HOW TO GUIDE Buying a Business
Thinking of buying your own business but don't know where to start? Our guide will take you through the entire process from due diligence and determining the value of the business to finalising the sale and managing your new business. Learn how with Congdon Fuzi today.
Buying a business requires thorough research. It's important that you have a deep understanding of the business and its financials. Proper due diligence is necessary for an accurate valuation and to avoid any unexpected issues in the future.
Let’s look at an overview of the due diligence process and each of the stages you’ll need to work through.
Pros and cons of buying a business
When you’re thinking about buying a business instead of building one from the ground up, there are a number of advantages. However, it’s important to be aware of the downsides and the things you’ll need to consider.
Pros:
Proven concept
When you buy a business, you can see straight away whether it’s a viable business or not. Unlike new companies that need time to ensure their product or business model works, an established business has already undergone this important stage. When you buy an existing business, you can avoid this step entirely, as someone else has already built the business.
Lower initial operating costs
When buying an existing business there are lower initial operating costs. You can avoid the expenses associated with securing a location, gathering supplies, and finding your first employees, which leaves more cashflow to focus on aligning the business with your vision and leveraging existing momentum.
Lower-risk financing
Established businesses are typically regarded as lower risks to banks and potential investors. This is due to their proven track record, which provides insights into future performance. This means lenders often consider them to be safer bets for investment.
Intellectual property value
When you buy a business, it’s common to also buy the intellectual property. Sometimes, the intellectual property can be worth more than the business itself. Think of technology companies as an example.
Adding intellectual property into a business can enhance its worth and potential for growth. By leveraging the acquired intellectual property, companies can gain a competitive edge, expand their offerings, and explore new opportunities in the market.
With the increasing importance of intellectual property in today's digital age, recognising its value and managing it can lead to significant business advantages.
Cons:
Higher upfront purchasing costs:
While buying an existing business may mean lower operating expenses, it's important to consider the financial aspect of buying one. When you purchase an existing entity, you're not only paying for the customer base, branding, equipment, and intellectual property, but also the substantial time, effort, and investment that went into building the business.
Buying a business can sometimes cost you more than starting a new one of the same kind, particularly for well-established and profitable businesses.
Lack of company knowledge
When you build a business from the ground up, you gain a real understanding of how it works and the dynamics of the industry it operates in. However, purchasing an existing business presents a different set of challenges. The need to quickly learn and adapt to the way the business runs can take time and effort.
Unknown risks
Discovering hidden problems during the due diligence process is important when buying a business. However, no process is perfect. Whether intentionally hidden or not, there is always a possibility of buying into a problem. It could range from simple equipment replacement to complex issues like a legal action. Once the purchase is completed, these problems become yours to resolve.
Employee resentment
When buying a business, an important but often missed issue is employee resentment. Often, employees feel connected to the business and the way in which they work. Meaning, they may be reluctant to embrace new leadership or changes to the way they do things. Seeing this and working with employees through change management is important for the new owners of the business.
Conduct due diligence
Before making your decision to buy a business, it is important to conduct due diligence. This process involves conducting thorough research to ensure that the business you are considering is a smart choice. By doing so, you can accurately assess its value and minimise the risk of any unexpected setbacks. Let's explore each aspect of the due diligence process in detail.
Discovering Your Industry
When it comes to buying a business, being well-informed about your industry is important. To ensure you make an informed decision, consider these questions.
Who are the target customers?
Knowing your potential customers is important to the success of your business. Understanding their preferences and needs will help you structure your offerings effectively.
Do the target customers align with the business's current demographic?
Ensure that the business you're considering aligns with the needs and interests of your target customers. A strong match will increase the likelihood of success.
Who are the primary competitors and how are they performing?
Researching and analysing the competition is important. Understand your rivals' strengths and weaknesses to position your business correctly within the market.
By answering these questions, you will gain insights into the potential growth opportunities and success.
Evaluate Finances and Assets
It’s important to work through the finances and assets of the business. Think of it as a financial health check. Doing this confirms that you are paying a fair price for the business and it provides valuable insight into its performance.
Financial Statements: Start with a review of the financial statements from the past few years. This will give you a clear picture of its financial stability and future.
Physical Assets: Then assess the value of tangible assets such as machinery, buildings, property, and inventory. This will help you determine the overall worth of the business and its physical assets.
Other Assets: Next take into account the value of intangible assets such as intellectual property, copyrights, and patents. These assets can significantly contribute to the overall value and potential of the business.
By carefully working through the finances and assets, you will be in a much better position to make informed decisions. And you’ll be a lot closer to understanding what the business is worth.
Review Legal Information to ensure your compliant
As you work through your due diligence it’s important to assess potential compliance issues. By doing this, you’re able to make better decisions and avoid future complications.
To start with carefully examine all documents regarding leases, insurance policies, and any other legally binding agreements. Make sure they’re valid and current.
As well as the documents above make sure you also have any other compliance documents in place that may apply to your particular circumstance. There are unique aspects to every business and purchase situation.
By working through your legal and compliance process you can continue with confidence knowing you have reduced your risks and created a pathway for easier transactions.
Evaluate the business profile
Understanding the business profile involves looking at key aspects of the business to determine if it’s managed well and is in good health. To do this work through the following factors.
Market conditions: Evaluate the performance of competitors and the overall market to understand where the business sits in the market.
Sales information: Look at, and ask plenty of questions regarding the sales reports and forecasts to understand how the business generates revenue.
Business history: Explore the history of the business. When did it start, why did it start and what has changed from that point until today. What lessons did the business learn along the way.
Procedure documentation: This is a really important part. Work out if the business has complete documentation covering its processes, procedures, and workflows. If not then this knowledge simply resides within the owner and employees.
Business plan: Understand whether the company has a working business plan to guide the way it runs it’s business.
Verify the seller and their claims
It’s important to ask for evidence to support the seller's claims. Don't simply accept what the seller says without the right support to valid the claim.
Consider the seller’s liabilities
When buying a business, it's important to carefully consider the seller's liabilities. Outstanding debts and obligations can potentially decrease the value of the business. It's also important to be aware of any employee entitlements or other liabilities that may be transferred to you as the new owner. Make sure to ask about these factors before making a decision.
Understand the real potential of the business
Uncover the true potential of the business you’re looking at. Don't leave potential profits on the table. Evaluate the business's longevity and explore the opportunity costs of your investment. Is there a better option for you.
Review current customers and suppliers
Looking at the current customers and suppliers is important. It's important to evaluate the state of your relationships with them. A business with a substantial customer base and trusted suppliers has a competitive advantage.
Employees
You need to remember that when you’re buying a business you’re bound by the relationship that each employee has with the business. For example, you’re now responsible for long service leave, redundancy and the particular terms of each employees contract.
Therefore it’s really important that you work through and understand each employees contract and the nuances within.
Buying a company v buying the assets of the business
It’s important to understand whether you’re buying the company or the assets within the company. An easy way to determine the difference between the two is when you’re buying the company you’re buying everything that sits within the company. When you’re buying the assets you’re buying an itemised list of assets that sit within the company.
Remember, if you’re buying the company you’re also buying the history of that company in terms of risk and potential claims.
Work out the value of the business
Your next step is to determine the value of the business. Of course the seller will have a number that they have calculated, but it may not be in line with the true value of the business.
There are several ways to determine the value of a business. Remember, you don’t have to pick just one, you can use a combination to arrive at an accurate and true number.
Let’s look at 5 different valuation methods
Current market value: Look at the state of the industry and compare the business to others within the industry.
Return on investment (ROI): Work through the business forecast and past performance to determine how likely it is to meet expectations and decide if the asking price is fair.
Business asset value: Calculate the worth of the business based on its tangible (equipment, client base, property) and intangible assets (intellectual property, brands, reputation).
Cost of starting from the ground up: Look at how much time and money it would take to start the same business from the beginning as a guideline for valuation.
Future profits: Consider the potential for growth and profitability. A business with a proven track record of high profits is usually worth more than one with narrow margins or minimal profit history.
Get an independent valuation
It’s often a good idea to ask a third party to look at the business you’re considering. An accountant, business advisor or broker can conduct an independent valuation. They’re trained in this discipline and they can be objective in the way they look at the potential business. Here is a look at what they’ll be reviewing:
Assets: All the assets of the business, including buildings, land, equipment, inventory and cash in the bank.
Liabilities: These include debts and employee entitlements.
Goodwill: The value of a business’s reputation. If the business is viewed positively, it can increase the value compared to one that has a negative reputation.
Commercial lifespan: If things continue as they are, how long can the business be expected to remain operational.
WIP: The active, outstanding contracts and projects the new owner will inherit.
Check the contract
We would suggest you ask your solicitor or lawyer to look through the contract to ensure that you understand the details of the contract. There should be a particular focus on the following areas:
A performance clause that clearly states the minimum takings of the business in the period leading up to the sale and settlement.
A condition that guarantees all representations made by the seller are accurate, written or otherwise, as well as one that ensures important contracts are transferred to you after purchase.
A restraint of trade clause that prevents the seller from opening a similar business in the same market for a certain number of years.
A material adverse change (MAC) clause that enables you to terminate or renegotiate the transaction if circumstances negatively impact the business before the sale.
Make sure you have the right to the business name
It’s important to ensure that the business is free for you to use. Check that there are no potential issues with other entities having copyrights or intellectual property related to it. Make sure the seller has:
Clear ownership of the business, with no restrictions or limitations.
The right to transfer ownership of the business to you with no issues.
Pay for the business in stage
It’s quite normal to structure the payments of the business you’re buying over a period of stages. This allows the payment process to proceed at a pace you’re comfortable with against a set of agreed milestones.
Finalise the sale
Now that you’ve worked through your due diligence, it’s time to finalise the sale. Let’s walk through each of these steps.
1. Make an offer
With due diligence done, it’s time to make the decision, whether to buy or not. If you decide to go through with the purchase, you’ll need to make an offer and begin negotiations. Once you’ve agreed a price, make sure you have a contract drawn up to formalise it.
2. When you sign the contract
Make sure both you and the seller have a copy of the signed contract (and any other signed documents). After signing, you’ll need to pay your initial deposit. Again, make sure you get receipts from the seller.
3. After signing the contract
Immediately after signing the contract, you’ll want to submit applications for the transfer of the business name to you. You’ll also want to ask that all licences, permits, certificates and other registrations be transferred.
4. Create and measure business goals
Once the sale is finalised and you own your new business, it’s time to start looking to the future. Lay out your goals for the business, and make them clear and specific. Then, start working towards them and track your progress.
Manage your new business, not just your books
Buying a business might seem overwhelming, but it doesn't have to be. If you follow the due diligence process you’ll be in a much better position to make good decisions.
If you would like help with buying a business please contact Paul Congdon at Congdon Fuzi.