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BUYING A SMALL BUSINESS

What to Look For in a Seller

So you're buying a business. You'll want to collect as much information as you can about the seller's business operations, finances and personal motivation.
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You have decided to purchase a business. This might be one of the most significant and expensive decisions you make. Acquiring another business is a life changing event with the end goal in mind to make money. You will have to call upon your team of experts including your accountant, attorney, and business broker to add it all up. In the simplest breakdown the seller sets a price based on both tangible assets (equipment, real estate, and inventory) and intangible assets (good will, client base, and supplier relationships). As the buyer, you must make sure all the research shows the potential for future earnings.

Regardless of how the deal is structured, as the buyer you need to collect from the seller detailed information about the company's business operations and finances. Oftentimes there are series of meetings—three or more—that take place between the prospective buyer and business seller. That initial face-to-face time is critical to the transaction. It is like the proverbial first date or first job interview.

There are two events that will actually be taking place. "While the buyer is learning more about the business operations of the company, the seller is evaluating the buyer to determine if they are experienced, financially qualified, and possess the necessary skills to successfully operate the company," explains Michael Fekkes, a Certified Business Intermediary and senior broker at Enlign Business Brokers in Nashville. "Therefore, a rapport or chemistry between both parties will greatly assist this information, exchange and create a solid foundation for the relationship."

In order for the deal to work out, there also needs to be a motivated seller. "If the business owner's attitude is 'I don't care if I sell the business or not' then that is not the level of motivation that a buyer wants," says Richard Parker, founder and president of Fort Lauderdale-based Diomo Corporation-The Business Buyer Resource Center, and author of How To Buy A Good Business At A Great Price. You want someone who has a certain exit date in mind, he adds. Find out from the owner, what will happen if he or she doesn't sell the business? You want know why is the owner selling? Typical answers are retiring, poor health, other business interests, or burn out.

There are four key areas (performance, management, transition, and finance) a buyer should focus on as well as list of questions to ask of the seller. Here is a quick reference point from which you can get started.

What to Look For in a Seller: Performance

"It is important to understand what the trends of the business are from a revenue standpoint and as an adjusted earnings standpoint," says Fekkes. "Looking over three years worth of financial documents is the most important thing the buyer should be doing as well as gauging if their experience, expertise and background will make them a suitable new operator for that business."

Some questions you should ask:

•    What have been key drivers to the performance of the business over the last three to five years?
•    What would your customer's say the company does poorly and extremely well?
•    What are the greatest opportunities and challenges that will impact the future potential of the company (i.e., industry trends, new products, new markets, or new technology)?
•    What percentage of revenue does each of your top five customers comprise?
•    Who are your major manufacturers and vendors that the business uses?
•    Do any of your suppliers represent more than 10 percent of your purchases?
•    What percentage of revenue does each of the top products and/services comprise?
•    What percentage market share does the business have? How has this market share changed over the years? What factors led to this change?
•    Who are the top competitors in the market?
•    What actions need to be implemented to grow the revenue and profits of the business? Why hasn't the business seller pursued these actions previously?

By asking what do your customers say your company does best and worst this forces the seller to tell you about the business through the eyes of the customer, says Parker. You are more likely to get objective answers, because the seller will respond based on customer feedback. "Why do your customers say they buy from you? This is another great question."

Finding out what percentage of revenue each of the top customers or clients represent is crucial because a quandary for buyers is that often the owner is in essence the business. "When that is the case you will have certain clients represent a disproportionate amount of the revenue, because the owner has grown that particular client through personal relationships," explains Parker. "What happens if those clients or customers stop buying from the business once you take over?"

Dig Deeper: How to Evaluate Your Company's Financial Position

What to Look For in a Seller: Management

"My favorite question to ask the seller is 'what keeps you up at night?' Anybody that tells you nothing is lying," Parker says. This question will help you drilldown immediately to core issues, challenges, problems or concerns related to the business. "I find that sellers are more likely to give you honest answers this way."

Other questions you should ask:

•    What is it that you do everyday? How much time do you spend on company business?
•    Who are the key employees or managers that are critical to the business?
•    Have they signed non-compete agreements? Will they sign an employment agreement?
•    Do they know the business is for sale? If so, what are their thoughts on this matter?
•    Do you have organizational chart of all employees?
•    How long has each individual been with the company?
•    Has there been any significant turnover?
•    What do you like the most and least about managing this business?

Parker also suggests finding out what the seller says he likes best and worst about the business because that will tell you where the problems are usually. "If they say they don't like dealing with the accounting side. Well the books and records are probably in disarray," he says. "Or they may say finding good people; that tells you there are some employee issues."

Dig Deeper: How to Build Your Management Team


What to Look For in a Seller: Transition

"A major concern for the buyer should be how is this business going to transition," Parker says. "Probably the single most important factor a buyer has to consider is how is this business going to operate with me as the new owner. And what looming threats are there?"

Some questions you should ask:

•    When you first started the business, what were your top three goals for the business and did you accomplish these goals? How have these goals changed over the years?
•    How long have you been preparing for the sale of your company? What was the catalyst?
•    Do you have a transition plan in place?
•    What do you plan on doing after the business is sold?
•    How would customers, vendors and family members react to the sale of your company?
•    How long are you available to assist with the business or training after the transaction?

Fekkes says it is important to find out if the owner has an updated business plan and under what conditions would it be made available for review. "My notion of being a successful business operator is that when you started the business you had a business plan that outlined what you wanted to accomplish and you constantly updated that plan according to changing circumstances," explains Fekkes, who also serves as a SCORE counselor. There is generally a six-week transition period for the seller to get the new buyer up to speed. Ideally you want to have handed over to you the business plan and the transition plan. "Having those two documents add value to the buyer. There is no way the seller can convey all of the necessary information about the business," he adds.

Dig Deeper: Are Your Customers Loyal to You or Your Business?

What to Look For in a Seller: Finance

How much will the seller finance? This is a question that needs to be addressed up front, says Parker. "Deals get done these days through seller financing." Over the last two years, many banks and finance companies are requiring that the seller give a certain percentage of financing to ensure that they have a vested interest in the business and to reduce the risk of the buyer's default on the bank note.

Other questions you should ask:

•    What percentage of the purchase price would you be willing to finance?
•    Are you willing to discuss creative deal structuring (e.g., earn out or employment/consulting agreement)?

When asked about seller financing during the first five minutes, Fekkes says his answer is generally something as follows: "The seller is willing to provide some component of owner financing based upon the T&C's of the deal, transaction price, and related industry experience of the buyer." He adds, "A seller should never negotiate owner financing without having a better understanding of the buyer and the terms of the transaction."

Overall, you should be prepared to know all of the drawbacks. Any time you spend evaluating a business to buy should involve considering the negatives at least as much as the positives, Parker says. If you know the problems ahead of time—slow deliveries from suppliers, ineffectual marketing campaigns, or poor relationships with industry regulators—you will know what needs fixing.

You need to do your homework before moving on to an offer, so be sure to get enough information in that initial face meeting to conduct further research. If you take away anything, adds Parker, it should be the answer to these four questions:

1) Do I like the business?
2) Can I see myself running it?
3) Do I like the seller?
4) Do I trust the seller?

The fist two answers will provide you some clarity about the next steps to take. "If you like and trust the seller, chances are you both will be able to work through any and all challenges that will arise," Parker explains. "If the seller believes that you can not only get the deal done, but also run the business successfully, they will go out of their way to make the deal happen."

Dig Deeper: How to Finance an Acquisition

Last updated: Jan 31, 2011




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