Best Practices for Buying a Business

By Staff Writer

Posted: September 29th, 2016

Category: Interviews

Richard Parker is the President of Diomo Corporation and author of the bestselling How To Buy A Good Business At A Great Price series. 

how to buy a business

We recently asked for his expert advice on the do's and don'ts for buying a business. Here's what he had to say:

How did you become so interested in helping people learn more about buying a business?

I had been buying my own businesses for several years and was very successful at it. I was considering the acquisition of a wholesale distribution business. After an exhaustive review and due diligence, I discovered that the seller had falsified the records - he had basically "cooked the books" and misrepresented numerous other components. It was only due to me having years of experience buying businesses that I was able to uncover the truth.

Obviously, I walked from the deal. Although I was furious, I remember sitting in my car outside and thinking two things: one, thank goodness I did not proceed with the purchase and two, I realized that the average person would have easily been tricked and likely would have bought the business and the consequences would have been disastrous. It was right then that I decided to put together a comprehensive educational and consulting program for prospective buyers to teach them everything they need to know about buying a business and to personally guide them through every step and major decision so they would never put themselves in that vulnerable situation.

What are the smartest things an investor can do when preparing to purchase a business?

The first thing they must do is to get a crystal clear picture of what type of business is right for them. They have to make sure any business they buy matches their strengths and will not suffer from their weaknesses. Second, don't be delusional either about the size of business they can afford. Third, find a business that has a solid base and one that will transition well to them as the new owner. There is nothing wrong with bland, unsexy businesses. Finally, and really this is the most important thing - get educated. There are non-stop, high stakes decisions that have to be made during the business buying process. Investing a bit of time to acquire the specific knowledge necessary will yield huge results.

What do you find are the biggest mistakes people make in this process?

A huge mistake they make is taking the word of the seller or broker as the absolute truth. Sure there are plenty of honorable sellers and brokers, but their goal is to sell the business and will often tell a buyer whatever they must to get the deal done. Listen to the seller but verify everything!

Next, many buyers wrongly think banks lend money for small business purchases, when in fact, they rarely do, and that is why it is so important to know how to negotiate seller financing. Another issue is they tend to get too emotional during the process and fall in love with the idea of being a business owner and dream about all the things they can do to grow the business. Chances are the seller has likely tried many of them. As such, it goes back to buying a good business with a solid history, and one they can build over time as they learn the business.

What considerations should someone make when deciding to purchase a business?

There are many considerations, but two major ones. First, how will business ownership impact their lifestyle? For example, are the hours the business operates compatibly with the lifestyle they want? If a buyer has a young family and doesn't want to be a slave to the business, they may want to avoid retail. Second, make sure they have adequate financial resources as a backup in case the business does not perform as expected, or they want to invest in certain initiatives to grow it. Way too many businesses both start-ups and existing ones fail because of a lack of capital.

What type of research is important to do before making an offer?

In many cases, a buyer will only have access to the more pertinent books, records, contracts, customer lists and other confidential information in the formal due diligence period which comes after an offer is accepted. So before then, the key is to do as much research as possible. Obviously, the financials have to make sense and generally, a buyer will have access to at least enough general financial information to compile a proper valuation. It is also imperative that you research the overall market for the company's products or services, the competition and how they stack up against them, the lease or property the company occupies, and the useful remaining life of any of the key assets necessary to operate the business.

Who should buyers turn to for advice or help with business purchases?

This is really a huge issue and a critically important question.

There is, undoubtedly, a misconception with far too many business buyers and especially first-timers.

First, regarding the resources, they absolutely need an attorney who specializes in business sales and ideally in deal sizes comparable to what they are purchasing. However, the attorney's role is to scribe the deal and to ensure that the buyer is protected; buyers should not look to attorneys to negotiate the deal. Most are not good at it (even though they think they are) and more often than not, they get in the way of a deal being done. With accountants, a buyer will want them to conduct the financial due diligence and provide advice regarding other financial matters.

Third, is the business broker and this is where buyers get off track. Brokers have a specific but limited role. They can help buyers access businesses for sale, act as a buffer between the parties, and help get the deal to the closing table because they have done it before. However, unless a buyer is paying them directly, which rarely happens, the business sale agreement is between the seller and broker, they only represent the seller or the deal and not the buyer, so looking to them for unbiased guidance is foolish. That brings us to the key adviser for a buyer. They need to hook up with a mentor or hire an experienced buyer's consultant. Every buyer should have someone on their team who has experience buying businesses and will only look out for their best interests. Next to buying a good business, having an expert on a buyer's team will likely prove to be the best investment they make during the process of buying a business.

What types of businesses should first-time buyers consider?

It does not matter whether you have never bought a business or have purchased hundreds of them. If the buyer is planning to operate the business than whatever it is that they do best has to be the single most important driving factor of the revenues and profits of any business they consider purchasing.

That said, if the buyer is a first-timer, they should buy a business that they understand - one where they do not have a massive learning curve, something simpler in nature, and one where they do not have to deal with a ton of moving parts.

Of utmost importance is being able to sustain the business after the sale and that requires a smooth transition to a new owner. The only way that can happen is when a buyer can grasp running the business within a reasonable time frame of a month or two.

What advice can you offer on finding investors or loans to help with business purchases?

It would be wonderful if traditional banks financed small business purchases but they rarely do. There are some good government programs but the qualifying criteria severely limit who can obtain a loan. Many buyers look to family and friends which is OK of course, but those too come with obligations beyond the financials. The single best vehicle to finance a purchase is through the seller. First, it is common. Second, in most cases, it is the only way to finance a purchase and third, it truly serves to validate what the seller has represented when they share in the risk.

What tends to be the most challenging or trickiest aspects of the purchase process?

There are three. The most challenging is finding the right business suitable to each individual's strength. It can take time and it requires diligence. The "trickiest" is usually proving out the financials that the seller has represented. They often embellish the add-backs, and so a flawless financial due diligence is imperative. Lastly, it is envisioning the future. Obviously, one cannot predict it, but a buyer is going to get a sales pitch from the owner and pressure from the broker about how wonderful the business is and can be under a new owner. Quantifying that takes knowledge and research, and thus the reason why I have been teaching and preaching the importance for buyers to get educated about the business buying process.

Once you find what seems to be a good business, you have to move fast and the only way to conduct diligent research in an expeditious manner is to know exactly what to do and how to do it.

What's one piece of advice you find yourself repeating to would-be business buyers over and over?

That's easy: buying a business is a process. There are very specific steps that must be followed. It takes time and work, but it's worth it. However, the only way to be successful is to have the specific knowledge required to make all the right decisions and so what I have repeated way too many times over the past 25 plus years is, "You have to learn before you can earn".

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