"But if I'm the buyer, I want all the assets and no liabilities. I want all the good stuff, and the bad stuff is yours. Maybe I will take some liabilities, but only those you tell me about."
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12. Don't skimp on due diligence.
During this phase, which can take several weeks or even months, you essentially ascertain whether what the seller has told you is true. Exercise extreme caution, and assemble the finest team you can afford. There is no substitute for top-notch advisers.
You need an accountant who understands how small businesses keep their books. You also need a lawyer to examine all papers and to check on any liens, litigation, or tax problems. Has the company ever been audited by the IRS? If the seller doesn't know, find out. "Be aggressive as a buyer on the tax side," counsels Pravda, "because it can really come back to bite you."
You can also be hurt by misunderstood inventory values. When Dennis Houser bought B&P Duplicating Ser-vices Inc., in Ormond Beach, Fla., four years ago, he thought he'd save money by relying on an audit by the seller's accountant. "It wasn't far off," he says, "except that the inventory that showed on the books was obsolete junk. I looked at it myself but didn't know what I was looking at." Consequently, when he bought the business for $310,000, he overpaid by $100,000. "It was just from stupidity and ignorance," he says now.
Beyond that, get lists of major customers and suppliers. Evaluate their relations with the business. Check for long-term purchase agreements. And evaluate the company's, and the owner's, reputation in the industry. Talk to competitors. The more you know, the better off you are.
Last, if there is any chance of environmental liability, have an expert conduct an audit. If you buy a business that ends up in a lawsuit -- even if the damage happened long ago -- it will likely be your problem now, and it can put you out of business.
Investigating all that is tedious, but you must be relentless.
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13. Be skeptical.
This point can't be overemphasized. Even if you love the company, look for reasons not to buy it. Base your decision on fact, not emotion; this is probably the biggest financial event of your life. "I was not skeptical enough. I looked for the positives," says Frank Agliata of Volusia Van & Storage. "That was a mistake."
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14. Don't forget to assess the employees.
You're not just buying a company; you're also buying the people. Give serious thought to who they are. Are they bright and competent? What are they paid, and exactly what do they do? Is there good chemistry -- are they the sort you'd invite home to dinner? And do they seem honest? Several years ago a Virginia woman bought a natural-foods store. The clerk, who came with the deal, had a strong rapport with the customers -- so strong, in fact, that she started selling them natural foods out of the back of her car. It took the new owner, baffled by plummeting sales, three months to figure out what was happening.
Meet with employees individually, without the seller. They can tell you things the seller never would. "I chatted at length with all of them," says Frank Shannon. "Before I'd buy any business, I'd want to do that."
Be aware that they're concerned about their jobs -- a change of command can be traumatic. So provide whatever assurances you can. Unless the company is tiny, you can't run it without key people. If their allegiance is to the old owner, will they stay?
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15. Make sure the final price reflects the real value.
There is no magic formula for valuing a business; in truth, even the owner usually doesn't know what the company is worth. Nor can your accountant tell you. Nor your lawyer. Setting the price is as much art as science, but there are some guideposts. David Bishop, president of American Business Appraisers, based in Sunriver, Ore., suggests thinking of a business as a money tree. It exists to bear earnings.
First, define which earnings base you're dealing with. Are you talking about earnings after tax, after depreciation, and after interest on debt, or before those items are deducted? The owner's compensation -- at fair market value -- should enter the equation, too.
The next step, Bishop says, is to come up with a multiple for that earnings base. It likely will fall between one and eight, depending on variables. If 80% of sales are to one customer, for instance, the company's earnings are more at risk than if sales are broadly based. If the company has equipment and vehicles that could be liquidated to recover much of your investment, it's worth a higher multiple than a service business with few hard assets is. Does it have patents, copyrights, or proprietary technology? What is the level of competition? How elastic is the demand for its products?
Let's say you've weighed all the factors, and the seller insists on getting eight times earnings, while you think a multiple of five is more realistic. What then? You can hire a certified appraiser, pay $4,000 to $10,000 for a comprehensive report, and wait 30 days for it. Or you can negotiate.
But be careful. "One of the main reasons businesses fail once they are bought is that their real value has never been identified," Bishop says. "Price and value get distorted. If the buyer is overloaded with debt that the company's cash flow can't service, both buyer and seller lose. If the buyer defaults, the seller never receives the great price he thought he got."
Throughout the process, the old saying applies: let the buyer beware. If you execute all the steps well, in the end you'll own a business. Then all you'll have to do is make it work.
GETTING IT WRONG
How buyers sabotage their companies before even closing the deal
There is no end to the errors of commission and omission made in the buying of businesses. It's a complex procedure, and you don't get to practice -- most people do it only once. How do business buyers most frequently undermine their chances to succeed as owners?
