5 Signs You Shouldn't Buy That Business - Due Diligence Basics

INTRODUCTION:

Getting involved with businesses for clients regularly as a small business accountant and experienced business valuer, I get to see some businesses for sale that should not be touched with a forty foot pole! 

Here are some signs that should help you identify when you need to be extremely careful before you hand over your hard earned cash. Most of these will come out when you do your due diligence but you still should be on the look out for anything that doesn't seem quite right.

Figure 1: Beware of risky businesses! The higher the risk, the higher the return will be expected.

1. The Figures Provided Don't Agree To Tax Returns Or BAS's

Never buy a business on cash not declared! So many times people fall for businesses that apparently haven't put the cash through the business.

Financial and management figures should also be cross referenced to the business activity statements and tax returns for the past three years. If there are any differences these should be investigated.

2. Customer Numbers Are Declining Rapidly

Always do a thorough analysis of customers both number and per customer spend. If the business is highly reliant on a few customers there maybe a strong risk you won't get the return on your investment if they are leave the business, go broke or are bought out by somebody else.

Look to see if major customers are locked in with contracts and if so, get legal advice before determining whether they are water tight.

3. The Industry Is Predicted To Struggle

It's always a good idea to do your research from a high level before you buy a business. What is the outlook for the industry? Companies such as IbisWorld can provide you with an overview or you should be able to get these from your small business accountants Sydney and Dubbo. This is also particularly so if you are buying in an area or region you are not familiar with. If the region is slowly dying or the council has plans to allow a highway bypass the business location you are thinking of purchasing then you need to do some thorough investigating.

4. The Big Boys Are Coming To Town

Why is the business being sold? Is a big player coming into the region which could decimate the small business you are buying? If so, will you be able to compete by providing superior service or some other point of difference or will you be priced out of business?

Figure 2: Will the big boys hammer you or will you will be able to survive through a point of difference.

5. Return On Investment Given Asking Price Is Way Too Low

Always consider getting a proper business valuation done by an experienced business valuer Sydney before you go in and offer a price. Sadly I see instances where various advisors with little experience in valuing a business offer a "3 times profit should be about right!" Valuing a business like this is very scary so you should always consider getting an informed and knowledgeable opinion first.

Of course, price and value can be two completely different things but I would always want to know the value before I can work out if I want to pay overs or not.

A small business valuation will assist you to determine what the return on your investment should be given the risk. The higher the risk, the higher the return is expected and the lower the price. A higher price for a business will generally be paid where the risk of poor future performance is low.

A business valuer will always assess risk which will then give you an idea of what the return should be and therefore the price you should be paying given these risks.

Figure 3: Risk Versus Return

CONCLUSION:

There are many other signs that will send out danger messages before you decide to buy that business you have always wanted. Some of the above are the most basic.

Better to buy a business with your eyes wide open rather than to go in blind and pay the ultimate price!