Buying an existing business is a big decision. It is critical that, as a prospective buyer, you spend time investigating the business prior to making the decision to purchase. Obtaining information about the business can help you make a well informed decision. You must be prepared to carefully assess all business records and risks while searching for any "skeletons in the closet."
The following is a checklist of information to gather about the business. This checklist serves as a guide in investigating the business. Throughout the process it is also important to consider your goals, objectives, and strategic plans for the business. Analyze your financial expectations and time constraints to confirm that you can make the business succeed. Keep in mind that a good investment for one person may not be a good choice for someone else.
Much of this information contained in the checklist can be obtained by interviewing the seller and asking questions. Other information can be learned by obtaining important business documents such as financial statements, tax returns, leases, etc. You can also gain information through observations or by talking with employees (if given permission by the seller).
Keep in mind that communication between the perspective buyer and the seller is important. The seller provides invaluable experience and knowledge that the prospective buyer needs in order to make a decision about purchasing the business. The seller also has a great deal of information that would be beneficial after transfer of ownership. However, it is important to be mindful of the seller's point of view when gathering information. The seller likely has invested much time, energy, as well as money into the business. A tactful approach to the investigation process can be advantageous during the negotiation phase.
Before spending time investigating a business for a potential purchase, it is advisable to gain an understanding about the realities of obtaining financing. It is recommended that you review the following ASBTDC articles:
Keep in mind that it is unlikely that you'll be able to obtain 100% financing to purchase a business. Lenders typically require buyers to contribute their own cash equity towards the business purchase. The general rule of thumb is that lenders like to see at least 20% to 30% of the project in the form of owner's equity (buyer's cash). If the business purchase price contains substantial "goodwill", the expected equity contribution may be greater.
Those seeking financing to purchase a business should develop a Loan Proposal. Much of the information you gather about the business will be required by a lender and should be contained in your Loan Proposal. In addition, you will also have to compile information for your loan proposal including financial projections, collateral information, and personal financial information. Another issue to consider is whether or not the business will provide enough income to pay loan payments and provide return to the owner. Loan repayment ability is extremely important to a potential lender. To learn about all of the information which should be in a loan proposal, it is recommended that you review ASBTDC information about developing a loan proposal:
A prospective buyer should request access to business financial records. This financial information is key to understanding past profitability of the business as well as projected future success. If the seller cannot provide adequate information, the buyer must make the decision to either terminate efforts or move forward at his/her own risk. If bank financing is involved, the lender will require adequate financial information.
___ Obtain the proposed selling price and determine what is included in the sale. How much of the selling price is allocated towards real estate, goodwill, equipment, inventory, etc.? What is the actual market value of those assets?
___ Determine the type of sale. Will it be an asset or stock purchase?
___ Establish whether or not the buyer will assume any business obligations or debts such as unpaid balances of accounts payable. If so, obtain all current loan terms, documents, etc.
___ Acquire business balance sheets & income statements (for at least three year-end statements & interim for current year), and federal business tax returns (at least the past three years). Confirm that all past taxes (state and federal) originating from the business are paid.
___ Determine whether additional working capital will be needed to conduct business operations after the sale.
___ Obtain business history information. What kind of reputation does the business have? How long has this business been established? Include the development/progress of the business and ownership structure.
___ Determine whether upgrades are required as well as identify needed changes to business operations. Are any leasehold improvements, equipment purchases, or general updates to the business necessary? What would be the costs of these updates?
___ Obtain a copy of the franchise agreement, if applicable. Will another franchise fee or a transfer fee have to be paid?
___ Obtain a copy of the proposed buy/sell agreement (unsigned) or information in writing about the proposed terms of the buy/sell transaction.
___ Request an explanation of seller's reason for selling the business.
___ Investigate any business leases for equipment, property, etc. Are leases transferable?
___ Investigate zoning laws to ensure compliance.
___ Determine whether or not the buyer will be able to continue utilizing the firm's intellectual property such as business name, patents, trademarks, trade secrets, product names, and any other proprietary information.
___ Research any licenses that may be required to maintain business operations. What are the costs?
___ Determine whether or not the seller will offer a non-compete agreement after transfer of ownership.
___ Investigate whether there are any customer product warranties issued by the company that may be future obligations.
___ Learn about staffing requirements and key employees. Analyze the roles and salaries of all employees in the business. Will you keep existing employees and/or key management during the transition? Do you have the experience and expertise to manage this new acquisition?
___ If applicable, obtain a copy of existing employee contracts and benefit packages.
___ Determine the likelihood that existing employees will stay with the business after the transfer of ownership.
___ Establish whether or not the seller is willing to stay on for a period of time after ownership transfers in order to provide knowledge and support.
___ Identify the products/services the firm provides. What is the current pricing system? Do you plan to alter the product/service mix? Are existing inventories and supplies included with the sale? What level of inventory will be in the business at the time of transfer? Does inventory consist of high quality saleable inventory or predominantly old inventory that will be difficult to sell?
___ Acquire a list of competitors, suppliers, and clients/customers, if possible. Can you retain customers and sustain revenues? Will existing vendors offer the new owner the same terms as the current owner? Will you forge new relationships with different suppliers or continue with current operations?
___ Determine the market area of the business and method of distribution. Fully understand the business's customer geography and target market. How large is the current customer base? Is there an opportunity to grow the customer base?
___ Research the industry. Is this industry growing? What are its strengths and weaknesses? Are their any emerging opportunities or threats? Gather information on current demand, seasonality, buying patterns, etc. Consider changes in the business environment which would affect operations and profit potential. The seller may have access to industry journals and information. In addition, outside industry research will likely be necessary.
This checklist is not an exhaustive list of information to obtain about the business. Rather, it should serve as a starting point. As you carry out your investigation, you may determine other questions or needed information. In addition to obtaining information from the seller, you must also consider future plans under your ownership and how changes would influence operations and cash flow.
There are numerous details to consider before purchasing an existing business. Thus, it is important to conduct a thorough investigation to minimize the chance of "hidden surprises." Remaining objective as you carry out your investigation of the business is critical so that you can make the right decision as to whether or not to move forward or walk away.