Key Factors That Help to Screen Potential Businesses You Might Buy
by Bruce Tannas
You’ve decided to start looking for a business to buy or you’ve found a business that you’re interested in purchasing. Before you fall in love with a business, there are some preliminary items of due diligence you should consider. Here are some criteria (not an exhaustive list) that will help you screen a potential businesses you might buy to determine whether this business is worth a further look or you can eliminate it from consideration:
1) Why is this business for sale?
You need to satisfy yourself that this business is for sale because the owner is ready to move on, either to retire or pursue another opportunity, rather than it’s for sale because the business is in trouble.
You should do a preliminary investigation into the business’ reputation. You should ask around about the business and also go online to check out reviews of the business. A good reputation is hard to make and conversely a poor one is often hard to shake. So the company’s reputation should factor into whether this business is a good opportunity or not.
3) Competitive position
There are a few key items to consider about the company’s competitive position.
- First thing you need to consider is the state of the industry in this market. Is this industry growing or shrinking? Talk to industry contacts and suppliers and ask about the state of the industry in the local market.
- How much market share does this business currently have? You can take the sales information from the company and compare it to the size of the market. You can get market size data from various independent sources, such as trade groups and regulatory bodies, and often from the company itself. For example, if there is ten businesses competing in the market then if all things were equal each business would have a 10% market share. So, to continue this example, if the business had $100k of sales per year and the market size was $2 million per year then they would have a 5% market share. In this case you might want to consider why does it have a comparably small share of the market and what/if anything you could do to change that? Also, you should look at whether the company’s market share is growing or shrinking (and why).
- How vulnerable is this business to new competition? While nothing is guaranteed, there are some industries where it is easier to enter or exit the market. Also, some business may have a competitive advantage that is either easier (e.g. pricing) or harder to match (e.g. exclusive contracts or proprietary technology). Overall, you need to consider if this business has enough of a competitive advantage to be sustainable with both current and potentially future competitors.
4) Financial health
You need to do an initial evaluation of the financial health of the business from a few perspectives.
- First, is this business profitable? The business needs to be profitable in order to borrow money as this represents the positive cash flow that can be used to service a loan. If the business isn’t profitable then you need to consider whether this is a temporary issue (e.g. due to the COVID related downturn) or you think you can make changes so it can be profitable in a short period of time (e.g. discontinuing unprofitable activities, eliminating staff, etc.).
- What is the financial trend in this business? You need to have a look at the last three years of the financial statements to see if the company’s financial health is improving or sliding. Pay particular attention to sales, margins, and profitability.
- Compare the business financials to industry standards. Each industry has standard margins and profitability that you can seek through industry associations or through running a report from Industry Reports – Stats Canada . How does this business stack up? And can it be improved if you take over?
There are a few items that need to be checked early on in your due diligence:
- The first is whether there is an operational system in place and whether that system is well documented. While the current owner may provide training it usually is limited so you need to ensure that there are effective, clear, and documented procedures.
- The second thing you should consider is whether there is a key employee that might be leaving if you buy the business. Would the business unduly suffer or fail if they did?
- Finally, if the business has a lease, you need to find out when it renews, whether it can be transferred to a new owner, and whether the business has the right to renew the lease.
6) Your fit
While this seems obvious that you need to fit into this business, you need to seriously consider it before getting to deep into evaluating the business. As the owner of a business you will be spending a lot of your time and effort on it. Are you ready to do that? Is this business something you can be passionate about? If not, maybe you need to look at another type of business. Is your skill set compatible with this business? If not, are you prepared to acquire new skills or improve them? Finally, is there something you bring to the business or something you can do to improve the results of the business? Most businesses are fully priced based on their current results so in order to improve your return on investment (ROI), you’ll need to be able to increase the profitability of the business over time.
Properly vetting a business takes time, due diligence, and the help of professionals including accountants, lawyers, bankers, business coaches, etc.. Since there are many opportunities out there for you to consider, the items outlined in this article will help you with screening the businesses to eliminate ones that don’t meet your needs and highlight ones you might want to look further at.
Connect4Commerce offers entrepreneurs and small business owners across the country a convenient and comprehensive place to connect, exchange goods and services, and advance their businesses. Be sure to check out further articles in our Business News blog for additional business tips and resources. Also, find professionals on our site that can help you with your business purchase and we can also help to find a business to buy that is right for you.