You can no longer suppress your entrepreneurial spirit and the time has come to fulfill your dream of business ownership. What questions should you be asking? Unfortunately, most small businesses for sale are being represented by the owner, so the process of fact-finding can often turn into a frustrating, adversarial battle with less than willing participants. As a business broker, my role is to scatter the fog of war by ensuring trust and transparency are maintained throughout the entire process. This allows for an objective and accurate analysis of the business on behalf of any potential buyer and their lawyer, accountant and lender. I need to know about a business before I'll allow someone to put their life savings into it, so it is crucial for me to seek answers to the same questions every buyer should be asking. Here are some of the most important ones:
1. "What are the true earnings?"
As you may be aware, the accountant prepared financials only tell one side of the story. They're often geared to minimize earnings and reduce or eliminate the taxes paid on declared net income. It is very common for small business owners to enjoy financial benefits that have been attributed to the business, but are in fact personal expenditures. Therefore the only way to accurately understand the true earnings and benefit to the owner is by analyzing a normalized or recast set of financials.
Small businesses that are owner-operated are best understood through seller's discretionary earnings (SDE), which is comprised of the net income with interest, taxes, depreciation & amortization added back to it, plus any one-time or non-recurring expenses, as well as the fair market wage of one owner working in the business. Certain industries, or businesses with a higher level of earnings and a full management team in place, will be better understood through an analysis of EBITDA or EBIT.
Either way, you must have knowledge of what the owner is paying themselves compared to what it would cost for them to replace their role with an employee. Your business broker and accountant can assist you in better understanding what's really going on from a cash flow perspective.
2. "Can this business survive in your absence?"
There are many small businesses that are so entwined with the owner that it's impossible to determine where one ends and the other begins. Their fear of giving up any control over the daily operations has resulted in a business that would not survive a transition. Their supplier and client relationships are dependent upon them, their bookkeeping and processes are in their head, all of their staff are family, etc. In fact, if you took them out of the business for a week it would start falling apart immediately.
Some of the best businesses I've dealt with were designed with the owner's exit in mind from the very beginning. This has resulted in management in place to run the day to day operations of the business, systems and processes that the staff knows and follows, key people in place that deal with suppliers and clients, and everything else that eases a transition. You need the business to function in their absence after the sale and the skills a new buyer brings to the table should make up the difference after the seller has been plucked out of the equation.
3. "Why are you selling?"
This is the one question that every single buyer has asked, and in many ways this is the most important question I need answered for myself. I serve a process that is dependent upon needs, not wants. If a business owner does not need to sell their business, they will have a marked lack of motivation necessary to either begin or complete the process. They will disagree with a market evaluation, instead choosing to wait for some clueless traveler to meet their over-inflated asking price down the road. Or they will get cold feet somewhere during negotiations or due diligence and back out of the process. I also expect full disclosure and need to know that they're not just looking to take their problem and make it someone else's problem.
What are the main reasons a business owner will have when they need to sell their business? Stress, health issues, extreme boredom or burnout, retirement, divorce, death or transitioning to family. It's almost always a human reason, and depending upon the answer they give I may not disclose that to a buyer, but will instead allow the seller to do so if they desire. An example of this are the unfortunate cases where we meet a client who has been diagnosed with terminal cancer and they need to sell their business so the proceeds can provide for their surviving spouse. In this situation, I will not undermine their negotiating position or breach their privacy by disclosing that to a buyer.
4. "Will the seller assist with the transition?"
Very few businesses can successfully change hands without a period of training and transition. How long that lasts will be dependent upon the industry, the experience of the incoming buyer and the wishes and needs of both the buyer and the seller. We would typically expect that a complimentary 2 week training period be provided by the seller, with anything longer than that falling under a paid employment or consultation agreement. If you're pursuing a business in an industry that you have no previous ownership experience in, then it's very important to understand the exact role and length of time the seller is willing to commit to in order to ensure you get what you need for the transition to be a success.
5. "Is the seller willing to provide financing?"
There is perhaps no greater mechanism in a transaction that benefits all parties such as seller financing. I rarely meet a savvy entrepreneur that is willing to buy a business where the owner doesn't put their own money where their mouth is. It allows a buyer access to the funds required to meet an asking price and complete the purchase, in addition to bridging whatever gaps of trust and perceived risk that may be present. When a seller has some skin in the game, the banks will feel far more comfortable in extending funds, as well. The unity of interest this creates for all parties is very powerful and can often be the difference maker between a business selling or sitting on the shelf.
6. "Why should I buy an existing business?"
Startups are often tied to the idealist and romantic notion of making an entrepreneurial go of an original concept. However, the numbers never lie and most startups will die a horrible, lonely death within the first five years. The good news for you is that a business that has been around for at least five years has a greater than 90% chance of still being around in another five years. This is why I always advise people to buy an existing small business with a proven track record of success. They've established themselves within their market, fended off competitive elements, built up a trained and experienced staff, honed their systems & processes, learned from mistakes, made the necessary course corrections, formed supplier relationships and attracted an army of loyal, paying customers contributing to a healthy bottom line. They have beaten the odds and now they want to impart everything they've learned onto you. What more could you ask for?
Where you end up at is a direct result of how you begin. If you're thinking of buying a small or medium-sized business, we would be pleased to answer your questions and assist you with starting this process. Let us put our expertise to work for you!
Ryan Jorden is the Managing Partner with VR Business Brokers in Calgary, Alberta, where he specializes in valuating and facilitating the sale of privately held businesses. You can reach him confidentially at firstname.lastname@example.org or visit our website to learn more. We can also connect on Twitter and Google+.
(Photo: Lord Jim, Flickr)