Basics of Buying a Business

What to check for as you begin investigating a prospective business purchase

Buying an existing business can be a much less risky and morequickly profitable venture than starting your own business fromscratch. But it's not entirely risk free and your success willdepend heavily on how wisely you choose and evaluate the businessyou buy.

Here are the "tires to kick" as you begininvestigating a prospective business purchase. These items are notmeant to substitute for an in-depth evaluation - which you willwant to conduct once you've gone through this first step.

Financial Statements
Look at both financial statements and tax returns from the past 3-5years to judge both the current fiscal health and financial trends.Make sure you see figures that are accompanied by an audit letterfrom a reputable CPA firm. Don't accept a simple financialreview or a compilation, because those are based on figuressupplied by the company. Is the business in sound financialcondition? Do financial statements match tax returns? Are sales andoperating ratios in line with the industry average? Your accountantcan help you analyze these figures to determine the net worth ofyour company.

Payables and receivables
Check the dates on invoices to see the business is keeping up withits bills. Normal payment times vary from industry to industry, butgenerally 30 to 60 days is standard. If bills are being paid 90 ormore days past the invoice date, the owner may be struggling withcash flow. Also find out whether any liens have been placed againstthe business because of unpaid bills.

Inspect the accounts receivable with a skeptical eye; oftentheir stated value is somewhat inflated. Take a close look at thedates on them to determine how many are delinquent and by how long.This is important because the older the receivable, the lower itsvalue and the greater the chance that it will never be paid. Whileyou're at it, make a list of the business's top tenaccounts and run a credit check on them. If the majority ofcustomers or clients are creditworthy but late to pay, you may beable to solve the problem with a more rigorous collections policy.If the clientele is financially unstable, start looking for anotherbusiness.

Key personnel are an important asset to many businesses. You needto determine how critical the employees are to the success of thebusiness. You also need to look at their work habits to determineif these are people that you can work with. How long have these keyemployees been with the company? Will these people remain with thecompany after a change of ownership? What incentives will you haveto provide to get them to stay? Can any key employees be easilyreplaced? What are their relationships with customers, and wouldcustomers follow any of these employees if they were to leave? Alsolook at the role the current owner plays in the company. Is this arole you want to play? Are there any current employees who can takeover those responsibilities if necessary?

These are the most important asset you may be buying with thebusiness. Make sure they're as solid as the other tangibleassets you'll be acquiring. Does the clientele have a specialrelationship with the current owner (long-time friends orrelatives)? How long have these accounts been with the business andwhat percentage of the income do they represent? Will they leave orstay when the business passes to new hands? Does the current owneror manager seem to have good relationships with the customers? Isthere a written policy for handling customer complaints, returns,disputes, etc.? Has the owner supported the local community or theindustry?

This is especially important if you are buying a retail business.How important is location to the success of the business? How goodis the location of this particular business? Is there sufficientparking to make it easy for customers to visit? How dependent isthe business on walk-in trade? What does the future hold for thearea? Is it in the process of rapid change from new residential orbusiness complexes on the way? Will the location become more orless desirable because of contemplated changes in theneighborhood?

Appearance of facilities
The environment in which a company operates can tell you a lotabout it. Take some time to eyeball the company's physicallocation. How does this place look to you? Did you have a goodfirst impression when you entered? How well is it maintained? Isthere any outstanding maintenance work to be done - leaky roof,peeling paint, poor signage? Is the place well organized out frontand in the back where inventory is kept?

When you're buying a business, you need to understand thecompetitive environment in which it operates. Pay attention toindustry trends, and how they might affect the company you'reconsidering. How competitive is this industry? Who are yourcompetitors and what are their tactics? Are price wars common inthis business? How has the competitive environment changedrecently? Have any competitors gone out of business? Why? You cantrack this information by contacting an industry association orreading trade publications.

Registrations, licenses, zoning
Make sure that key business licenses and other legal documents canbe easily transferred. Determine what the process for transferwould be, and what it would cost, by contacting the proper stateand local authorities. If a company is a corporation, what state isit incorporated in? Is it operating as a foreign corporation in itshome state?

How a company is perceived can be a serious asset or a liabilitythat can't be judged from a balance sheet. There are a widerange of intangibles that you need to consider when you'reevaluating a company -- everything from the way it services itscustomers to how it answers the phones to whether or not itsupports the community or the industry. This category is oftenreferred to as "goodwill." Talk to customers, suppliers,competitors, banks, and owners of other businesses in the area tolearn more about this firm's reputation. Remember that it isvery difficult to change a negative perception.

The viewsand opinions contained herein are not necessarily those of AmericanExpress and are intended as a reference and for informationalpurposes only. Please contact your attorney, accountant or otherbusiness professional for advice specific to yourbusiness.

Copyright © 2002 American Express Company. All RightsReserved.

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