When considering purchasing an existing business, you must do your due diligence and ask the right questions to ensure you’re making a sound investment. Many business owners sell their businesses as an exit plan during a decline in profitability, which means you could end up overpaying if you don’t determine the actual value of the business.
Transferring ownership of a business is a long process that can take about 6 to 9 months. To ensure that you are making an informed decision and maximizing your chances of success when buying a business, it’s essential to understand every small aspect of the company.
In this guide, we’ll provide you with a comprehensive list of important questions to ask before buying a business, covering areas such as financials, legalities, operations, and more. By following our guide on smart questions to ask before buying a business, you’ll be well on your way to making an informed decision and maximizing your chances of success.
So, let’s dive into the 11 questions to ask when buying a business:
1. What is the History of the Business, and why is the Owner Selling it?
Why the owner is selling the business should be one of the first and most important questions to ask when buying a business. Understanding the history of the business and why the owner is selling it are crucial when considering buying a business. Asking the owner why they are selling can provide valuable insights into potential issues or opportunities. Although retirement is a valid reason to sell, it’s important to determine if any deeper issues could impact the business’s future success.
2. How much of the Business’ Success do you (the owner) Attribute to Personal Loyalty rather than Business Loyalty?
When buying a business, asking the business owner how much of the company’s success is attributed to personal loyalty rather than business loyalty is critical. Personal relationships, such as long-term clients, suppliers, or even employees, can significantly affect a business’s success. If the owner heavily relied on these relationships, the business’s value could decrease after the change in ownership, and it may be challenging to maintain those relationships.
The importance of understanding personal loyalty in a business lies in the risk of losing clients or suppliers after a change in ownership, especially for businesses with a small customer base or those dependent on a few key clients. If the business’s success is attributed to business loyalty, like its reputation, or product quality, it may have a more stable and transferable value.
3. What is the Business’s Current Financial Status, Including its Revenue and Profit Margins?
When considering buying a business, one of the most crucial aspects to evaluate is the company’s financial status. Understanding the business’s current financial situation is essential to determine its potential for future success. As a potential buyer, you need to do thorough financial due diligence and ask the owner about the business’s revenue, profit margins, expenses, and any outstanding debts or liabilities.
- Revenue: It’s important to clearly understand the revenue stream to evaluate the business’s earning potential. Analyzing the revenue stream can also help you identify any patterns or trends that could impact future growth.
- Profit margins: It’s essential to understand the profit margins to determine the company’s profitability and efficiency. This can also help you identify areas where you can potentially increase profits or reduce expenses.
- Expenses: Understanding the expenses is crucial to evaluate the company’s overall financial health and identifying areas where cost-cutting measures may be necessary.
You should also do your due diligence to calculate the working capital of the businesses to assess the company’s current health.
4. How is the Relationship Between the Company and its Customers?
One of the next crucial questions to ask when buying a business is to understand the relationship between the company and its customers. The customer base can significantly impact the business’s success, and understanding their loyalty and potential issues will play a key role in evaluating the company’s long-term potential.
Start by asking the owner about the customer base, demographics, and the company’s relationships. Additionally, ask about customer retention rates and marketing strategies’ impact on acquiring and retaining customers. You should also inquire if there are any unified potential issues or complaints the customers may have had with the company and how they are resolved. By gathering this information, you can gain valuable insights into the company’s reputation, the quality of its products or services, and its approach to customer service.
5. What is the Intellectual Property Status of the Business?
Intellectual property refers to the ownership of creations of the mind, such as inventions, designs, literary, artistic works, and images used in commerce. Understanding the status of the business is critical to ensure you’re purchasing all the necessary rights and protections such as trademarks, patents, copyrights, and trade secrets. You should also inquire if the business owns any intellectual property and if licensing agreements are in place.
6. What Growth and Expansion Opportunities Do the Business and the Industry Offer?
Understanding the growth potential of the business and industry is essential to ensure that you’re investing in a viable and profitable venture. You need to ask the owner about the business’s growth history, future plans, and any potential roadblocks. Also, research the industry and market trends to determine potential opportunities for expansion or diversification.
7. Can you Explain How you Arrived at the Purchase Price for the Business?
During the exploration or negotiation stage, it’s important to ask questions about the business’s financials as they can provide valuable insights into the owner’s mindset regarding the company. In reality, businesses with a listing price of under $1,000,000 have a success rate of only 20% in terms of being sold, while businesses with a selling price over $2,500,000 have a success rate of less than 1 in 3.
In addition to finding out the asking price, it’s crucial to ask how the owner arrived at this price. A fair purchase price should be no more than three times the annual profits, driven by demand, and realistic for the market. If the asking price is within your budget and perception of the company’s value, you should proceed with additional questions about the business’s financials.
8. Does the Business have any Undisclosed Debt or Liabilities that may Impact the Purchase Price?
You’ll want to ask, specifically, about undisclosed debt and liability because they can significantly impact the purchase price and the overall value of the business.
If you don’t make a written, legal arrangement for the owner to pay off those debts before the acquisition — or deduct them from the purchase price, you could legally be responsible for them as the new owner. You should also review the financial records to ensure that there are no surprises after the sale is complete.
9. Will you Grant my Auditor Full Access to your Financial Records?
During the M&A process, conducting due diligence with an independent auditor is crucial. Once you’ve discussed financials with the current owner, you must ensure that the financial statements match their perceptions and statements.
Security is a key consideration during the M&A process, so ensure they have a secure and confidential way to offer your auditor access to relevant spreadsheets and documents. You won’t want to trust quotes off the top of the owner’s head when it comes to financials. Dig deep into the spreadsheets to determine the following:
- Gross annual revenue.
- Lifetime profits.
Any discrepancies between the financial and owner’s statements can be a significant warning sign, indicating that you should avoid the deal, as you may face unpleasant surprises during the M&A process.
10. What is the Proposed Handover Period, and How will the Transition of Ownership be Managed?
Asking about the proposed handover period and transition management is crucial to ensure that you clearly understand what to expect during this period. This includes how long the handover period will last, what support the seller will provide, and any obligations or expectations that will be required from the buyer.
11. What Process Will My Team Use To Access Due Diligence Documentation?”
It’s important to note that 50% of all buy-sell transactions fall apart during the due diligence process. Thus, a virtual data room (VDR) is a crucial tool in the M&A process, as important as asking the right questions when buying a business, to ensure a secure and organized environment to review confidential documents. A VDR provides a secure, centralized location for auditors and stakeholders to review confidential documents and financials, with changes tracked and digital access revocable.
If a company lacks a well-organized and confidential means to share mission-critical data, it may raise concerns about their commitment to the M&A process and other corners they may be cutting.
So take the time and follow our guide of questions to ask before buying a business, so you can conduct thorough research before making such a significant investment.
When you see a company using CapLinked, it’s another sign they are serious about security, confidentiality, and the M&A process.