10 warning signs to look for when buying a business

1st January, 2021

Alarm bells

Buying a business will probably be the most important and largest investment decision you will ever make in your working life. It may seem like a gamble, either giving you financial freedom or destroying your financial future.

From my years of experience in undertaking due diligence work for potential business owners, I have unmasked some alarming warning signs. If they were caught sooner, potential buyers would have saved thousands of dollars.

I have a belief that no one sells a good business. Why would you? If a business is running well and providing cash flow and profits — and the owner is not required to work 60-80 hours a week — then why sell it? The fact that a business is being sold is a warning sign in itself. There could be legitimate reasons, but you must delve deeper to separate fact from fiction as to why the business is for sale.

To avoid the heartache of paying too much for a business, there are 10 warning signs to look out for.

READ: Your common accounting questions: buying a business

1. The seller refuses to disclose all financial information

Get suspicious when the business owner is not forthcoming with the financial records or does not answer all your questions in relation to the financial accounts, profit and expenses for the business.

Sometimes business owners will hold back key information such as bank records, customer lists and recent sales history. If you feel the seller is not being completely upfront and honest with you in providing this information, then beware.

2. Loss of interest in the last 12 months

Most business owners do not sell a business overnight. It is a decision they have made over time, and after they’ve chosen to sell, it may take considerably more time to find a buyer. Once they have reached this decision, most business owners refuse to reinvest any more money into the business to improve or to grow it.

You will often find plant and equipment maintenance being neglected, repairs being postponed, reduced or no money being invested in staff training, marketing and advertising.

Make sure you look closely at these expense categories over the last 12 months to see if the owner has lost interest. If this is the case, then you may be stuck with lagging sales and a need to invest additional capital to make up for the neglect.

3. The business is in a sunset industry

It is not worthwhile purchasing a business in an industry that has plateaued or is in decline. Typical brick and mortar businesses in the retail space are struggling at the moment, and I would certainly advise anyone to look closely before they purchase such a business.

It may be the main reason why an owner is trying to sell. They have had a good run over the last five to 10 years when the industry was buoyant, and now with emergence of eCommerce, they are struggling to grow that business. Do your research on where the industry is going in the next two to three years. This includes closely monitoring any existing and potential competitors in the space.

4. Secret shopping wasn’t pleasant

Do your own surveillance and snoop around. Visit the place of business as a potential customer, and gauge for yourself the following:

  • Customer service levels
  • Cleanliness and state of disrepair
  • Staff enthusiasm
  • General business activity

A quick walk around the business premise with your eyes open will reveal key warning signs that aren’t obvious from just eyeballing the financial accounts. Is the place busy with a steady flow of customers, or are there no customers in sight? Are staff keen and enthusiastic to assist you, or are they bored and passive? Does the business look clean and well maintained or run-down and tired? Nothing beats opening your eyes and ears and pretending to be a potential customer. It can reveal a lot.

5. Poor customer reviews

Research the web to really gauge customer opinion. While customer reviews can be one-sided, you will need to get an overall feel as to whether the marketplace is happy and satisfied with the existing business.

A pattern of poor customer reviews online is a clear warning sign the market is not happy and may shop elsewhere. You need to bring this to the attention of the seller and find out the reasons why. It may be difficult to reverse a poor customer sentiment once it’s in cyberspace.

6. Disgruntled key staff members

If possible, talk to some of the key employees within the business. You are going to rely on them in the next 12-18 months to help educate and assist you in the transition phase of the business, so you certainly want them to stick around for that period of time.

Disgruntled employees will look at a change of business ownership as the perfect opportunity to jump ship to a competitor. A sure warning sign is if the business owner refuses to allow any communication between you to their key employees.

7. Poor credit rating and borrowing history

Do an online credit reference check on the business. In the report you will discover whether the business pays its suppliers on time and whether there are any pending legal actions against the business. The last thing you want is to purchase a business only to get a stack of lawsuits served to you.

Make sure to delve into any current or outstanding warranty issues for products. You don’t want a huge bill of warranty claims after you purchase the business. Get all outstanding warranty claims quantified and signed off by the owner. Ask for a reduction in the purchase price if the outstanding warranties are significant.

8. The business relies on a few customers

This is another warning sign that most potential business owners neglect. Does the business rely on a few large customer accounts? You run the risk of a significant downturn in sales and profit if you lose just one of these major customer accounts. Trawling through the customer list will reveal any warning signs here.

9. Unpaid tax and employee entitlements

Request from the business owner information in relation to taxes and unpaid employee entitlements.  Make sure that these are completely up to date and that there is no outstanding tax or unpaid entitlements to staff.

You could be on the verge of half your staff walking out after the purchase simply because they are owed wages and entitlements that date back to before you became the owner. Also, request a business tax report from the tax authorities and check for any amount outstanding. Any unpaid taxes will be revealed in this report and will send your alarm bells ringing.

10. Your gut instinct tells you so

Among all the warning signs discussed so far, go with your gut. Trust your instincts. If things just don’t stack up, then walk away. After helping many clients purchase their first business, I still find that the biggest warning sign comes from my gut.

Are your ‘spidey-senses’ starting to tingle? Are your instincts giving you a good or bad vibe about the owner and the business? I tell clients to trust their instincts the most when making that final decision to sign on the dotted line.

Buying a business can be the most harrowing or the most thrilling experience of your life. There’s a lot at stake — your financial future and the future of your family. So before you take the plunge, follow my list of ten warning signs to look for and hopefully you’ll make the right choice.