Buying a business can be exciting. But before you buy one, train yourself to look for the telltale signs of a faulty deal.
Buying a business isn’t for the faint at heart. It takes equal parts courage and money, and it also requires time, ample research, and going with your gut.
If you’re thinking about buying a business, you probably know about the research part. There’s a lot of due diligence that has to come before signing on the dotted line. But in the end, you have to trust your gut, because even if you pay a hawkish attention to details, the best deals on paper can turn into the worst nightmares imaginable.
Before you buy a business, keep an eye out for the following telltale signs of a faulty deal.
This one is a no-brainer, but it’s one of the harder ones, because no owner will present themselves as dishonest. Instead, they may be actively honest with what they do tell you, but downplay valuable business-related information.
One area to look at will be the owner’s discretionary income. This is the amount of money that the owner takes home after business expenses. While the revenue may remain consistent, it could spell serious trouble for this business if the amount of owner’s discretionary income is declining.
It’s also a good idea to know what the owner plans to do after selling the business. It’s possible that the owner will set up a competing business and take their existing customers with them, while leaving you with the debt. It may be advisable to include a non-compete clause in your purchase agreement.
While drafting the agreement, be sure to also include a disclosure agreement. This obliges the owner to provide key information about the business that you’re buying, including lawsuits, liens, problems with vendors, and problems with employees. For more information on what to ask, read up on the most important questions to ask when buying a business .
2. Recent Developments
While performing your due diligence, make sure that you check for any recent or future developments in the works.
An owner may decide to sell because of new competition. Think Walmart located next to a mom and pop grocery shop. The owner may have received a heads up on a future development in the area, and is selling before the business loses value .
The competition may come from the inside. Perhaps a popular employee is leaving the business and will open a competing business with your current customers.
Also , be on the lookout for new, emerging technology that may render the business obsolete. You would have been a smart business owner to sell your video rental store in 2004 — and a very disappointed business owner had you bought that store, no matter how well it was doing at the time.
3. Poor or Failing Equipment
A deal isn’t a deal if you’ll have to invest a lot of money in replacing old, outdated equipment and furniture. Make sure to check all of the equipment in the store for working or usable condition. Replacing these items out of pocket can be an enormous expense, especially if you will have to do so right away.
You should also make sure that the business owns the furniture and equipment outright. Dealing with liens, leased equipment, and creditors can get messy quickly. Avoid it if possible, but at least make sure everything is on paper if it isn’t .
Ideally, buy a business with new equipment. Failing that, be sure to adjust the value of the business in accordance with replacing the necessary equipment.
4. The Money is Funny
This is where you’ll need to roll your sleeves up and check the financials. You need to match internal financials with tax files. Go back at least three years, but preferably five if possible. Compare the business’ financial statements with federal and state tax documents.
If something doesn’t match up, it’s a red flag.
Also, don’t settle for the business’ financial review of itself. If the business does not want to provide you with their tax information, it’s a definite red flag. Because this is a complicated process, hire a CPA firm to do the audit for you.
5. Not Up to Date with Taxes
As mentioned in the section above, it’s crucial to review a business’ tax returns, and not simply for checks and balances against their internal financial records. You need to make sure that the business has been paying their taxes. If not, you will be held responsible for this outstanding debt — and the government always collects.
Pay special attention to sales tax. Some local businesses, especially restaurants, have a tendency to under-report income to avoid higher sales taxes. This puts the business that you will now own in the uncomfortable position of state audit. If the state finds the business owes back sales taxes, it’s coming out of your pocket.
Check with your local department of revenue for a tax clearance certificate.
Final Thoughts
While there are a lot of great reasons to buy an existing business, make sure that you look out for these red flags in the process of your due diligence. Happy shopping.
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For additional information regarding Florida business sales, acquisitions and valuations, please contact Eric J. Gall at Eric@EdisonAvenue.com or 239.738.6227. Also, visit our Edison Avenue website at www.EdisonAvenue.com or my personal website at www.BuySellFLbiz.com.
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