How to ask the right questions when buying a business

4th December, 2017

We’ve all had a wild idea to buy that funky little café down the street, and one day walked past and found the ‘for sale’ sign up. Want to make your move?

As we approach the new year, many people think about how they can gain financial independence. Buying an existing business can seem like a great option.

But those looking to buy a business need to make sure they do due diligence.

It’s something that’s urged by Perth-based accountant Tracey Loubser.

As the city starts to slowly recover from its post-mining boom slump, she’s being asked to run her eyes over more potential business purchases.

“What I’ve noticed from a few proposals is that there are many gaps in the information presented – and they’re not something a buyer would necessarily pick up,” Loubser told The Pulse.

She said it was common for vendors to only present a snapshot of the business – and a lot of buyers didn’t ask enough tough questions or ask for more information.

“They need to be asking things like; what’s happened over the past two or three years and asking questions around why this went up, why that went down.”

“Sometimes sales decrease because of economic conditions or the vendor just lost interest in the business, and that’s fine from the buyer’s point of view – but they just need to be asking the right questions.”

So what other mistakes are people making when it comes to buying a business?

Leading with the heart

A lot of people look at the small business up the street and fall in love with the potential of the place, rather than looking at the numbers in an objective way.

Loubser said this was the biggest mistake she had run across.

“They want that business so badly and they want it to work, but they don’t ask for any additional financial information and do enough due diligence,” said Loubser.

The desire to close the deal and get into the business of their dreams also means people aren’t getting the numbers they do get independently checked.

“Unfortunately many people don’t seek professional advice, and aren’t open to spending a little money to review a business – which may in the long run save hundreds of thousands of dollars in the future,” said Loubser.

They don’t look at labour costs

Labour costs are a major part of any business, but Loubser said this was often underestimated by buyers, and in some cases understated by sellers.

She described a situation where she was called in to review a potential purchase, only to find that something wasn’t quite sitting right.

“We looked at the stated cost of labour, and we ended up comparing it to the rates per hour and then looking at how many hours the business was open each year.

“There was no way that they would be able to successfully keep the doors open with such a small labour outlay.

“The business owner must have been investing huge amount of their time to keep the doors open, and many purchasers don’t buy a business to just take over another job”

They don’t understand systems and processes

There’s a reason why franchises are so popular for people looking to buy a business: everything is documented so you can walk in and start operating straight away.

Loubser said a great business would document everything so anybody could take over the reins.

“A business that has everything documented in terms of how everything works are the best types of businesses to buy,” she said.

READ: How to write a policies and procedures manual

She said some people, particularly first-time business buyers, could be surprised by turning up and then not knowing what’s going on.

It’s crucial to get a good handle on how the business operates. This can sometimes be achieved by a set hand-over period where the business owner stays on for a certain period of time.

People look at a sales line…and that’s it

All too often people looking to buy a business will look at a revenue or a sales line, but not ask how those sales are made.

For example, people looking at a revenue figure won’t be able to figure out whether sales are repeating or non-repeating.

“The best business models are those where a customer or client is sold to once, and is then on auto-repeat once a month or once a year,” said Loubser.

“The hardest business to run and hardest to sell is where you have to go out and sell to a customer for every transaction.”

For example, a website designer needs to sell a website design project by project, but if they also offer hosting services then that revenue is repeated every month or quarter.

Loubser also said prospective buyers would be well advised to look at how invoices were recovered.

“The average business owner spends eight hours a week chasing unrecovered debts,” said Loubser, “and cash flow is one of the main reasons why businesses fail.”

READ: How to save 59 percent on a key cost