10 Questions to Ask Before Buying a Business

 10 Questions to Ask Before Buying a Business

Many experts are predicting that a huge wave of businesses will become available over the next decade or so as baby boomers look to sell. As the economy continues its climb into a full-blown recovery, it just might be the perfect time for you to fulfill that lifelong dream of buying a business. Before you take the plunge, however, you should take the time to ask yourself a series of questions that will help make sure you're prepared for the rigors of business ownership. Certainly the team of advisers you assemble to make such a deal—such as business brokers, attorneys, and accountants—can help you in determining the value of a business and what you should pay for it. But there are additional questions you need to ask yourself, and the seller, to find out if the business you've targeted is everything it's cracked up to be. With that, here is a list of 10 questions that you should get answers to before buying the business of your dreams.

1. Is buying a business the best decision for you right now?
Perhaps the most important questions to start asking involve whether buying a business is a good fit for you, says Keith Emmer, principal at Startegix in New York City. "If you're just bored or looking to try something, what happens when you have to do the tedious tasks that every entrepreneur must do?" asks Emmer. If that's the case, you might want to consider a hobby instead.

If, on the other hand, you see real opportunity and have always tended to see the world a little differently than others in your corporate job, owning a business may be right for you. "At the same, you should ask yourself if right now is the best time to make the commitment to buy if say, you're almost vested in your retirement plan," says George Krueger, president of Bigg Success, a business education and consulting firm in Champaign, Illinois. "It's probably a small sacrifice to get the full benefit of your employer's contributions," he says. "You can use the time to get prepared to buy a business."

2. Will your spouse support you?
Owning a business will affect your relationship with your spouse, in one way or another, says Krueger, since both of you will need to make the emotional and time investments that come from riding the entrepreneurial roller coaster. "So your spouse has to be prepared mentally and emotionally as well," he says. "If not, you may find that your biggest challenge comes from home rather than your business." You need the physical capacity to work long days, especially in the early days.

3. Who runs the business when the owners go on vacation?
One interesting question to get an answer to involves asking when was the last time the sellers went on vacation, how long were they gone, and what kinds of problems happened when they were away, says Kent Boehm, a business coach in Alberta, Canada. That helps determine how tied the business owner is to the day-to-day operation of the business. "The more often the owner goes on vacation the better quality of life they have," says Boehm. "The problems that occur while on vacation are sometimes an indicator of how much babysitting the owner has to do."

4. Do the numbers add up?
This one seems obvious, but a lot of new entrepreneurs don't really think about what exactly their return should be, says Krueger. "If you plan to be an absentee-owner, will the business provide a reasonable return on your investment, given the risk?" he says. "On the other hand, if you will be an active owner, will it provide the return on your investment and compensate you adequately for the time you're investing?" Kruger also suggests subjecting the projections you're using to what he calls "stress testing," such as finding out what might happen to cash flow if sales are below your expectations or costs run above your projections? "Bankers often see if you'll be able to pay them back if profits are off by 25 percent," he says. "You should run similar scenarios."

5. Are there any other skeletons to worry about?
You'll also need to do your homework when it comes to finding out everything beyond the numbers that might affect your new business, says Chantay Bridges, a senior real estate specialist with Clear Choice Realty & Associates in Los Angeles. He suggests finding out answers to the following questions.

Are there any easements, exclusive rights, or right of ways that impact the business?

Has the business ever been a crime scene or has it been vandalized?

Has the seller run into any trouble with the state, government, or IRS?

What is the business zoned for? Is the area hazardous?

6. What do the customers have to say?
A step that many business buyers fail to take is talking to current customers in the business, and not necessarily the ones that the seller handpicks for you. "Unless you know who buys from you and why they buy from you, you will be flying blind," says John Torrens, a veteran entrepreneur who also teaches entrepreneurship at Syracuse University. "This is good to know before you engage in a letter of intent and is especially important during due diligence. What you find out can help you if you take over the controls."

7. How does the business make its phone ring?
Obviously, any business needs to have a growing customer base to be successful. So it might be worth asking the seller about what kinds of things they have done to market their business and to generate inquires from new prospects, says Boehm, at least so that you know what you might need to do more of once you take over. "Ask them if they know which marketing efforts create the most leads," he says. "What you want to try and find out is what marketing they are doing, if any, and how effective it is."

8. Why is the seller really getting out?
The seller knows his or her business better than you do, says Krueger. That's why you should make the time to ask him or her about why they are selling. The rub, however, is that you'll usually hear reasons like "retirement," "health reasons," or "other opportunities." Your challenge, Krueger says, is to find the real reason. "You may never find out, but you should certainly try," he says. "Build a relationship with the seller and be thorough in your due diligence."

9. Will the seller keep some skin in the game?
Working with a bank or lender is an important step in buying your new business. But, with credit tight these days, it's not uncommon for sellers to step up and finance at least part of the sale, even though they would all prefer an all-cash deal. If you can get your seller to put their money on the line, it may serve as a signal of the seller's confidence in the future of the business, says Krueger. "Remember that they know more about their business than you do," he says. "If they're not willing to let any money ride on the business, should you?"

10. What is your exit strategy?
This is an important question to ask even as you make the decision about whether to buy a business or not, says Alex Corrigan, who heads up the M&A practice at Delap, a 78-year-old accounting firm in Portland, Oregon. "This should be considered right from the start because," Corrigan asks, "what if you have to sell the business or get out sooner than you thought?" Along the same lines, he suggests that you should also have a buy-sell agreement in place if you happen to have any partners involved in the business.

Maintain Your Mental Well-Being

This week the US government revised the food pyramid — that diagram that's been with us for decades that is supposed to remind people how to eat well. The model needed a revision, and the new version, called Choose My Plate, is a big improvement.

However, there's a different epidemic happening out there that's getting less attention, perhaps because it is less obvious than the epidemic of obesity we're experiencing. It seems we may be entering an era of an epidemic of overwhelm. A time when too many people's mental well-being is being stretched through multi-tasking, fragmented attention and information overload.

The trouble is, we are short on simple, clear information about good mental habits. Few people know about what it takes to have optimum mental health, and the implications of being out of balance. It is not taught in schools, or discussed in business. The issue just isn't on the table. Businesses schedule time as if the brain had unlimited resources, as if we could focus well all day long. Every week I talk to an organization who says that their biggest problem is simply the overwhelm their people are feeling. Without good information about the mind and brain, we may be stretching ourselves in ways that may have bigger implications than poor eating habits.

This platter has seven essential mental activities necessary for optimum mental health in daily life. These seven daily activities make up the full set of 'mental nutrition' that your brain needs to function at it's best. By engaging regularly in each of these servings, you enable your brain to coordinate and balance its activities, which strengthens your brain's internal connections and your connections with other people.

The seven essential mental activities are:

Focus Time. When we closely focus on tasks in a goal-oriented way, taking on challenges that make deep connections in the brain.

Play Time. When we allow ourselves to be spontaneous or creative, playfully enjoying novel experiences, which helps make new connections in the brain.

Connecting Time. When we connect with other people, ideally in person, richly activating the brain's social circuitry.

Physical Time. When we move our bodies, aerobically if possible, which strengthens the brain in many ways.

Time In. When we quietly reflect internally, focusing on sensations, images, feelings and thoughts, helping to better integrate the brain.

Down Time. When we are non-focused, without any specific goal, and let our mind wander or simply relax, which helps our brain recharge.

Sleep Time. When we give the brain the rest it needs to consolidate learning and recover from the experiences of the day.

We're not suggesting a specific recipe for a healthy mind, as each individual is different, and our needs change over time too. And we're not suggesting that business suddenly changes everything and reorganized all of work. The point is to become aware of the full spectrum of essential mental activities, and just like with essential nutrients, make sure that at least every few days we are nudging the right ingredients into our mental diet.

Just like you wouldn't eat only pizza every day for days on end, we shouldn't just live on focus time and little sleep. Mental wellness is all about giving your brain lots of opportunities to develop in different ways. In organizations, from a practical perspective, this means allowing people to work from home more, to be more flexible, to give people more autonomy.

In short, it is important to eat well, and we applaud the new healthy eating plate. However as a society we are sorely lacking in good information about what it takes to have a healthy mind. We hope that the healthy mind platter creates an appetite for increasing awareness of what we put into our minds too.

A Tale of Reported vs. Actual Income – Sellers Beware

Among the genre of small business owners, there is one individual whom I met that stands out from all the rest. He was the epitome of one obsessed with a need to minimize his reported taxable income. I was amazed at the lengths he went to, to distort his sales revenue and expenses on his financial statements. You name it, he did it: pocket cash sales and never enter them on the books, bloat reported expenses by recording personal purchases such as travel, meals, magazine and newspaper subscriptions, personal auto expenses, home repairs and maintenance and so forth as business expenses. He held back credit sales in November and December and didn’t book them until January; he stuffed his postage meter in December with enough postage to last him until August but reported the total purchase as an expense in December, and on and on. Moreover, he was quite proud of this accomplishment. He told me that he met with his CPA several times a year to “brain storm” new ways to minimize his reported income. The energy he put into this practice was enormous. He was truly consumed not with just a desire, but it seemed to me, a compelling need to avoid paying income taxes.

However, the enormous difference between his advertised earnings and what appeared on his financial statements and tax returns didn’t sit well with the buyers.

In addition to the negative affect that distorted financial performance reporting has on a business’s market value, such statements also become less useful—and in many cases useless—as a business planning and control tool. This is dangerous because there comes a point in a growing business where the absence of accurate financial reporting becomes the kiss of death.

There also comes a time in most growing businesses when the need arises to borrow money to finance new operating equipment, leasehold improvements, the purchase of real estate, inventory perhaps and so forth. Without good financial statements (and accompanying tax returns) that demonstrate a history of solid earnings, the ability to borrow the needed money becomes significantly more problematic.

And finally, one always runs the risk of being audited by one or more taxing authorities. If they should discover that you have been deceptive in reporting your company’s earnings, they can make you wish you hadn’t. In fact, I asked the business owner who I have told you about here if he was at all concerned about an audit. He assured me he was not. He said he was confident that he was much too clever to get caught by an auditor. I had my doubts about that. After all, he readily spilled the beans to both prospective buyers. One of those buyers could have been an under-cover I.R.S. agent. They really do stuff like that. Now there’s something else to think about.

How Buyers Put a Price on Your Business

If you're looking to sell your business, you probably have a number in mind. Here's why it might differ from what an acquirer is willing to pay.

A funny thing happened when I was first approached by someone who wanted to buy my printing company: I forgot everything I knew about sales.

Instead of listening to the customer and understanding his or her needs, I went into negotiations with potential buyers focused on my needs. I wanted to get a certain multiple for my business but failed to put myself in the shoes of a buyer to figure out what he or she would be willing to pay.

It was a rookie mistake on my part. Any first-year salesperson knows the first step in selling is figuring out what the customer needs. I should have asked about buyers’ goals in wanting to acquire us. In particular, I should have tried to understand what kind of return they were looking for on their investment in an acquisition.

The price buyers are willing to pay for your business depends on a lot of factors, but one of the most important is the return they expect to get and the risk associated with achieving that return.

Assuming your revenue is flat or growing modestly, the higher the return on investment the buyers are looking to achieve, the lower the multiple they will be willing to pay for your business.

At the risk of oversimplifying a complex equation, if the buyers are looking for a 22 percent return on their investment in your company, then they will derive the multiple they are willing to pay as follows:

100 ÷ 22 = 4.5 times EBITDA

Provided you’re not the next Google and you don’t have the cure for cancer, the buyers would be willing to pay around 4.5 times EBITDA to buy your business.

If, however, their expectations for a return are higher, let’s say 30 percent, they will be willing to pay less for your business:

100 ÷ 30 = 3.3 times EBITDA

So what drives up buyers’ expectations for return on investment while at the same time driving down the price they are willing to pay for your business? In a word, risk. The riskier your business looks to buyers, the higher their expectation for a return will be.

Likewise, with your own investments, you are willing to settle for a lower return when you buy relatively safe assets, like a government bond. But when you buy that risky small-cap fund, you expect a higher rate of return in exchange for putting your capital in harm’s way.

So how do you de-risk your business in the eyes of an acquirer?

• Client risk—do you rely on just one or two key clients for most of your business?
• Supplier risk—will you be in trouble if one of your suppliers goes under?
• Depth of management—what happens if a key employee disappears?
• Contracts—do you have legal agreements in place, or do you rely on handshakes?

Ask yourself these questions to judge how risky your revenue stream is. Investors want to know that things won't fall apart if something unexpected happens. Show them safety in your pattern of earnings, and you can expect a higher offer.

When you sit down with people interested in buying your business, try to find out what their expectations for return on investment are. That will tell you a lot about what their offer will look like and how risky they view your business. From there, you can do the math and anticipate their offer price and decide whether or not you want to keep talking.

Misconception for Small Businesses

So many people assume that when there is a recession that small business must shrink. Not only does the small business market offer continued growth during a recession, it also offers relative stability. Take a look at the growth rate of the small business market versus that of consumer spending.

Consumer spending sports impressive growth rates during the best of times but also suffers big swings during recessions. Conversely, the small business market offers a more stable source of revenue through good and bad economies. Year after year changes in the small business growth rate are less than a third of the drops seen in discretionary consumer spending.

Small business is not only an important source of diversification for enterprise companies but also a relatively safe haven for investments during recessions.