Purchasing a business represents a substantial investment, yet many buyers are ill-equipped to make a truly informed decision. As a result, even if you are among the well-prepared few who have done some form of due diligence before making an offer, your "gut feeling" could very well lead you astray. So, how can you address this challenging situation?
At CMP, we work with business buyers daily to help them develop better and more thorough strategies for making informed purchases. This post will discuss 15 questions that every serious buyer should consider before acquiring a business.
So, let’s get right down to it.
What Questions Should I Ask When Buying A Business?
Questions About Financial Health
Need a clear picture of the business's finances? Here are some key questions to help you get the details:
1. Can I Review the Business's Financial Statements?
A business's viability is assessed primarily and fundamentally through its financial statements. If you want to know a business's worth and understand why it is where it is today, then it is important to know what those financial statements say.
For instance, an income statement provides insights into a company’s earnings, expenditures, and profitability over recent years, which can help calculate various profitability ratios. However, to determine the viability of this profit, a detailed review of the balance sheet is essential. The balance sheet offers a comprehensive snapshot of a company's worth, detailing its assets and liabilities.
2. Are Tax Returns Available for Review?
Reviewing a company’s past tax returns provides a detailed account of its financial history. Tax returns are a reliable data source because they are consistent across companies, and you can verify that the financial statements provided by the seller are accurate.
The tax return also includes information about whether the business has paid fines or settled disputes with the government.
3. What Is the Annual Gross Revenue and Profit Margin?
Understanding both revenue and profit is essential when assessing a business's performance. A company may generate substantial revenue yet have little to no profit. It's important to understand the main drivers of a company's income and how much of that income is left at the end of the day.
Understanding revenue and profit is essential for assessing a business’s financial health. Even with high revenue, a company may struggle to achieve substantial profit. How does a Safe Harbor retirement plan work in this situation? This plan simplifies compliance by ensuring contributions and eliminating much of the annual reporting, making it a valuable tool for growing businesses working to maximize profitability.
4. Are There Concerns About Cash Flow or Profit Margins?
Investigating potential financial red flags is crucial when buying a business. The cash flow statement provides valuable insights into a business’s cash management, showing how money is generated and used. It helps identify whether the business struggles with cash shortages or inefficient cash management.
However, while the cash flow statement reveals how well the business manages its revenue, it does not directly reflect profit margins. Profit margins are better assessed through the income statement, which details revenue, expenses, and net income. A poor profit margin might indicate high costs or pricing problems. By examining both the cash flow statement and the income statement, you can gain a comprehensive understanding of the business's operational health and financial stability.
Questions About the Business Owner and History
Learning the owner's motivations for selling can tell you a lot about the business. It's central to grasping the past, present, and future of the establishment.
5. Why Are You Selling the Business?
It's important to understand the motive behind the seller's actions. The query "Why are you selling?" might seem simple and obvious, but it is an excellent gateway to gaining what could be transformative business intelligence. The seller's response to that question can offer a range of insights about business opportunities and challenges when integrating the purchase into your operation.
If a business owner says they're selling because of financial troubles, you should be very careful. That's a huge red flag. But if they want to retire, you have less to worry about. Retirement is one of the more common reasons for selling a business, particularly with the Boomer generation.
There are many other reasons somebody could be selling a business, and while you may not get a completely transparent response, having this information is key in order to make a decision. If the seller is hesitant to disclose why they put their business up for sale, this may be a reason for concern.
6. How Long Have You Owned the Business, and What Is Its History?
A business's long and stable history can reveal a lot about its origins and the path it has taken to get here. A long and successful history can also create a feeling of trust in the community. If it has been around this long, chances are, it may be doing something right!
7. Who Are the Current Business Owners, and Are There Multiple Owners Involved in the Sale?
It’s important to understand who owns the business. Having more than one owner can often complicate making important decisions or changes, especially when there are conflicts of interest.
Questions About Assets and Liabilities
Understanding what assets are part of the deal is vital. Also, asking if an independent auditor has appraised the business can provide a clearer picture of its true value.
8. What Assets Are Included? Have You Ever Had the Business Appraised by an Independent Auditor?
When buying a business, you must know the assets that are and aren’t included. Assets can be divided into two main categories: tangible things, such as equipment and real estate, and intangible things, such as intellectual property.
You have to do some pre-purchase due diligence to guarantee you aren't overpaying and to familiarize yourself with any potential value discrepancies. It's advisable to seek the services of an independent third-party appraiser for an impartial take on the business's assets. If the business has been appraised before, it's worth scrutinizing the report. If not, consider paying for your appraisal. CMP can help you with a business valuation.
9. What Liabilities Do You Have?
Liabilities can include outstanding debts, legal obligations, and other financial commitments that may impact the business's financial stability. Identifying these liabilities is essential to avoid inheriting unexpected costs.
Uncovering all liabilities helps ensure you’re not caught off guard by hidden debts or obligations. Ensure any liabilities not included in the sale are addressed and resolved before finalizing the purchase.
The principle of successor liability means you might inherit unresolved obligations if the seller doesn’t settle them. Confirm that all liabilities are documented and dealt with to prevent additional financial burdens post-purchase.
Questions About Day-to-Day Management and Operations
Explore the business's daily activities by identifying its top clients and determining how it makes money. These insights reveal what drives profitability and keeps the business thriving.
10. How Does the Business Generate Revenue, and Who Are Its Most Profitable Clients?
The revenue model of a business reveals how it earns its income and identifies the primary sources of revenue.
Knowing the most profitable clients provides insight into the business’s key revenue drivers. This highlights significant relationships and the sources of its financial strength.
Additionally, being aware of the dependency on major clients helps assess the risk of a crucial client leaving. This information is critical for evaluating the business's stability and growth potential.
You’ll want to know how much of your revenue your major clients make. Having too few clients that are propping up your financials could be a major issue if they decide to stop doing business with you.
11. What’s Your Marketing Plan and Do You Track Its Effectiveness?
The company's marketing plan can be used as a basis for the study of its acquisition and retention of customers. Its marketing strategy outlines the tactics and campaigns it uses to generate leads and sales. Judging the success of these approaches can be done using certain yardsticks.
One is the cost of customer acquisition, or, on the flip side, how much it takes to secure a new customer. Another is the conversion rate, that is, how many leads it takes to get to one sale. There's also the issue of return on investment (ROI), as in how the company's marketing efforts are doing for the money spent. Understanding these issues will provide some insight into the effectiveness and efficiency of the company's marketing plan as it currently exists.
Is the company currently using any of these online marketing strategies? If not, it could be a good opportunity to grow the new business further. However, it’s important to understand your ideal clients and whether they are even ‘online’ during their buying process.
It should be noted that an online presence shouldn’t be neglected in nearly every industry today.
12. What Are Your Payment Terms and Average Time to Payment?
Being familiar with the payment cycle is critical because it directly impacts a company's cash flow. A good cash flow is one of the foundations for a healthy business.
13. If Necessary, Are You Open to Staying On for a Short Time to Ensure a Smooth Transition?
The change of ownership must take place without a hitch. When the old and new owners work together, day-to-day operations are more likely to continue smoothly.
Of course, there are exceptions to every rule, and if the current owners have had a negative impact on employee morale or customer relations, it may be best to simply cut ties with them and not have them stay on.
Questions About the Market and Competition
Ask about the business’s main competitors and market to understand its competitive edge. This will help clarify its position in the industry.
14. Who Are Your Primary Competitors, and What Is the Business’s Market Share?
Many enterprises fail because they neglect to research their competitors thoroughly. You must be very familiar with your competition to beat them when buying a business.
15. What Is the Outlook for This Industry and Business?
It’s crucial to examine the industry's prospects when trying to understand its long-term possibilities. This kind of forecast can help you understand how industry trends, growth rates, and even new opportunities or challenges might emerge.
When doing this, it's also vital to understand the company's position in the industry. Is it well-positioned to capitalize on the industry's long-term trends and enjoy future growth, or is it stuck in a rut? In any case, this tells you a lot about the firm's future.
Are there any technological advancements that could negatively impact the business? The last thing you want is to invest in a company and have technology make it all but obsolete within a few years.
Conclusion
Don’t be afraid to ask the right questions and hard questions when buying a business. Yes, you may ruffle some feathers, but this is your livelihood. If that’s what it takes to get the answers you need, then so be it. These fundamental inquiries are key to the decision-making process and help uncover all the essential details about the business you intend to buy.
Don’t shy away from eliciting advice from legal and financial professionals during the discovery phase of buying a business. When you pay attention to detail and have comprehensive insights into all the essential aspects of business, you can ensure a fair deal and the promise of long-term success as the new business owner.
Don’t be afraid to walk away from a deal because you can’t finish due diligence, or once it comes back, you aren’t fully satisfied with the price of the business.
At CMP, a trusted Utah CPA firm with locations in Salt Lake City, Logan, and as a CPA firm in St. George, we specialize in business consulting, financial audits and reviews, business valuations, and more. Our experienced team is here to help you make informed investment decisions and achieve your business goals. Contact us today to ensure your acquisitions are both strategic and successful.
