Business Buying Due Diligence
Business Buying Due Diligence: Areas to Explore with the Seller
Areas to Explore with the Seller
There are seven essential questions - actually categories of questions - that buyers must ask sellers before buying a business.
However they are named, numbered or described, these questions represent the essential areas of information which buyers must master. In fact, they are the same categories of questioning I pursue with my seller clients.
What’s the Company Story?
Even before buyers look closely at the sales and earnings of a business, they need to let the seller tell them the company story. When was it started? Why was it started? What’s special about it? Why does the seller wish to sell?
The answers to these questions will tell a story that the buyers must fit themselves into. If they can’t picture themselves owning the business, they shouldn’t buy it.
Is it a story of a shaky operation that’s too new or, worse, in decline? Is the business established and steady? Does it have a good record, reputation and growth rate?
Whatever the company story, buyers must have the motivation to enter the story at this stage and carry the business forward.
The 1996 sale of The Whip & Spoon here in Portland, a retail kitchen accessory shop, offered an interesting example of the power of the company story to create buyer prospects and value. The company has such an attractive company story that buyer prospects literally rushed to buy it! (Note: In 2000, we were involved in its marketing for a second time, but this time the company story had been marred seriously by a declining sales record and poor management. There were months of marketing time and eventual buyer even changed the name!)
What’s the Numbers Story?
Most buyers know to ask about the sales and earnings history. What are historic income and expense levels? Are the income and profits declining or increasing over time? But these numbers also tell a story - a “numbers story” - one that should be combined with the company story for a complete telling.The most important part of this question, however, is “Where does the business go from here?”
Yesterday’s income and profits were probably created by the actions (or inactions) of the owner. Will the new owner’s actions be different? What impact will the new owner have on the operation? Probably a lot!
Advisors who are experienced in larger businesses will often put too much emphasis on yesterday’s “numbers story” as a predictor of the future when they analyze a small business. Small business revenues are not as easily forecast as those of larger businesses. A change of ownership can have dramatic performance results.
Small business buyers must try to predict what the business’ future will be under their ownership and see if it will work for them.
What’s the ‘Workstyle’?
I use the word “workstyle” as a name for the process of how the current owner makes the business work. Buyers must interview the seller carefully on this issue. It’s not just the number of hours the current owner puts in that counts - it’s what the current owner does during those hours. And, what does the business require of a new owner?
Sometimes, what the current owner is doing is not what the new owner should do! In fact, I would argue that, in most cases, new owners choose to be different. That’s usually good!
After hearing the seller explain the current “workstyle”, buyers then need to assess possible changes and ask whether or not buying the business will create for them attractive and interesting work.
How’s the Workspace?
“Workspace” is the name I give to “where” the business takes place - its physical location and its market position. Is the workspace appropriate for the production of the business’ product or service? Is the business accessible to its customers?
If buying the business involves the purchase of real estate, most buyers feel protected by current disclosure requirements.
But, whether buying or even just leasing a physical space, a buyer must ask questions about this “workspace” which are beyond the legally required disclosures.
Is this “workspace” compatible with the business’ production and marketing missions? Is the space right for planned growth? Is it in the right location to serve its future markets? These questions may be difficult for some sellers to answer; other sellers may have many insightful comments, stories and suggestions.
250 years ago, for most businesses, the best location was where the trail met the river. 150 years ago it was where the railroad crossed the trail. In 1900, it was a downtown corner in any sizable city. In 1960, it was right off an interstate highway exit. By 1975, it was in the shopping mall.
Today, in addition to physical space, location may also mean a mailbox, a toll-free telephone line or a home page on the Internet!
Where’s the Industry Going?
Every business is affected by larger trends - those of its “industry” or “trade” - within the context of the general economy. For every business, there is a related professional group, sometimes more than one.
Buyers need to ask sellers what they know about the larger industry trends and trade practices and what industry or trade groups are important to the business.
Industry and trade associations are often great sources for specialty publications, “how to” books, financial ratio studies of member companies, annual meetings, seminars, tapes, trade shows with specialty vendors, and even recognized industry experts who are available for consulting.
From these sources, buyers need to analyze the important trends of the business they’re planning to buy. Although buyers usually need to protect the confidentiality of the business, this does not prevent them from doing some confidential research.
Where’s the Competition Coming From?
Some sellers frankly don’t know where their competition is coming from! Others can give buyers a ‘Who’s Who’ litany that includes competitor names, marketing strategies, and even sales and profit estimates!
Sellers are often out of touch with the newer sources of competition. So, even if they are given a complete list by a seller, buyers should check it out for themselves: putting themselves in the business’ customer/client shoes, stepping back, and taking a long look. Where’s the real competition coming from?
Calling and visiting the competitors is usually acceptable behavior, as long as the selling company’s confidentiality is maintained. Sellers will often insist on strict compliance with non-disclosure agreements they require buyers to sign. When competitors know another in their business is for sale, they can easily launch a damaging effort to recruit employees and customers.
What Are the Terms?
Finally, buyers need to make sure they understand the asking price and terms.
If the business is listed with a business broker, these questions will be answered by the broker. But, if there is no broker to provide insight into the seller’s price and terms, asking the seller direct and detailed questions about alternative terms is needed to give a buyer a special insight into the seller’s motives, desires and level of common sense.
To perform all of the ‘due diligence’ homework required to analyze any business acquisition without knowing the possible terms can be a real time waster. If a seller doesn’t seem to have a common sense approach to the price and terms of his/her business, buyers are best advised to move on!
Adding Value to Small Businesses: What Else Counts Besides Profits?
Value Drivers in Business Sales
Consistent profitability. Well trained staff and a variety of e-commerce clients.
The cyclical nature of the economy can add uncertainty to the timing of an acquisition, or an exit from a business. However, unlike the clarity of an improving economy or the risks inherent in a downturn, buying or selling at a market high creates a unique set of challenges.