An in-depth look at profit and losses can speak to the financial status of a business.

4 key questions to ask before buying a business

November 16, 2017 3:46 pm Published by Leave your thoughts

You'd be hard-pressed to find a better time to be a business owner than right now. Indeed, approximately 25 million people in the U.S. have started a business since 2015, according to Babson College. And of those who haven't, more than half – 57 percent – believe the current environment is rife with opportunity to launch one.

It isn't just in major metropolitan areas that entrepreneurship is soaring either. The same is true for midsized cities, specifically those whose populations are between 100,000 and 500,000. Almost 30 percent of business leaders who operate in these locations are more satisfied with the availability of resources versus those headquartered in MSAs, based on a survey developed and conducted by the Amarillo Economic Development Corporation. These operators were also more satisfied than their big city peers with their operational costs.

At the same time, though, running a business isn't easy – especially when you go into the process thinking it will be a piece of cake. This largely explains why the longer companies are in operation, the less likely they are to survive. According to the figures from the Bureau of Labor Statistics, 80 percent of companies make it to their first-year anniversary. Thereafter, the rate drops rather dramatically, with only 50 percent still open five years after launch.

Going over the books is a lengthy but necessary process to ensure you've done your due diligence before buying. Going over the books is a lengthy but necessary process to ensure you've done your due diligence before buying.

While there's no silver bullet to success, knowing what you're getting into is in the early going is crucial. In short, if you're buying a business – whether it's been around for a short time or several years – you need to perform plenty of due diligence.

Here are a few key questions you should be sure to find the answers to prior to signing on the dotted line and taking over the reins.

1. What is the company's money situation?
First and foremost, get a hold of the business' profit and losses. A P&L report, when done properly, should have lots of relevant information for you to examine, detailing considerations including accounts receivable, the type and amount of debt that is on the books, profit margin, overhead expenses and overall revenue. You may want to hire an attorney to do this if you're unfamiliar or uncomfortable with the process.

2. Are there any outstanding legal issues?
Of course, business entities are taxed in a different manner than regular citizens, and are also eligible for certain deductions. This is part of the reason why you'll need to examine what legal matters are at play. For example, are there any liens that have been issued? Has anyone filed a lawsuit, alleging improper service or conduct? What contracts exist with key employees, and if so, how do they differ from those of regular staff members? These are all matters that you'll want to get more information on, ideally with a business law firm.

3. What is the business' structure?
From limited liability corporation to sole proprietorship, partnership to S-corp, business structures run the gamut. There's no right answer to which is the best one, as each has its strengths and weaknesses. The bigger the company, the more involved this process will likely be. For example, if its a corporation, you'll want to get a hold of a list detailing how many shareholders there are and what their stakes are. You should also see what the company charter consists of to gauge if it's in alignment with your long-term goals.  

4. What is the company's 'value'?
How much you end up paying for the company will largely depend on its relative value. The term "value" can take on several different permutations. For instance, as noted by Score, a market-approach valuation is typically the method used by small businesses, detailing how the company stacks up against its competitors. An asset-based valuation, on the other hand, is utilized when a company may no longer be making money but has plenty of property that can be purchased, be it in the form of equipment, inventory or real estate.

Due diligence may be time-consuming, but it's imperative to pursue before coming to a purchase agreement. At Hudspeth Law Firm, due diligence is our specialty, offering practical advice and quality service that brings simplification to the i-dotting, t-crossing process. What's more, we do it in consultation with our clients, ensuring they understand what's happening every step of the way. Contact us to learn more.

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