If you are buying a business, and you don’t do incredibly thorough due diligence, you should have your head examined. You should have hundreds of questions when buying a business that you want to ask the seller, and you shouldn’t stop there.
Nothing is more reckless than throwing a big chunk of your life savings into a business without making absolutely sure you aren’t buying a total lemon. You may have heard the statistic that 98 percent of new small businesses fail. The odds are not in your favor, so you need to do what you can to improve your odds.
Although a business can be wildly successful and bring you great riches as well as tremendous satisfaction, you will be fighting an uphill battle if you buy a business that doesn’t have the tools in place to succeed.
Every business is different, and will require a unique approach to performing due diligence. But here are 10 general questions you should ask before you buy any business:
10. Does the Business Have Existing Liabilities?
Want to buy a lawsuit? You might be doing just that.
Any business that has been up and running for awhile could have liabilities, ranging from unpaid overtime to potential sexual harassment claims to personal injury claims.
It could be that the person who is selling the business knows something you don’t know, and hasn’t disclosed something significant to you. Or it could be that the business owner didn’t even know that the cooks in the back of the restaurant were sexually harassing the waitresses.
You can’t buy the entire business in its current state without buying both the assets and the liabilities. However, you may be able to buy just certain assets of the business instead of buying the entire business. If you can buy the business assets, you will be better off.
9. Have All the Taxes Been Paid?
You want to be sure the business has been paying all of its taxes over the years.
If the business is a services business, then the taxes will be less significant. If it’s a retail business, there could be substantial sales tax liabilities. This is especially likely to be true if the business deals in a lot of cash transactions. Either way, if the business has employees then it needs to pay payroll taxes. If the business hasn’t been paying these taxes, there’s a risk the business could be audited even a couple of years after you’ve purchased the business when the seller is long gone. You would be left paying for years of unpaid taxes, effectively reducing the purchase price of the business you bought much after the sale went through.
8. Are there any Problems with the Existing Lease?
If the business is leasing commercial space, you should look closely at the business’s existing lease agreement. Most commercial real estate leases are drafted heavily in favor of the owner/landlord, and require the approval of the owner/landlord for any assignment of the lease. Make sure you don’t close the sale before you have secured the owner/landlord’s approval of the assignment of the lease. The owner may also require a lot of proof that the incoming business owner (meaning you) has the financial ability to pay the rent. So get ready to turn over those tax returns.
The property owner could also require that the seller remain liable for the debt for the duration of the lease. That may not impact you, but to the seller it may come as a surprise. Needless to say, this could be a major barrier to finalizing the sale of the business, so you should be sure to clarify whether this will be required.
You may want to read more about tips for negotiating commercial leases if you are a small business.
7. Is the Business Scalable?
This may not matter to some new business buyers, but it’s an issue you should consider. Are there expansion possibilities for the business, or are there limits imposed by the nature of the business? If the business is structured so that it can’t possibly expand beyond its current size, then you may be stuck in the grind, working every day just as if you were an employee.
For example, a one-on-one consulting business can’t possibly scale up because it will always require one-on-one service. By comparison, a business that produces and sells a piece of software is highly scalable, as you only need to pay the cost of reproducing the software to sell many more copies.
6. Is Your Spouse OK with you Buying the Business?
Owning and running a business will affect all of your friends and family members, but no more so than your spouse. In order to make sure your business is a success, you will need to put in significant helpings of time and energy, and your job will be infinitely harder if your spouse is not supportive. Make sure you have a serious conversation about the time and energy you will need to put in very early on so that these issues aren’t a source of friction later.
5. Are Old Customers Coming Back?
The #1 source of new business is old business. You will have a much easier time getting previous customers to buy again than you will getting new customers to buy for the first time. For this reason, you should have a sense of how many buyers are first time buyers and how many are repeat customers. If the business’ current customers are buying once and not coming back, you should figure out why this is happening.
While you’re at it, be sure to bone up on ways you can continue to get business from past clients and grow your small business.
4. Are you Able to Handle Tedious, Repetitive Tasks?
One of the difficult aspects of running your own business is that you may have to regularly work on tedious, repetitive chores which are integral to the business. For example, if you have a passion for baking and love baking more than anything else, then you buy a bakery, you will still have to pay bills and balance the books each month without fail, and you may still have to clean up the shop each night or clean the front step every morning.
It is possible to hire employees to handle much of the repetitive tasks, if the business is large enough. If you can’t hire employees or outsource the repetitive tasks which go hand-in-hand with being a small business owner, you may want to think twice about whether you would be better off as a bakery employee rather than a bakery owner.
3. Have You Checked Online Reviews?
Many businesses, particularly in the retail sector, live and die by customer reviews on any one of dozens of social review-sharing websites such as Yelp, Urbanspoon, or Citysearch. If your business is one which will be affected by the quality of reviews posted online, you better take a look around to see what reviews are currently shaping the public’s perception of your potential new business.
If there are too many negative reviews to overcome a past negative perception, you may benefit from throwing out the name and theme of the existing business and re-branding as a “new” business, even if everything else stays the same.
2. Can You Keep the Seller Involved?
The Seller is going to be one of the most, if not THE most, knowledgeable person about your business. Before you negotiate the purchase agreement, you should consider keeping the seller on board for at least 6 to 12 months to help with the transition period.
Given the lack of availability of credit right now, you might want to see if the seller will finance at least part of the sale of the business. Between financing a portion of the sale, and remaining working, the seller will have a vested interest in making sure the transition goes smoothly.
1. Is Buying This Business Right Now the Best Decision?
Even if you are completely convinced you are ready to buy, take a step back and ask yourself if this business acquisition is truly the best fit for you. If you are bored or just looking to try something new, then perhaps you want to sleep awhile on this decision.
Do you have any other good suggestions for questions you should ask before buying a business? Feel free to share them in the comments below.
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John Corcoran is an attorney with Plastiras & Terrizzi in San Rafael, California (Marin County). He advises clients about real estate/land use, general civil litigation, and small business matters. He can be reached at (415) 250-8131 or firstname.lastname@example.org.
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