Skeletons in the Closet – What to look for before you Acquire a Business
The due diligence process involved in buying a business often includes a financial team, a legal team, and possibly other experts to review the additional areas of the target acquisition. Since this process includes a thorough examination of the details of the business, it is important that all avenues are explored so the buyer is aware of any potential “skeletons in the closet” of the company being considered. While some questions follow that may help identify the skeletons lurking within, a business intermediary professional is an excellent person to help a buyer to become aware of other potential issues and how to deal with them.
Management
- Is the owner/president/CEO constantly interrupted by telephone calls, emails or other diversions that require immediate attention? These interruptions may indicate a business in crisis or a general failure of management to control the business.
- Do employees seem to take pride in what they do and also in their company? Are they happy?
- Does the business experience a lot of turnover in either management or at the general employee level?
Marketing
- Is the company experiencing loss of market share, especially when compared to competitors? Price increases may increase dollar sales, but the important measure is unit sales.
- Is the company introducing new or improved products or services? A firm’s ability to do this is a critical part of the operation, affecting its success and potential for growth.
- Does the company participate in trade shows? Is the interest level high, or is the activity over at a competitor’s booth?
- Does the company have an excellent Web site and is it technologically above the competition?
Finance
- Does the firm produce monthly financial statements? Are the annual financials produced on a timely basis?
- Does the company take advantage of trade discounts, or is it late on paying its bills? These practices could be a sign that the company has poor cash-management policies.
- Are the margins and benchmarks better than industry standards?
- Has the company used up its entire credit lines and, if so, how (and why) have they been used? Is the firm on any kind of credit watch?
General Business
- Is the firm in a stagnant or even dying market, and can it shift gears quickly enough to make changes or enter new markets?
- Does the company have too many suppliers – or not enough? Is the inventory turnover better or worse than the competition or industry standards?
These are just a few of the business areas that an astute acquirer should investigate, but these areas may be outside the scope of the general due diligence procedures.
The due diligence on the financials and the legal aspects are obviously very important, but the answers to the above questions may ultimately determine what price to offer and if the sale is finalized.
Other Potential “Skeletons in the Closet”
- Unrealistic depreciation on capital equipment
- No allowance for bad debt
- Under-insured
- Under-accrued liabilities for taxes, sales taxes, and unused vacation and/or sick time
- Slow-moving or outdated inventory
- Under-funded retirement programs
The Perfect Business
- A fair and reasonable price.
- A fair and reasonable down payment.
(Ideally, 40 percent of the purchase price or less.)
- Seller financing.
- Sales that show a reasonable increase through the years.
- Earnings that provide a new owner with an appropriate annual salary.
- A compelling reason for sale.
- A desired or popular business type.
- An attractive and/or strategic location.
Looking for a Business? We can help. It is well known that in many cases the best business to buy is one that is not being actively marketed. We can find the right business for you with our specialized buyer representation program.
What Factors Should Buyers Look For in a Company?
It has often been said that valuing companies is an art, not a science. When you are considering the purchase of a company, three main factors are almost always considered when the seller arrives at their offering price.
Quality of the Earnings
Some accountants and intermediaries are very aggressive when adding back, for example, what might be considered one-time or non-recurring expenses. A non-recurring expense could be: meeting some new governmental guidelines, paying for a major lawsuit, or even adding a new roof on the factory.
The argument is made that a non-recurring expense is a one-time drain on the “real” earnings of the company. Unfortunately, a non-recurring expense is almost an oxymoron. Almost every business has a non-recurring expense every year. By adding back these one-time expenses, the accountant or business appraiser is not allowing for the extraordinary expense (or expenses) that come up almost every year.
These add-backs can inflate the earnings, resulting in a failure to reflect the real earning power of the business.
Sustainability of Earnings
As the new owner a primary concern is if the business will sustain the earnings after the acquisition. In other words, you don’t want to buy the business if it is at the height of its earning power; or if the last few years of earnings have reflected a one-time contract, etc. Will the business continue to grow at the same rate it has in the past?
Verification of Information
Is the information provided by the selling company accurate and timely, and is all of it being made available? A buyer should make sure there are no skeletons in the closet. How about potential litigation, environment issues, product returns or uncollectible receivables?
For more advice on the important factors in consideration of buying a business contact The Bridlebook Business Group at 610-325-7066 to help you get the best value for your investment..
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