Do your due diligence – things to look for when buying a business
In 2017, PwC surveyed 2802 family businesses in Australia and found that they planned on selling their business or listing if publicly at a rate twice that of the global average. Rather than aim to hand over their businesses to their children, many family-run businesses today seek to monopolise on the success of their business and push their children towards other avenues for success in and outside of business. Without a hungry market, this could not be possible, so what is the main reason Australians love to buy existing businesses? Risk.
Starting a new business is famously difficult, but of course can result in the greatest returns as a longterm investment (hence PwC’s findings), but buying an existing business mitigates the risks associated with starting a new business, allowing buyers to enjoy the benefits of the lessons learned by original owners in terms of the processes that underpin a successful business.
As a buyer, what then do you look for in a successful business that will maximise this benefit as opposed to starting your own business?
Transparency in finances
This is, by far, the most important thing to look out for when considering an existing business to buy.
You will need a good accountant to assess the financial statements of the business for the past 2-3 years. If they have been audited, this makes the process easier, but if not, then you will need to gain access to physical evidence of these transactions, such as bank receipts etc.
Acquire a full list of suppliers, if this is relevant, and check each one off in terms of inventory within the business as well as contacting these suppliers to see whether the business has paid them regularly, on time, and whether they are in debt to them. See how prices have increased over the years for these suppliers and check against their own competitors’ prices to see whether the business has room to decrease running costs associated with inventory.
Acquire receipts of associated assets in the business. One of the most important industries for this is within hospitality. Restaurants, bars, and cafes are nothing without their physical assets (coffee machines, kitchen etc.). You need to see how much they were purchased for, when this occurred, the frequency of repairs etc., and physically inspect the assets to check for longevity. This applies to any business that relies on physical assets (computers, equipment, machinery).
Workplace or customer reviews
Gain a sense of customer satisfaction in the business, whether it be in terms of longterm customer numbers (the business should have clear and evidenced proof of customer numbers through their financial records and other sources, such as website analytics) or other sources, such as online reviews and local neighbourhood sentiment. This is where you need to immerse yourself in the local ecosystem to ascertain how the business is valued by its customer base.
How have they paid their staff?
Look at how wages have changed in the business. This will reveal more about the health of the business than almost any other metric, as it is often the first thing to be sacrificed by a struggling or mismanaged business. If they have barely changed in years, you have reason to ask why. Do the wages match industry standard and how are they distributed within the business. Are there those that receive incomes that do not match their expertise and experience? Wages are one of the most important indicators of healthy business management, so make sure to focus on these.
What does the competition look like?
Is the business at risk of becoming irrelevant through technological advancement? Are there clear oppotunities for growth and innovation? Where does the business sit in relation to its competitors, and are there clear ways in which it can meet the challenges of competing?
How does the business generate growth?
Does the business rely solely on word-of-mouth, which can be a reasonably and effective method to generate ongoing growth, or does it diversify how it approaches the growth of its customer base? What is its history of paid spend on growth (i.e. advertising, whether online or offline) and how has the owner approached the strategy behind paid growth. If there is a significant amount of paid advertising, you will need to try to ascertain to what level business is generated solely by advertising and what is generated by returning business. One that relies solely on new customers/business is not building goodwill, which gives you power to negotiate.
What are the business processes?
How does the business function on a day-to-day basis? This is the best way to identify areas that are in need of improvement or those that may give you reason to look elsewhere for investment. For example, a startup may have inefficient management processes, which stifle innovation and keep the business from progressing. If there are issues within the business that you cannot find the source for, this may be a good reason to avoid its purchase.