What you need to know about buying a business

10 essential questions to ask when considering a business purchase

1. Does the acquisition make sense?

Don’t buy a business just because you can. You need a clear vision of what you expect your company to achieve in future years and how an acquisition will help you get there.

• Does an acquisition make more sense than internal expansion, licensing, franchising or a joint venture?
• Will an acquisition increase your market share?
• Will the acquisition improve your competitive position?
• Will it enhance shareholder value?

Have a clear vision of what you want to achieve with an acquisition, how you value the acquisition, which employees you want to retain and how to integrate both businesses.

2. What will the impact be on your business?

Acquiring a company creates financial obligations and operational changes that can drain your cash flow in the short run. If those changes aren’t properly handled, they could cause your company to spin out of control.

You should shop around for financing to establish a structure that allows you to reinvest in the business you’ve just acquired. Every acquisition will be different, but experts generally advise entrepreneurs to find a mix of financing, which can include seller financing, term debt, mezzanine and minority equity.

3. Do you know what you're buying?

An acquisition target could be cooking its books or dealing with lawsuits. Financial records do not always reflect reality. Many entrepreneurs later realize that they overpaid for the company they bought.

Investing in a proper due diligence process should ensure a fair price. Since the business’s value is typically based on a combination of earnings before interest, taxes, depreciation and amortization (EBITDA) and the outcomes of any adjustments, the due process will also help negotiate the appropriate purchase price.

4. Is your business ready for an acquisition?

Entrepreneurs often think exclusively in terms of what they can afford without considering the integration process.

To prepare for an acquisition, businesses should have a detailed plan listing what needs to be integrated between the two companies and how to do it. A formal post-merger integration plan will help you focus on the most critical elements of the process, right from the start.

5. How will you finance the acquisition?

A change of ownership often increases a company’s debt and decreases its profitability due to interest payments and other expenses. This can lead to a period of tight finances following the transaction.

The financing mix can significantly affect your rate of return on the acquisition and how much risk you’re taking on.

It’s important to consider all your options when financing the deal. Ask yourself if you’ll be able to provide all the equity financing yourself or if you’ll need partners. Who might your partners be? Will their objectives match yours, from business plans to exit strategy and timing?

6. Why do customers value the business?

A business with an established customer base may be more expensive to buy, but this isn’t necessarily a bad thing. You’re inheriting the company’s goodwill, which can come with better access to immediate cash flow and existing customer relationships you can build on.

But to make sure a business is worth your time, find out why people buy from them.

• Is it great products or top-notch service?
• Is it their employees’ experience and professionalism?
• Is it the customers’ relationship with the owner?

You’ll also need to find out whether a change of ownership will change that.

See what people are saying about the company online. It may not be representative of the full picture, but it will give you a good glimpse into how the business is perceived and what needs to be done to change any negative feelings.

7. Is the product or service unique in the market?

If you’re targeting a business in a competitive industry, find out how the company differentiates itself, as this is key to why clients keep coming back.

If there is no obvious differentiator, consider what you would need to do to set yourself apart from competitors, as well as the effort and cost that would entail.

8. What’s the company culture like?

Carefully observe the company’s management style, the quality of its work, and its relationships with employees and managers. See if they align with your philosophy and whether it’s worth making any changes. Remember that rapid change following an acquisition can be met with resistance from employees, vendors and partners.

Long-standing employees are also a big plus. They know the company, the products and the processes. And they can offer insights into the business and the industry. If turnover is high, ask yourself what the cause is. Could it be because of competition in the industry? Is it the company culture? An aging workforce? These questions will give you insight into any human resources issues or needs.

9. Do you know enough about the business or industry?

Don't fall into the trap of buying a business in an unfamiliar field because it seems like a sure thing.

It's much more difficult to succeed in an industry in which you have no experience or little interest. Evaluate your skills, interests and experience, and make sure the business matches those attributes. Choosing familiar territory greatly reduces the risk of failure

10. Will this new business fit with any existing businesses you have?

If you are growing your business through acquisition, you will need to look for synergy in key areas.

• Products or services should be related or complementary to what your existing business already sells.
• Marketing and sales methods need to mesh well with one another.
• Production and delivery methods will need to be harmonized.
• Staff from the new firm will have to be integrated into your business, and you will need a plan to deal with potential redundancies.

It can be a good idea to start thinking about the integration plan during the due diligence process.

Additional questions:

• Why is the owner selling?
• How diversified is the business’s customer base?
• Is the industry or geographic region heading for difficulty?
• Are there hidden costs you are missing?

Pros and cons of buying a business

Pros

1. Track record—Buying a business gives you an established customer base, team, business plan and operation.
2. Income—The best acquisition targets are likely to already have solid sales and profits. A new venture, on the other hand, can take a long time to build revenue and become profitable, and the risk of failure is significant.
3. Financing—The assets of the company you are buying can help secure financing for the purchase. Lenders are less likely to take a chance on a start-up.
4. Vendor assistance—Existing owners often help finance the purchase of their business by providing vendor financing. Besides being a good source of patient capital, the vendor’s investment motivates the former owner to facilitate a smooth transition.
5. Market knowledge—Acquisition may be a good strategy if you want to expand into a new industry or geographic location where you lack contacts and knowledge.

Cons

1. Poor fit—It can be difficult to find the right company to acquire, one that is a good fit with your existing business culture and strategic goals. A poor choice can cause the acquisition to become a sinkhole for your time, money and other resources.
2. Integration challenges—Integrating a new company into your existing operations can be harder and more time consuming than entrepreneurs realize. Expected payoffs often don’t materialize as quickly as planned.
3. Vision conflict—It may be harder to impose your vision on a company that already has its own culture and history than if you were to expand a business you already own. Some entrepreneurs like the challenge and excitement of starting an entirely new company or embarking on an expansion where they can put their stamp on from the beginning.
4. Dependence on the old guard—A rocky ownership change can prompt key staff to leave and imperil customer relationships. That can be especially problematic in a business that is highly dependent on the involvement of the owner or certain employees.

Unexpected things to prepare for when buying a business

It can take a long time to finalize the transaction

Usually, a home is the biggest purchase of your life, but for many entrepreneurs, it’s a business purchase. It could take a year or longer from when you start discussions to when the transaction closes.

“Soft” issues will likely come up

Watch out for clashing cultures between your existing business and the one you’re buying. Culture dissonance can sink your acquisition.

Know how long the seller will stay on and what role he or she will play. Be candid about how you and the seller’s relationship is going to work during the transition and afterward.

You may see an initial increase in debt and a decrease in profit

The majority of businesses don’t hit their financial forecasts in the first year. You’ll want a flexible financing structure.

A financing package will typically include the following:

• your contribution as the buyer
• a loan from a financial institution secured on the assets of the company
• financing provided by the seller (a.k.a., vendor financing)

Many entrepreneurs also use mezzanine financing to round out the package. Mezzanine financing is a hybrid of debt and equity that isn’t secured by specific company assets but instead is based on historic and expected cash flows of the company.

Next step

Discover how to work with a valuator, the methods they use to determine the value of your business and how valuation impacts price by downloading the free BDC guide on Business Valuation.