Buying a business is a big deal (literally). The investor needs to research the company extensively, so their knowledge of all aspects of the business and its financials is as complete as possible. This due diligence work is essential to an accurate valuation and to not getting any nasty surprises down the track.
So, what does due diligence involve? Here’s an overview of the process and a handy checklist to get you started:
Buying a business can help you bypass some of the difficulties involved with building a business from scratch, but purchasing an existing business does come with some downsides and considerations to keep in mind.
When buying a business, you avoid one of the biggest traps of starting a new business: determining viability. New companies often go through a long period where the owners need to focus on making sure that the product, business model, or both are viable. When you buy an established business, you can generally skip this phase entirely — someone else has already done it.
Purchasing an existing business means you don’t need to worry about the initial startup expenses involved with securing a location, gathering supplies and finding your first employees. This frees up cashflow to focus on aligning the business with your vision and building on existing momentum.
An established business is almost always seen as a lower risk to financiers and potential investors. The reason is simple: it has a proven, real-world track record that can offer some indicator of future performance. This generally makes it a safer bet for lenders.
When you purchase a business, you often acquire that business' intellectual property as part of the deal. This has the potential to be much more valuable than the business itself. Many tech companies, for example, are explicitly acquired for their intellectual property, which can be incorporated into the acquirer’s software or become an addition to their software suite.
While buying an existing business might mean lower operating costs, you do have to consider the purchasing costs involved. When you buy an existing entity, you’re also paying for the existing customer base, branding, equipment, and intellectual property, along with all the time, energy and money poured into building the business and ensuring viability.
What this means in practice is that purchasing a business can sometimes be more expensive than starting a new business of the same type. This is especially true for companies that are well-established and profitable. Of course, the upside is that you get to bypass a lot of the uncertainty of the early stages.
When you build a business from the ground up, you become intimately familiar with its inner workings, as well as the industry. When you purchase an existing business, you have to learn about it after the fact. Not having this context can add pressure to day-to-day operations.
Although the due diligence process is extremely thorough in most acquisitions and business purchases, no process is perfect. There’s always the risk of buying into a problem that remained hidden before the purchase, whether intentionally or not. This could be as simple as equipment that needs replacing, or it could be more complex, like a poor brand perception. Once the purchase is finalised, that problem now also belongs to you.
One issue that perhaps isn’t acknowledged enough is resentment and negative feelings among employees of the business being purchased. Many organisations begin to feel a bit like family to the employees, and the processes and methods of the organisation can become deeply ingrained. As a result, staff may not appreciate new leadership or changes to the procedures they’re used to. This is a reality that needs to be carefully acknowledged and managed by the new owners of the business.
One of the most important steps in buying an existing business is conducting due diligence. This is where you do your background research and confirm the business is a smart investment. Here’s a small business due diligence checklist to help you get started:
The first step in the purchasing process is to thoroughly research the business you’re looking to purchase. Known as due diligence, this is an in-depth research project that makes sure all aspects of the business are explored and analysed. This helps with accurate valuation and minimises the risk of surprises.
Your goal here is to learn as much as possible about the market of your potential business purchase. Some questions to ask when buying a business include:
Answering these questions will help you understand what opportunities there are to grow your customer base and increase revenue.
After you conduct market research, you’ll want to look into the business' financials. This research serves a dual purpose: it helps back up the business' valuation, so you can confirm you’re paying a fair price and it provides useful insight into the business' performance.
Here, you’re looking for potential compliance issues, since these will all become yours after the sale is finalised.
Here, you want to look over high-level items like business plans and forecasts to make sure the business has been managed well and is in good shape. Look into:
An important part of due diligence is finding the evidence to verify the seller’s claims. Be prepared to go digging for information and not just accept what the seller says at face value.
Any money owed by a business can decrease its value. Additionally, some liabilities, such as employee entitlements, are transferred to the new owners, so be sure to enquire about these.
A business is an investment, and it’s important to make sure it’s a good one. As such, evaluate the commercial life of the business and consider the opportunity costs — are you passing up other investments that might be better than this one?
You should carefully consider the status of customer and vendor relationships. A business is in a strong position if it has a large customer base and a few preferred suppliers.
After investigating a business, the next step is to determine its valuation. The seller likely has a number in mind, but it may not align with the company’s real-world value.
There are several ways to assign value to a business. You’ll likely want to use a combination of methods to arrive at an accurate and fair number.
It’s never a bad idea to bring in a third party to evaluate a business. An accountant, business advisor or broker can conduct an independent valuation and let you know if everything aligns with the asking price. They should review the following:
You should have the contract evaluated by a lawyer before signing to make sure there are no surprises or misunderstandings. More specifically, have them look for or ask for the following inclusions:
This one’s important, but easy to overlook — make sure that the business' name is free to use and that there are no potential issues with other entities having copyrights or intellectual property related to it. The seller should have:
When setting up a payment plan for the business, work out terms that allow you to pay in stages. This is so the business transfer can occur at a pace you’re comfortable with. It also allows you to retain part of the purchase price for a longer period.
Now that you’ve worked through your due diligence checklist, it’s time to finalise the sale and start running your new business. Let’s walk through some steps and explore what to ask for when buying a business.
With due diligence done, it’s time to make the big decision — whether to buy. If you decide to go through with the purchase, you’ll need to make an offer and begin negotiations. Once you’ve agreed a price with the seller, make sure you have a contract drawn up to formalise it.
Make sure both you and the seller have a copy of the signed contract (and any other signed documents). After signing, you’ll need to pay your initial deposit. Again, make sure you get receipts from the seller.
Immediately after signing the contract, you’ll want to submit applications for the transfer of the business name to you. You’ll also want to ask that all licences, permits, certificates and other registrations be transferred.
Once the sale is finalised and you own your new business, it’s time to start looking to the future. Lay out your goals for the business, and make them clear and specific. Then, start working towards them and track your progress.
Buying a business might seem daunting, but it doesn't have to be. With this checklist for buying a business, you now have what you need to make a smart purchase.
Of course, the real work begins after you close the deal. MYOB can help you manage your new business from top to bottom, with accounting software and more. Try MYOB for FREE for 30 days.
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