Buyer Beware: 5 pitfalls to avoid when purchasing a business
Recently, I consulted in a lawsuit involving a buyer who used a faulty valuation theory and compounded the problem by failing to do adequate due diligence.
They were sure it was a great opportunity and were afraid if they didn’t act fast, someone else would beat them to it. Now, they could end up losing millions.
Especially when considering buying a business, reliable information is the key to success. As a buyer, you need to know exactly what you are purchasing, and that means avoiding these five primary pitfalls:
- Not understanding the real value of the business.
The first and most important step in purchasing a business is determining its value. A potential owner may pay too much for the business if he or she uses a “rule of thumb” or general industry methodology, rather than actual analytics based on the company in question.
- Failure to perform adequate due diligence.
Another critical step in determining a company’s value is independently confirming that all information the seller provides is correct and accurate. Before entering into an agreement, dig beyond the surface with a qualified financial expert to verify the accuracy of all information you are relying upon for the sale — contracts, agreements, accounts payable and accounts receivable.
Financial records may not reflect, for example, that a customer who owes a substantial amount to the company recently filed for bankruptcy.
- Absentee ownership.
You, as the buyer, and your team should not rely solely on the veracity of the company’s existing leadership during and following the sale – leadership that may include the current owner. Involve yourself in the process and provide oversite in person or have a trusted team on the premises.
- Not knowing why the business is for sale.
Why is the owner selling at this time? Is a big box store opening down the street? Do recently enacted government regulations require an expensive equipment upgrade to remain in business? Is technology changing the climate for the business?
Be sure to learn about the industry and research trends that will affect future profitability.
- Making too many changes too quickly.
Establish a team of internal and external advisors to consider the merits of any proposed changes in personnel or process. Do not make changes until you determine they are needed to increase value, enhance the process or improve morale.
Purchasing a business, if done correctly, can be a personally, professionally and financially rewarding experience. Don’t be blinded by the lure of business ownership. To be successful, you must think with your head, not your heart.
Learn all that you can, not only about the particular business you plan to purchase but about the business environment in which it operates, locally and globally. If you do not have specific industry experience or knowledge, consider bringing in a partner who understands that end of the business.
Above all, make sure that the asking price is an accurate reflection of the company’s worth. A professional accountant or CPA can be a valuable partner when acquiring an existing business and making it your own.
Keith R. Gordon, CPA, CFF, CVA, is Senior Manager, Business Valuations, with Boyer & Ritter LLC. He has nearly 25 years of experience in business valuations, litigation support, accounting, income tax and management consulting. Contact Keith at 717-761-7210 or firstname.lastname@example.org