Future profit potential, and how much you can impact that future, is the most important intel you can have when purchasing a business. Future growth will ultimately be the measurement of the merits of the investment and is key to your achieving a good return.

However, one of the key steps in determining whether or not you should purchase a business is to complete a comprehensive due diligence process to determine the health of the company and to ensure no details have been overlooked. 

Key Considerations for Buying a Business

One the most serious shortcomings when evaluating a business is to focus only on historical performance without considering what the business might be capable of under new management. While its history provides some insight, it is what will happen to the company in the future that is key.

In any conventional evaluation process, the buyer will pay for what has been achieved but will buy for upside potential. Successful acquisitions are all about generating a premium on the investment. The major "determinator" in considering an acquisition should be how a new owner can improve the business. Probing for underlying growth opportunities that are ripe for exploitation will help achieve that goal.

Some factors to consider in gauging the company's future under your ownership that could enhance and expand the bottom line could be:

  • Is there is a skill set that the current owner is lacking, that you possess? For example, a stronger marketing background or more technologically inclined.
  • Are there additional markets that a new owner should pursue?
  • What additional products could be delivered to existing customers?
  • Where are the best profit margins realized and can they be expanded?
  • Can the technology be licensed?
  • Will demand for the product or service increase as population grows?
  • How will enhanced marketing campaigns and sales efforts affect growth?
  • Are there opportunities to grow through acquisition?
  • Can growth be achieved by expanding geographically, increasing manufacturing capacity, or adding multiple locations?
  • Would additional hires impact growth?
  • Or, would streamlining the workforce be more beneficial?
  • Is franchising feasible?
  • Are there online strategies ripe for growth?
  • Are there areas to explore that could decrease operating costs?
  • Would the company benefit through additional workforce training and education?

The Major Components of a Business Pricing Model

Most business pricing models have two major components: a base, usually revenue or profit, and a multiplier. To get the base you need a clear view of the revenue picture from previous years, the historical performance. The multiplier is derived from industry-specific ranges. That multiplier is actually the number of years it will take to recoup the price you just paid for the business, assuming it doesn’t grow (or shrink.) Having a clear view of the future – and how much you can impact that future – is the most powerful intelligence you can have when determining the soundness of a business investment.

For example, if you pay 3x earnings, and believe you can double the business in twelve months, that is a good deal. If you pay 10x earnings, and you expect 10% growth – it’s going to take a very long time to see a return on your investment. While 10x earnings is an exaggeration, it illustrates the point of return on investment.

Using these principles as a guide in making an acquisition decision may markedly increase the chances that your journey to profits and success will end with positive results.

Due Diligence is Vital

Performing due diligence on a business being considered for purchase should be conducted much like a surgical procedure. The operation should be an organized examination of the vitals of the company.

This stage of buying a business begins once you have made your offer and the seller has accepted. A contractual agreement has been entered into between the buyer and seller outlining the price and terms of the sale. The contract is contingent upon the business passing "inspection," which is the due diligence period allotted to the buyer.

Since it is the buyer's responsibility to uncover any potential problem areas of the business, it is important to be prepared. This is the time to cut to the chase with checklist in hand to confirm all material facts of the business and validate what the seller has represented. The buyer, being the leader of the procedure, may call in specialists, such as an attorney to examine the legal aspects of the business and an accountant to scope the numbers. Depending on the size of the business, a buyer will typically have about two to four weeks to complete the process.

The following checklist represents vital aspects of a business that a buyer may wish to examine during the due diligence period. This checklist is not meant to fit all scenarios or to be all-inclusive, but to serve as a guideline.

  • Organization and Good Standing
  • Accounting and Financial Information
  • Physical Assets
  • Real Estate
  • Intellectual Property
  • Employees and Benefits
  • Licenses and Permits
  • Environmental Issues
  • Reports, Studies, Appraisals
  • Taxes
  • Contracts, Agreements, Leases
  • Product or Service Lines
  • Customer Information
  • Litigation
  • Insurance Coverage
  • Vendors, Suppliers, & Professional Service Providers
  • Market, Marketing and PR Campaigns

When purchasing a business, the greatest asset you have at your disposal is information. This includes not only evaluating the possibility of future growth and the business’s current value, but also utilizing extensive due diligence to determine if your enterprise will present the best return on your investment.