Being your own boss can be a dream come true or a nightmare. Investing your life’s savings in a business requires courage, determination and hope in equal parts. As over 50% of small businesses fail within the first four years you must take steps to ensure that you are not part of those statistics.
Our last article discussed the value of doing your research, having a business plan and getting your figures right before you commit your life’s savings. Due diligence is essential when you are planning to buy a business and should be a condition of every business contract.
Due diligence is more than just examining the financial records of the business you are thinking of buying. It means amongst other things, taking a close look at sales trends and cycles, staffing, employees and productivity. The failure to monitor productivity can lead to a business with real potential for success losing money.
Why is it being sold?
The first question to ask is why is it being sold? Buying a business that appears to be failing is not necessarily a bad thing if you can identify the reasons for the failure and do not repeat those mistakes.
One of the major causes of small business failures is under-capitalization. Eighty two percent of small businesses fail because of cash flow problems. Finances and management issues are key areas of concern for every business and combined with poor market conditions are a recipe for disaster if not identified and tackled early before it all spirals out of control.
What are you buying?
What assets are included in the sale? Is the plant and equipment owned or leased? Is there any intellectual property that should be assigned?
Before entering into a contract to buy a business, identify the assets of the business as these will help you determine how much you will offer.
A full list of plant and equipment and details of any intellectual property should form part of the schedules to the contract. If it is important to you, make sure it is included in those schedules.
It is important to know what the business owns, what is loaned and what is leased. Taking over the lease of an essential piece of plant and equipment may be an expensive overhead that you did not count on.
Who is the target market?
What does the business sell and to whom? Identifying the core business and the target market of the business is essential not only to make your business plan but to put that plan in action. If you fail to identify that market you will waste your time, energy and money chasing the wrong customers.
It is also necessary to identify what marketing tools are suitable for your business. Advertising can be expensive and it is important to choose a marketing tool that is a good fit for your business and your target market and the best and most efficient use of your resources and energy.
What costs are involved?
In addition to the purchase price, there will be stamp duty payable on the value of the business and any stock.
There may also be lease costs as you will most likely have to provide a replacement security deposit or bank guarantee to obtain the landlord’s consent to the assignment of the current lease or the grant of a new lease. Don’t forget to factor the first month’s rent into your calculations as this is usually payable at the settlement of the contact.
Besides the costs of acquiring the business, there may be accounting and legal fees, incorporation costs and fees for licences and permits. You should also have some working capital included in your budget to keep you going until you establish your cash flow.
Is the business profitable?
You will obviously examine the financial records of the business but your accountant’s advice should include the level of income you need to generate to meet the costs of the business. Does the business currently generate that income? If not, are there any savings to be made by changing the way the business operates – what is working? And what is not? Look at the sales records. What are the fixed and variable costs – leasing, staff, etc
If it is a service or retail business, are there any warranties or refunds, outstanding vouchers or gift cards? What about works in progress? All of these may be a potential liability for you.
Managing your expectations
Ideally you do not buy a business to work in it but to manage and grow your asset. In reality, however, you may find that there is less and less time to work on the business because you are working in it. Where possible delegate and outsource to allow yourself the time to work on that business plan. Owning and managing a business does not mean that you must be in control of every aspect of its operations – only those that count.
This article contains general advice only. For more detailed information, make an appointment to come and see us at Smithfield Law