Despite a sluggish global economy, the retail industry continues to see growth. The National Retail Federation's 2016 economic forecast, projects retail industry sales (which exclude automobiles, gas stations and restaurants) will grow 3.1 percent. This year's expected growth exceeds the 10-year average of 2.7 percent.
The industry's health, low barriers to entry and affordable asking prices continue to fuel interest in retail acquisitions. But not all retail businesses are shoo-ins for success. In fact, many retailers do not have the essential components needed for sustained profitability and growth. To avoid a poor investment choice, buyers should arm themselves with a list of smart questions.
What to Ask When Buying a Retail Business
Compared to other industries, the retail sector offers some of the most affordable opportunities in the business-for-sale marketplace. According to BizBuySell.com data, the median asking price for manufacturing businesses in the second quarter of 2016 was $510,000. On the other hand, retail businesses had a median asking price of $230,500.
However, affordability doesn't necessarily mean less risk for the buyer. In fact, the retail sector, like the restaurant category, has a notoriously high failure rate. And the rise of online shopping has only brought more competition to traditional brick-and-mortar stores. Before you commit to an acquisition, it's crucial to know what you're getting into. Be sure to ask the following questions:
- Is the lease transferable? The success of traditional retailers hinges on three factors: "location, location, location." Before buying a brick-and-mortar retail business, check to see if the lease in place is transferable. Some landlords are hesitant to assign leases to new owners, especially those that lack prior retail or small business experience. If the lease is transferable, check to see if it's long-term. If possible, try to negotiate additional options to give yourself at least ten years of contract length. If the lease is not transferable, carefully consider how a change in location might impact existing customers.
- What is the business worth? Although profitability always drives a business' asking price, inventory is one element that makes valuing a retail business more difficult. Sometimes a company's inventory is treated separately than the business' asking price. Other times, profit and inventory are combined. In either case, it's important to determine whether you believe all the inventory acquired is saleable. Be sure to bring up any inventory you believe will be hard to sell in negotiations.
When valuing the business, it's also important to look at the business' cash flow. Retail businesses typically sell for a multiple of cash flow, so it's important to confirm that the asking price is based on verifiable cash flow--and not the owner's personal estimate.
- Are you capable of identifying future product offerings? For retail stores driven by their product offering, buyers should be certain that they're capable of identifying the types of products their customers will want. If product curation is performed by the current owner, it may be worth seeing if they can stay on as a consultant or paid employee while you get more familiar with the business. Not all sellers want to be involved with the business after the sale, so make sure you bring this subject up early in the sales process.
- Does the business depend on a few key customers? You might be buying a store that looks very successful, but if it relies heavily on a few customers, you're taking a major risk. If key clients feel particularly loyal to the previous owner, they might be upset by new ownership and take their business elsewhere.
- Can you sustain successful vendor relationships? If possible, review the list of vendors the current owner works with. Contact these vendors for information about pricing and to get a sense of their relationships with the store. If major vendors feel particularly loyal to the previous owner, there's a chance they could jump ship once you take over, or at a minimum offer less favorable terms.
- What is the store's current reputation within the community and online? Quality customer service is crucial in the retail industry. Talk with customers to better gauge the store's reputation and consider how their perceptions might change once the operation is under new ownership. Take a closer look at customer feedback on websites like Yelp and other review sites to better gauge their online reputation.
There are many nuances to consider when buying a retail business. Enlisting the help of a business broker that knows how and when to ask retail sellers the right questions can help further protect your interests.