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5 Things You Must Do if You’re Buying a Small Business

February 13, 2017

If you are planning on buying a small business, you’ll be making a lot of new connections. A move like this can net you new assets, new employees and a new income stream. All of these are beneficial in theory. However, purchasing a small business is a big step that often entails taking on significant risk. Here are five steps you must follow to limit that risk and avoid buyer’s remorse.

1. Pick the Right Business for You

While some might consider this obvious advice, you’d be surprised how many people buy small businesses solely based on top-level financial considerations. Just because a company operates with a high profit margin, for example, doesn’t mean it’s necessarily the right business for you. Can you maintain your interest in running this type of business for the long term? If not, you may not have the motivation to really give this business the attention and care it deserves. If you’re managing a business within an industry that interests you personally, you’ll likely expand faster, engage with your customers better and make fewer mistakes. Be realistic about your management abilities, and don’t overextend yourself. If you’re used to managing three or four people, you might not have the skills to manage a crew of dozens. Even if you were born with immense management talent, it takes time and experience to truly learn any skill. You can be ambitious without setting yourself up for failure.

2. Put Together a Team of Experienced Professionals

Once you’ve picked your industry and the business size you’re suited for, you’ll need to put together a team to help you narrow down your choices further. Your team will consist of professionals who can help you make sense of the voluminous paperwork you’ll receive from each potential seller. Attorneys, bankers and accountants are all great candidates for this team. These individuals can help you accurately estimate what a business is worth, which is generally less than the seller’s initial asking price. A business broker can also prove helpful for filtering out businesses that don’t deserve your consideration. Still, you should be careful when choosing a broker. The broker doesn’t get paid until you purchase a business, so some brokers might pressure you to sign on the dotted line prematurely. Realize that it can take years to find a company that matches all of your criteria. Patience is a must if you want to avoid making a buying decision you’ll regret for the rest of your life.

Note that when and if you do succeed in buying a business, you’ll want to make sure cyber security is a high priority for all senior leaders. To learn more about cyber readiness, check out Hiscox’s Cyber Readiness Report 2017.

3. Buy a Company With a Great Reputation and a Solid Future

When you’re initially meeting a seller, don’t take everything you hear at face value. However personable and accommodating the seller might seem, there’s no denying that you and the seller have different prevailing interests. As part of your due diligence, acquire a credit report for all individual owners and for the company as a whole. Speak with customers and suppliers directly to gauge the company’s real-world reputation. Does the company you hope to acquire have business insurance? If not, this might be a warning sign that the current owners tend to cut corners. They might also cut corners when it comes to disclosing vital information you need to make an informed decision.

In some cases, excellent past performance might not be enough to assure you that a particular business is a good investment. For example, emerging political or macroeconomic trends can create uncertainty around heretofore successful industries. In cases such as these, you can protect yourself by insisting on performance criteria for sale closure. In this type of arrangement, the business has to meet specified performance goals within a predetermined trial period. If the company performs as hoped, you’ll have the confidence to move forward with your investment.

4. Avoid Shortcuts When It Comes to Due Diligence

Before buying any business, have the owner provide past financial statements and projected future statements, which are known as “pro forma” statements. This is where your accountant can provide crucial assistance by identifying errors or questionable numbers. Don’t commit until all of your questions are answered completely. Dig deep and make sure you receive complete and accurate information about all prospects.

5. Negotiate the Buying Price From a Position of Strength

Once you’ve determined the business you’re sure you want to buy, you must negotiate from a strong position. Setting the conditions for a great buying price starts long before you sit down with the seller for a face-to-face negotiation. One way to negotiate from a position of strength is to find a seller with distressed finances and a strong incentive to sell sooner rather than later. Put the word out that you’re looking for this exact type of seller. Networking is key for this step, and so is patience. It’s ideal if you can network with financial professionals, most of whom have a few clients who fit this bill. While it’s not ethical for financial professionals to give you specifics about any of their clients, they can certainly put clients in touch with potential buyers. Though much of the buying process involves following mechanistic patterns, negotiating the final buying price requires imagination and perhaps even a bit of showmanship. As with any kind of negotiation, you don’t want to look too eager to close the deal. Even if you feel desperate to finalize the sale, you’ll want the seller to think that walking away is still an option for you. Be honest with yourself when assessing your ability to “stay in character.” If you don’t think you can manage it, consider using a surrogate. Better yet, you can just broaden your list of finalists and genuinely lose any unhelpful attachments. Finally, confidence is important for any negotiation. You can gain confidence by practicing beforehand what you’ll say and how you’ll respond.