10 Questions You Must Ask Before Buying a Business
Doing your due diligence before buying a company will earn you bargaining powerand help you avoid unforeseen problems. Here's what you need to know.
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Andrew Cagnetta bought his first business -- a pasta shop in Wethersfield, Conn. -- at age 25 and quickly realized he hadn't done his homework thoroughly enough. Although he stuck to the shop's original recipes and products, customers began complaining that the recipes had changed. Sales declined, and in less than two years, Cagnetta and his cousin, the co-owner, ended up selling the store.
They had bought the shop from two elderly women who had run it for years, not realizing how integral the previous owners had been to its success. "One question I should have asked [the previous owners] was what do they think drove people to the store?" Cagnetta says.
He would never make that mistake again. 22 years later, he now owns Transworld Business Advisors in Fort Lauderdale, Fla., which helps buyers ask the right questions before buying a business. "There are no stupid questions," Cagnetta says. "The more questions you ask, the less risk there will be."
Where to begin? Here are 10 key questions to ask sellers before agreeing to buy their business.
What are your biggest challenges right now?
You want be aware of potential minefields, said Chet Walden, the late president and CEO of Walden Businesses, an Atlanta-based management and acquisitions firm. For example, if you're buying a company that will need $1 million in capital improvements, he says, you need to learn that upfront while you're still negotiating the purchase.
What would you have done differently?
This question can get the owner talking about opportunities he didn't pursue but would have liked to, said Joe Bodine, CEO of American Business Masters & Investments Inc., an Overland Park, KS-based business brokerage firm. This question could help you learn how much growth potential the business offers -- from untapped markets to additional product lines to new marketing opportunities.
How did you arrive at your asking price?
Often, sellers will base their asking price on arbitrary factors such as how much money they'll need to move on with their life. Find out what quantitative information they have to back up their asking price, said Richard Parker, author of the series, How to Buy a Good Business at a Great Price (Diomo Corporation, 2001-2012). "You want to understand their thought process" and get a sense of your bargaining power, he says. If a seller arbitrarily arrived at his asking price, there's likely more room for negotiation.
If you can't sell, what will you do instead?
Learning the owner's plans if he can't sell the business is another way to determine your bargaining power, said Victor Cheng, a coach for CEOs and author of Case Interview Secrets (Innovation Press, 2012). For example, if the owner would give the business to an employee or close it over time if he couldn't sell it, you probably have more room to negotiate a lower price.
How will you document the financials of the business?
Parker recommended making sure there's a clear paper trail for the company's financial data. You need access to tax returns and other documents to back up the owner's assertions about the company's revenue, other income sources, and profits or losses. If the seller has unrecorded income, how can he prove it in writing?
Do you have any past, pending or potential lawsuits?
Walden advised that the last thing you want is to inherit a lawsuit. Ask if there are any pending or past legal proceedings and avoid buying any business that could potentially get you involved in litigation. For protection, get the response in writing in case the owner is concealing any legal matters that could come to light later.
How well documented are the procedures of the business?
Often small businesses operate with no set procedures in place, Cheng said. This might work well for the existing owner, but you'll need some sort of direction, such as manuals on company policies and practices.
How much does your business depend on a key customer or vendor?
You might be buying a company that looks very successful, but if it relies heavily on any one customer or vendor, you're taking a big risk, Cagnetta said. If major clients and vendors feel particularly loyal to the previous owner, they might jump ship once you take the helm.
What will employees do after the sale?
You need to know whether employees are aware of the pending sale and what their plans are, Bodine said. In case any key employees should decide to leave, make sure they have signed non-compete and non-disclosure forms so they can't immediately take customers or business practices to a competitor.
What skills or qualities do I need to run this business effectively?
Find out which skills or leadership qualities are most important to keeping the business going and figure out if you've got them -- or can learn them. Cagnetta recalled a client who bought a swimming pool business without realizing the physical demands of pouring chemicals into pools in the Florida heat, and an introverted buyer who purchased a bingo hall without understanding the importance of greeting guests at the door.