So, you have decided to leave the safety of a monthly pay cheque and move into the world of being a business owner. Firstly, congratulations on taking the leap of faith. Although the stability of your income may not be quite the same, the reward of having a job you look forward to daily is priceless.
One of your first decisions is whether to set up a new business or buy an existing business. Although there is no right or wrong answer, you should carefully assess the merits of both and pick which suits your personal circumstances and expectations.
If you choose to purchase an existing business, you are effectively buying the cash flows from existing customers. Upon identifying a target business, it’s important to perform a detailed due diligence review before placing an offer to purchase. This review can save you from significant losses and provide you with some valuable information to help you operate the business more effectively.
The list of questions and information to review will depend on the nature of the business and its industry. However, we have set out a preliminary list of essential due diligence questions to ask before buying a business.
1. How Has the Business Been Valued?
Ask the vendor or their representative how they reached their asking price. Although there is no formula – after all, a business is worth what a third party is willing to pay – most will sell for a multiple of 2-4 times their earnings (after wages).
2. What are You Purchasing?
A business sale will be either in the form of an asset sale or share sale. An asset sale will usually minimise the risks to the purchaser.
3. What are the Business’ Financial Records?
At a minimum, we recommend you request and review the following:
- last two financial years accounts (Profit and Loss and Balance Sheets);
- current year financials;
- last four quarters of Business Activity Statements (BAS);
- last income tax return; and
- listing of every asset the sale will include.
You should physically inspect the assets during the sale process and record the valuation of the assets.
4. Are the Financial Records Accurate?
Pull the financial records apart and confirm their accuracy. For example, look at coffee sales compared to kilos of coffee the business purchases. You may even choose to look at website traffic to see if the numbers match what was provided.
5. Will You Retain Existing Employees?
Generally, if you are only purchasing the business’ assets, employee entitlements will not transfer to you as the new owner. Instead, the business’ current owner will terminate the employee’s relationship on the last day. The new owner may then choose to offer new contracts to the workers.
6. What is the Trial Period?
The most important step in verifying income is to agree on a minimum trial period. During the trial period, you should see minimum sales of no less than the average turnover provided in the most recent financial records. A trial period should be no less than seven days to avoid the effect a day of the week can have on turnover. It’s also not unheard of for the owner to organise additional customers so be savvy and hands on during this trial period.
7. What Do Other Stakeholders Say?
One of the best sources of information are staff, suppliers and customers – take every opportunity possible to speak with them and ask questions about the business.
8. Have You Engaged a Business Broker?
Business brokers receive payment through commission on the sale so be wary of their motives.
9. Have You Prepared a Business Plan and Financial Forecast?
Taking the time to develop a solid business plan and financial forecast will force you to understand the drivers of the business. You should use the plan as a key reference document when purchasing and operating your new business.
10. Has a Lawyer Reviewed the Sale of Business Agreement?
Ensure that you engage a lawyer to review the following carefully:
- Sale of Business Agreement,
- Lease, and
- Section 52 statement by a vendor (if applicable).
11. Does the Business Require Any Permits or Licences?
Request a copy of all relevant permits and licences (for example, liquor licences or a local food permit). Speak directly with the regulatory bodies to ensure that the permits are in good standing and can be transferred upon sale.
12. What is the Handover Period?
13. Have You Received All Available Records?
The processes that enable a business to run smoothly are critical to its success. Confirm that you have received all available records. If no such processes exist, then start documenting during the trial period.
Purchasing a business is an exciting and challenging venture. However, we cannot overstate the important of conducting your due diligence before signing a sale of business agreement. Take your time, and do the work to ensure a smooth handover.
Tim Roberts is Managing Director and founder of TR Consulting. TR Consulting provides a one-stop solution for businesses requiring professional services including consulting, advisory, financial and digital marketing solutions.
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