Buying a Business? 16 Common Business Buyer Mistakes
The following is a discussion of 16 common mistakes made by first-time or novice Buyers in their search for a business to purchase. Use this checklist to help you from making the same wrong moves.
(1) Inadequate Assessment of Capital Resources When a business broker attempts to QUALIFY A NEW BUYER in terms of his financial resources, the primary Buyer capabilities of interest are:
- cash on hand available for a down payment
- additional funds available for working capital
- credit or borrowing capacity
From experience, brokers recognizes the necessity of having a reserve of funds for working capital including, operating costs, transition costs, changes desired by the Buyer after purchase, additional advertising and a safety margin. The BUYER’S ASSESSMENT of his financial resources should be made prior to searching for a business to buy in order to focus efforts on acquisition candidates that fit financial capabilities.
(2) Unrealistic Expectations
Owning your own business is “the American Dream.” To convert this dream into reality the Buyer must have a practical perspective. It is not realistic to expect to invest $10,000 or $15,000 and earn a first year profit of $100,000. It is not realistic to acquire an established company with a growing customer base, numerous employees, and assets – and expect to be an absentee owner. Yet the above are true examples of Buyer misconceptions. As you continue to collect information, ask questions, read and pursue specific business opportunities, you will begin to gain a feel for the market. This could take from one month to six months for a full-time Buyer or over a year for someone investigating businesses on a part time basis.
(3) Not Asking the Right Questions
Know what questions to ask when meeting with Business Brokers and Business Owners. A Business Broker will help you understand the process of buying a business and, after a standard pre-screening procedure, will provide you with the information you need to determine your level of interest in a given business. The Seller too, from your first meeting, should be candid and open in answering your questions unless they would prematurely reveal trade secrets or proprietary business information.
(4) Not Understanding Or Following The Correct Steps
Many Buyers begin having problems when they don’t understand THE STANDARD STEPS in the process of buying a business. Each step has a specific purpose and sequence, which when followed will save all parties — Buyers, Sellers, Brokers, professional advisors — time, effort and money.
(5) Using a Haphazard Business Selection Approach
Beginning Buyers can easily fall into the trap of trying to investigate and pursue every business currently on the market at the same time. The logic behind this approach is: “If I see enough businesses, I’ll eventually recognize what I’m really looking for.” Unfortunately, this scattered and unfocused method seldom works at all and the excessive time and effort it requires quickly burns out the Buyer, and the business broker, for that matter. Again, by following the correct sequence of events, the Buyer can gain direction and channel his efforts towards those business opportunities most suitable to him.
(6) Buying On Emotional Reasons Rather Than Sound Business Decisions
It’s quite possible to find yourself falling in love with a business. This, in itself, is not necessarily harmful. In fact, it’s important that you can feel an attachment to the business you’re buying. However, the danger is in allowing your infatuation to blind you to the economic realities of the business. Follow the proper guidelines and PERFORM DUE DILIGENCE in order to make a measured business decision. This decision should be based on a realistic assessment of both the positive and negative expectations of the business, while allowing for an acceptable level of risk.
(7) Communications With the Seller
The Buyer should understand that Sellers list their companies with professional business brokers because they realize that they don’t have the personality, temperament , or time to deal with a wave of potential Buyers. The Business Broker is the buffer between the two principals and facilitates communicate allowing a calm, smooth negotiation process to occur.
(8) Inability to Negotiate
When a business for sale is listed at a very reasonable fair market value and would be an excellent purchase at the listed price, the Buyer still believes a lower price must be negotiated in order to get a good deal. The Buyer cannot justify in his own mind paying the full asking price even though it may be an excellent acquisition. In our everyday lives, practically everything we purchase has a price tag and we simply pay the stated price. We are not conditioned to negotiate the price we pay for our groceries, for example, nor is it acceptable. However, when attempting to purchase a business, which is perhaps the most important financial decision of our life, we expect to be able to negotiate a low-down, bargain price. Unfortunately, we may not have the experience, skill or temperament to negotiate at all. Those Buyers unwilling or unable to negotiate for themselves would do well to seek the assistance of experienced advisors because it is successful negotiation that gets a deal done.
(9) Failure to Have All Agreements in Writing
Both Buyer and Seller should recognize the benefits of a well-documented transaction which is truly in the best interests of all parties. Whenever possible, every major agreement, understanding or obligation of the parties should be clearly defined in mutually agreeable language, signed or initialed, dated and retained for future reference.
(10) Misinterpretation of Financial Information
Many Buyers make the mistake of spending a great deal of time collecting massive amounts of data on the business and little time trying to interpret what they have collected. If a Buyer does not understand such things as cash flow, add backs, recasting, owner’s draw, or debt service, he should make himself knowledgeable in each of these important areas and seek the assistance of a transaction-experienced accountant.
(11) Failure to Verify Business and Financial Data
Another common mistake of many Buyers is to blindly rely on verbal statements and claims made by the Seller or his agent, without verifying their accuracy or validity. One Buyer, who made an offer on an Italian restaurant, relied on the Seller’s opinion that the neighborhood road construction project would be completed within 60 days. A couple of follow-up phone calls would have revealed that the project was not scheduled to be completed for another 8 to 10 months. Had the Buyer realized this fact prior to buying the business, he could have negotiated terms which would have reduced his debt service payments to the Seller and thus, improve his cash flow position during his first year of operations. Once again, verification and follow-up is the responsibility of the Buyer and this is the purpose of the due diligence phase.
(12) The Misuse of Professional Advisors
Professional advisors includes attorneys, accountants, business brokers, bankers, as well as any other experienced consultant qualified to assist the Buyer. There is often a tendency on the part of new Buyers to misuse professional advisors. Some inexperienced Buyers make the mistake of neglecting to seek any third party professional assistance. Unfortunately even the simplest transaction can become complicated overnight, which results in confusion and disagreement leading to the eventual loss of time and money for all parties. Other inexperienced Buyers find themselves overly relying on professional advisors even to the extent that they may refuse to make any decision or take any action without the pre-approval of the advisor. Some common sense tips to remember when working with advisors:
- The advisor works for you and should provide support and counseling to help you reach your objectives.
- Seek advice from professionals in their own area of expertise only. Don’t seek detailed tax advice from a banker or market value advice from an attorney.
- Supply your advisors with pertinent, factual information upon which they can give you sound advice.
- Don’t expect anyone else to decide whether a business is a good deal or RIGHT FOR YOU, as this is a decision only you can make.
- Don’t seek professional advice prematurely. For example, don’t hire an accountant to do extensive research on the potential tax consequences of a business acquisition before the business has been investigated and a tentative agreement has been reached.
(13) Over Deliberations and Indecisiveness
In their sincere efforts to avoid making a mistake or jeopardizing their family’s savings, many novice Buyers will often defer making any decision on a potential business purchase. Their logic is “if I’m meant to get the business, I’ll some how get it. If not, then it was not meant to be.” Unfortunately, these Buyers are allowing fate to control their destinies. Those unable to ever make a decision and take action would probably be wise to avoid attempting to buy a business altogether, because successful ownership requires the ability and willingness to make decisions and accept risks on a daily basis.
(14) Letting Advisors Kill the Deal
Professional advisors can make or break a deal. Buyers must articulate their wishes to their team of advisors in order to have them working together towards a common goal. Each advisor, such as an attorney or an accountant, has a specific role in the transaction and should be working on behalf of their client — you the Buyer — to achieve the objective for which you engaged them.
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
- Contracts, Agreements, Leases
- Product or Service Lines
- Customer Information
- Insurance Coverage
- Vendors, Suppliers, & Professional Service Providers
- Market, Marketing and PR Campaigns
(15) Not Having A Business Plan Ready
An essential part of any business is its plan for success. Your business plan lays the foundation and groundwork for your new venture.
Business Plans are a standard requirement by lending institutions, including SBA lenders, when pursuing financing for a business acquisition. However, business plans should be looked at as part of the bigger picture, as an architectural blueprint, the guide that will elevate your enterprise to the level you envision.
The discipline of constructing a business plan gives you the opportunity to examine and understand the challenges ahead and generate realistic expectations for your new business. This involves cohesively organizing your business ideas and financial needs and aligning them with detailed marketing and management plans that conform to your budgetary constrictions.
How far ahead should business plans look? A three year prospectus is standard since circumstances can change over long periods of time. Business plans should also include contingency plans since investors or lenders will want to know how the company will continue operations should something happen to the owner.
Your business plan should have a cover sheet and a table of contents. The cover sheet includes the name, address, and telephone number of the business along with the names of all principals. The table of contents lists the headings and subheadings in your plan as shown in the sample outlined below.
A business plan has four segments:
1) Description of the Business / An Executive Summary
This section is a statement of purpose and summarizes what is contained in the plan, such as the company’s mission, objectives and key elements. The summary allows investors or lenders to learn about the company without having to wade through the entire business plan. Also included is the location of your business in terms of desirability and accessibility.
2) Marketing Plan
Marketing usually involves determining who your customers are, identifying their needs, and fulfilling those needs. Questions you need to answer include: Who is likely to buy your goods and services? What is your potential market share? How can you hold and expand your customer base? What is your pricing strategy? Who are your competitors in the market and how can you differentiate yourself from them?
3) Financial Management Plan
Financial management is one of the keys to keeping your business profitable. Plan a realistic budget that covers initial working capital and operating costs. Consider how much cash you have for a down payment. How much money will you need to purchase the business? How much will you need for initial working capital? How much will you need to pay debt service, earn a livable wage, and make a reasonable return on your investment?
Your operating budget should show the expenses you will incur and how they will be paid. You should cover the first three to six months of operation. This section should also address your accounting system and inventory control. You should also include any financial data and supporting documents listed in the sample table of contents outlined below.
4) Management Plan
The existing business owner may already have operating procedures, manuals, and materials. You can describe any training and assistance that you will be receiving from the previous owner. Who will be your prospective management team and what are their credentials? What are your plans for hiring and training personnel?
Sample Table of Contents
- The Business
- Business Description / Executive Summary
- The companies products and services
- Legal entity of the firm (ie, LLC, Corp)
- Marketing Strategy & Implementation
- Target Market & Competition
- Operating procedures
- Management Team & Personnel
- Business insurance
- Financial Data
- Loan applications
- Capital equipment and supply list
- Balance sheet
- Breakeven analysis
- Pro-forma income projections
- Pro-forma cash flow
III. Supporting Documents
- Tax returns of principals for last three years
- Personal financial statements (all banks have these forms available)
- Copy of contracts
- All supporting documents
- Proposed lease or purchase agreement for building space
- Licenses and other legal documents
- Resumes of all principals
- Copies of letters of intent from suppliers, etc.
A good business plan is a solid structure, the specifications that will help you achieve your goal. Make the plan an active participant in your company, it is a tool to measure your progress and keep the vision on track.
For more info on this subject refer to these helpful websites:
(16) Choosing the Wrong Attorney
Many buyers do not know if or when an attorney may be needed in the process of buying a business. That question always comes up when chatting with people beginning the process of searching for a business to buy.
As a rule, it is recommended that buyers should consult their attorney for the review of any legal documents. Some of the types of documents involved in closing a business purchase that may be candidates for attorney review are:
- Covenant not to compete
- Employment contract(s) (for existing employees or the current owner)
- Review of the escrow instruction
- Review of promissory note
- Review of new or assumed lease
- Review of any agreement produced by the other party
- Checking for any pending lawsuits against the business, or any other liability problems
Attorney’s can draw up non-compete agreement for the seller to sign, as well as employment contracts for key employees who are critical to the operation of the business. You don’t want the seller or manager setting up shop down the street while you are getting your new business up to speed. It is wise to interview key employees to make sure there is a good fit.
Your legal counsel can make or break the deal. Therefore, if you choose to engage an attorney to assist you in the purchase process, it is important that they be deal friendly and transaction experienced. You must articulate your objectives and seriousness in getting the transaction completed. And that, unless something completely unanticipated is discovered, the attorney’s job is to pull the documents together to get the deal done.
In many instances, the sale of a business fails to close because the attorney for one side makes too many demands of the other side. Certainly, you want your attorney to protect your interests, but not to the point where the demands are so onerous that the other party walks away from the deal.
Business brokers can refer you to legal professionals if you don’t already have one that is experienced in legal issues related to business transfer transactions.
If there is no one monitoring the details and leading the progress of the transaction, the ball can be dropped somewhere along the way. The broker’s role at this point in a business transfer transaction is to act as the intermediary. The business broker–having been through the process many times, much more often than any of the attorneys or other advisors involved–knows the pitfalls. They keep the deal on track and act as the captain that keeps the team working together towards the common goal…….the successful consummation of the sale. As long as all advisors involved are operating on the same wavelength as their respective clients — the buyer and the seller — the odds are good that the process will be timely and smooth.
Working With Certified Business Brokers Will Help Ensure That You Avoid These Common Business Buyer Mistakes
Purchasing a business may be one of the most important decisions of your life. Absolutely nothing should be left to chance. In many instances, it may be challenging for you to get the information you need or to evaluate your situation objectively. Working with CBB means that we will take you through every step of the process to help you purchase the right business for your goals.