Three Risks of Buying a Business & Profiting off the Opportunities they Create
Why start from scratch when you can get a great deal on what someone else started?
In today’s sexy startup culture, buying an existing business has lost its vogue. But every year thousands of entrepreneurs become millionaires by buying and growing businesses without the startup headaches of venture capitalists, zero revenue, and no business processes.
If you like the idea of being the sole business owner, improving an okay business and taking things from good to great, buying a business is probably the best opportunity for you. Since every reward comes with risk, I have put together the top 3 risks I see first-time small business buyers face, the profitable opportunities they present, and the diligence to find these opportunities.
Risk 1: The business owner IS the business
The owner of the business is a lynchpin. They make all the sales. They manage all the customer relationships. The employees depend on their expertise and training. If you remove the owner, the business struggles and collapses.
Use this as a negotiating point when bargaining for the deal. If the business IS the business owner, then that person needs to be part of the deal. Structure the buy-out to include an employment contract or consulting agreement, as well as an earn-out. That way the ex-owner is incentivized to hand-off their knowledge and help you succeed.
Interview customers, vendors, and employees. Listen to if they mention the business owner’s name more than the business name itself. Ask employees questions about their job and see if they know the answer, or if they look to their boss for the answer. Review the org chart for an ops manager and sales person who have been in the business a long time.
Risk 2: The employees will flee after change of ownership
You buy the business and all the good employees get scared and quit.
Use the change in leadership to inspire hope and motivate. Or, determine who is holding the organization back and needs to go. Firing bad employees will make the good ones optimistic of a turnaround. For the good ones, challenge them to help grow the company and incentivize them to stay through promotions, profit sharing, or equity.
Work with the current owner to identify key employees. Be your own judge of this, in case the owner is downplaying any key people. Sales, engineering, and operations are typically critical areas. Meet with key employees in advance, if the owner permits, to discuss their ongoing role in the organization and align expectations. You’d be surprised how simply listening to and reflecting the feelings of employees will make them feel more comfortable and taken care of! Ask about the company culture and decide what parts to keep. They may also give you keen insights about the strengths and weaknesses of the company.
Risk 3: Running out of cash
You base your purchase price, valuation, loans, and cash forecast off historical financials, only to find out a few months into owning the business that the numbers were all wrong and you are losing cash.
Negotiate a better price on your deal with findings in a due diligence report. Use the cash forecast in the report to secure better terms on your business loan or lock the owner into seller financing. You can even persuade the seller to pay for the cost of accounting clean-up or bad inventory.
Hire financial professionals to help with your due diligence. This team will research key areas like unpaid payroll taxes, incorrect accruals, bad inventory accounting, and other ways owners can exaggerate their financials, either intentionally or by accident.
Turn these risks into opportunities by performing smart diligence, and you too may become one of the small business millionaires without starting from scratch.
LJ Suzuki is a fractional CFO with CFOshare, an outsourced finance and accounting department for small businesses.
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