You think you have found the right business to buy - well done. Now stop and do your homework. Do a thorough investigation into the business and make sure you are not buying someone else's problem.
Many businesses advertised are described as outstanding investments, rare opportunities, have excellent returns, potential to grow, operating under management, no experience necessary, high growth business or will be sold soon so get in quick. These phrases and thousands of others describe a business on the market to be sold. Each of the above have hidden meanings and the challenge is to find out the real facts about the business without wasting too much of your valuable time. Here are six (6) key things to look closely at when investigating a business to buy.
1 The WIWO sale – must sell
Walk In Walk Out. Typically we would tell our clients to quickly walk out as there is a good chance this business is on its last legs. In most cases what WIWO means is that the vendor is not going to provide you any details on the business, apart from maybe the lease. A WIWO typically is a cash business that will not show a profit and is looking for a buyer that has cash, no borrowings and is priced for a quick sale. There are few conditions so Caveat Emptor – Buyer Beware. When dealing with a business broker selling a business advertised as a WIWO, ensure you don’t lose the envelope that they have provided with the business details because it’s unlikely you will have any more information to decide whether this business is suitable to invest your hard earned money.
2 The UNDER MANAGEMENT business – maybe too good to be true
Under management is a term loosely thrown around to attract passive investors. Passive investors are keen on businesses that operate automatically with supposedly minimal human intervention such as a coin laundry, vending machine operations or automated car washes. Having a day to day job and a passive investment appears to provide a balance of security and income. Be careful of any business advertised as operated under management or can be operated under management.
In many cases where advertised under management, investigate how often the owner is at the business and the role they undertake. Under Management may just mean the owner does not work twenty four hours a day any more in the business just eight.
Where cash is involved, the owner needs to be involved. Purchasing a business to be operated under management without your involvement is a risk, and you need to be totally satisfied that systems and procedures are in place along with stringent internal controls before you let go of the reins.
3 The SHORT LEASE- the disappearing act
A major issue with any business purchase is the lease. Whilst rent and outgoings are obvious costs in the lease, a major consideration is the term or length of the lease and options. Most shopping centres will only negotiate any extended lease within the last six months of the lease term, so there may be uncertainty as to obtaining a new lease. There are so many hardship stories of lessees not been granted new leases and having to close shop or be relocated somewhere else in a shopping centre which may not be an ideal location.
In most cases, as part of negotiations, ensure you address the lease and prepare an offer where possible with a lease extension as a condition of the offer. Let the vendor or business broker work on your behalf.
4 RENT – keeping you awake at night
In many shopping centres where businesses and particularly franchises are for sale, have a close look at the lease payments and outgoings. Many of these businesses have a high volume of sales and require significant transaction counts on low margin items to pay the rent. If rent and outgoings exceed 10% of turnover, there is a significant ongoing financial commitment. The business broker won’t tell you but the main motivation of many shopping centre business sales are motivated by the vendor wanting to be released from their lease commitment
Look closely at the Security Deposit or Bank Guarantee to be held which can be from three to six month’s rent. Funds tied up over the length of the lease.
5 The BUSINESS PROFILE – No profile then beware
Many business brokers prepare a Business Profile or Information Memorandum on the business for sale. Firstly, if a business broker has prepared a business profile then the broker has done an excellent job and saved you time and money. The business profile should provide a summary of the business and include the business financials, including sales history, a copy of the lease (where applicable), Profit and Loss Statement and comparable year on year results, staffing requirements, list of plant and equipment, location details, asking price and a general business overview. If a franchise, then franchise details including payments and terms and franchisor costs should be highlighted within the business report.
Not all business brokers or businesses for sale have a business profile prepared. Beware, as these businesses may end up wasting you so much time and effort as you continually seek information that is not forthcoming. We steer clients away from businesses that do not have the information ready and available on request so an informed decision to purchase can be made in a timely manner.
6 PROFIT – Dig deep to find the facts
Trying to work out the true profit of a business can be a challenge in itself. Whilst most business incur personal expenditure in the business with a view to minimising their tax obligation, when the time comes to sell, these expenses are typically ‘added-back’ to reflect the ‘true profit’.
Add-Backs need to be addressed when determining the valuation of the business but not necessarily reflect the purchase price. Add Backs may include but not limited to the owners salary, motor vehicle expenses, depreciation, and interest on borrowings. Remember, if you are purchasing the business you will also incur these costs and this should be reflected in your purchase price.
The key takeaway here is for you to invest in finding the true profit of the business, because that is the bottom line of purchasing a profitable business…