll and other business taxes. And do not just take their word for it, ask for a “clearance letter” from the state taxing authority. Finally, be sure that the business has all the required permits to operate and is in compliance with all governing laws and regulations.
- Is the Business Healthy and Does it Have Strong Growth Potential?
Numbers can be deceiving. Just because the business has generated net revenue during the previous few years, this does not necessarily mean this will continue. You need to take a close look at which way the business is trending (upward or downward), the level of competition it is facing, the health of the industry as a whole, and similar factors. You should also take a good honest look at your own skillset to determine if you have the skills (as well as the passion) to effectively replace the current owner and keep the business running successfully.
- Does the Business Have the Appropriate Entity Structure?
The type of business entity you are getting into is very important, because entities have various tax and legal obligations, and there are advantages and disadvantages with each. Also, depending on the type of entity the business is under, it may be much better to purchase only the assets of the business rather than the entity itself. Doing this could provide certain tax advantages, and it could also help shield you from liability if the business owes any money the owner does not tell you about.
Need Help with a Business Purchase? Contact the Experienced Attorneys at Garmo and Garmo, LLP
Purchasing a business to a major undertaking, and even with a small business, you will need a lawyer to help you navigate all the complexities involved and ensure that your best interests are fully protected throughout the process. If you are looking at buying a business in San Diego or anywhere in Southern California, get in touch with the seasoned business attorneys at Garmo and Garmo, LLP. Call our office today at 619-441-2500 or send us a message through our online contact form to schedule a consultation.