3 Things to Know When Buying a Business

buying a business

3 due diligence recommendations when buying a business.

 

Whether your buying an existing company or investing in a franchise, you’ll want to hire professionals, including accountants and lawyers, to help you work through the process. If not, you may be overpaying or find hidden liabilities that may come back to haunt you.

Not every entrepreneur starts a business from scratch. Sometimes they find an existing business for sale that suits their talents and needs. This includes any manner of businesses or even a franchise. In this article, we we’ll discuss what you need to do before moving forward on such a purchase and the need to do your due diligence.

“Due diligence” is defined as the act of performing a reasonable investigation into the facts and circumstances of a transaction to get a complete understanding of the transaction.

Your goal is to get as much information about the transaction as possible so you can make an informed decision before jumping into any purchase. Such a purchase shouldn’t be from just the heart, but also must be carefully and objectively analyzed, usually with the assistance of both your attorney and accountant.

3 due diligence recommendations when buying a business:

1. Buying a Business-Property and Assets

Having just completed work on a purchase for a client, let me walk you through what we had to do to properly determine if it was the best deal for him.

The business was found through a business broker who advertised it on behalf of his client. It’s very important to remember that business brokers aren’t working for you. Their job is to sell the business for their client. Read the brokerage contract very carefully or, better yet, have your attorney review it. The initial terms are usually presented therein as to sale price and asset allocation. Then it’s time to start doing your homework.

In our particular case, the business was being purchased out of state. It’s always imperative that you visit the site to see what really exists. If it’s a brick-and-mortar operation with real property, you need to get a current valuation of the real estate and check for any liens against the property and if all real estate taxes have been paid. If it’s a rental property, one thing you want to be sure of is whether the lease is transferable and what terms the landlord would expect from you.

You also want to examine any equipment that comes with the purchase. The seller will be valuing that equipment in the purchase price. That valuation will have a direct effect on your taxes, so how the assets are valued is very important to you. The higher the hard assets are valued, as opposed to goodwill or other intangibles, the better for you. The opposite is true for the seller, so this will most likely be a point of negotiation. Be sure to get the best fair-market value that you can.

2. Buying a Business- The Finances

While the attorneys are reviewing the contracts and doing lien searches, your accountant will be looking at all of the financial information. That will include the assets as well as the debts and liabilities of the business. Your accountant will need to look over the past financial information including, but not limited to, the financial statements, tax returns, the entity structure, payroll and compensation policies, and owners’ draw.

In some cases, this may require analyzing the general-ledger accounts for the past year and current year-to-date.

The general ledger will reveal a much more detailed picture of the expenditures. Of course, if the business has kept its books and records on the accrual basis, as opposed to the cash basis, you’ll also look at the accounts payable and receivable. Your accountant will then look to determine if the purchase price appears to be fairly valued and will do a projected financial outlook based upon the findings.

In the case of my client, the current year-to-date numbers, when projected out, showed a significant decrease over the prior year revenues.

We searched the Internet for related businesses in his geographical area and, sure enough, found that in the current year a new competitor had entered the market, draining about 20 percent of the sales from our seller. Never underestimate the value of the Internet in assisting you with learning more about the area, the industry or general fiscal trends. This find resulted in a negotiated decrease in the asking price and terms of sale.

3. Buying a Business- Eyes Wide Open

Due diligence can be as straightforward or as complicated as the business that you’re buying. The key is to learn as much as you can about the business so you walk into the deal with your eyes wide open.

The more time you and your professional team spend doing the necessary leg-work, the better the chances are that you’ll buy a business without going-concern issues, at a fair price, with favorable payment terms and a tax-favored allocation.

Related articles:

Eli Mendoza on Equity and Financing [video]

Moving on Up Through Mergers and Acquisitions

Legalities of Mergers and Acquisitions

About the author

Sandra Napoleon-Hudson

Sandra Napoleon-Hudson is the managing member of Sandra Napoleon-Hudson CPA LLC, based in Atlanta. Her expertise includes multi-state taxation for corporations, partnerships and individuals, business consulting, sports and entertainment taxation and IRS representation. As a former partner of a New York firm, she appeared frequently on television and in print media.

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