Top 5 Mistakes Business Buyers Make When Buying A Business

Entrepreneurs who are buying a business tend to get excited and emotional over the prospects of their new opportunity, often forgetting to apply some basic rules which might save them years of pain and suffering. Over the years I have worked with many a number of them and I have seen them make the same mistakes repeatedly. This quick summary should help you avoid some of the more important ones.

Buying A Business Mistake 1. Buying the wrong business

It may not be true. Do what you love and the money may not follow, but I can say, with certainty, that if you buy a business you don't love, not only will it ruin the business, it can ruin your life. Make sure you have a real passion for whatever it is you're going to be doing for the next few years. You may be passionate about the product, the customers, or even the marketing or the sales. And of course, make sure the business somehow makes good use of your personal skill set.

Buying A Business Mistake 2. Not doing your due diligence.

Due diligence on a business opportunity goes far beyond the financial statements. Understand the customers, the market, the business reputation and positioning, the vendors, the competitive space, the debt, and a host of other factors. And dig deep. A business may appear to great on the surface, but can have serious problems underneath. An old saying has it that "The Devil is in the details." Examine them - all of them - before you make your final decision.

Buying A Business Mistake 3. Not understanding why the seller is selling.

An owner may say they want to retire, but the real fact is that he is losing his lease. Another says she is simply tired of the business and wants to move on, when in reality a major competitor is coming to town, and she is scared out of her wits. Find out the real reason the business is being sold. You may still decide to go ahead, and that information may help you negotiate a better deal.

Buying A Business Mistake 4. Not having a good contract

Just like when buying a home, there are many points to negotiate besides the price. There are the payment terms, financing, covenants about the property, inventory issues, accounts receivable, debt and other financial encumbrances like liens, intellectual property issues like trademarks, patents and copyright ownership, non-compete clauses, and dozens of other details. While a strong contract won't save a bad business, a weak one can kill you. Don't proceed along any lines where major questions are unanswered. And make sure you hire a lawyer familiar with business purchases to review your agreement.

Buying A Business Mistake 5. Not knowing the real business valuation

It's easy to overpay for a business when you don't have a proper business valuation. 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. Get financial statements and sales journals going back as long as you can - up to five years. Do the same for expenses. Each industry has its own basic model for comparison. Some industries, such as software, focus on revenue or sales while most others focus on earnings, or an adjustment to earnings called EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization.) The multiplier is also industry based, and can range all over the map. The company's assets and liabilities - both real and contingent - as well as the strength and consistency of cash flow, also affect the price you are willing to pay. It's a good idea to get a professional evaluation of the company, if only to use as a starting point or bolster your negotiating position.

Here is a sixth mistake that is less obvious to many buyers, yet should actually be the first thing you consider when deciding on a business to purchase

Not having a clear picture of the future

Remember the multiplier I mentioned above? 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 important information you can have when purchasing a business. If you have to pay 3x earnings, and yet you believe you can double the business in twelve months, that is a good deal. If you have to pay 10x earnings, and you expect 10% growth - it's going to take a very long time to make any money on the deal.

If you think the industry is going to take off, or you can expand revenues rapidly and flip the business - you may be acquiring in to a gold mine.

Even if it doesn't work out exactly, you must have some view of the future.

This view includes industry trends, the overall market, regulations, societal changes, technical trends, as well as your ability to grow this particular business through better sales, improved marketing, more products, effective service, documented systems, and increased an capital base. Each of these enhancements can dramatically improve the existing business.

Just because you don't make these mistakes doesn't mean you will be successful, but avoiding them will definitely increase the odds in your favor.