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Entrepreneurship: Used Business for Sale

By Dr Paul E Adams |

"Small opportunities are often the beginning of great enterprises." - Demosthenes

If you think buying a used car is a gamble, a "used" business is a bigger gamble. A "pre-owned" business does not come with a warranty. Yes, your accountant can look at the books and tax history, but there is more to the value of business than taxable income. Neither your accountant nor attorney can tell you if you are buying a treasure or trash. Only you and your analysis can do that.

Just as there are undiscovered treasures in flea markets, there are businesses that are bargains. Illness, family pressures, or the strong desire to call it quits can motivate an owner to quickly sell and not hang around for the top price.

If your heart is set on buying a business, know that it is a " caveat emptor" or "let the buyer beware" transaction. Don't think puffing up value is limited to the current "Rogues Gallery. " Many presumed business opportunities are promoted by slick entrepreneurs looking for a big pile of chips at your expense.

If you have located a business that you are interested in, start your analysis with the earnings and cash flow. Look at the past five years tax returns. Review the sales, cost of goods, expenses, and profits. Look at the net profit before taxes and any unusual items and multiple it by six- that should be the upper limit of what you will be willing to pay for the firm.

Study the balance sheet and check out the net worth or owner's equity. If the company is insolvent- you may want to look elsewhere. Assuming the business has equity, you may wish to start negotiations with an offer to buy at a price close to the value of the equity. It will be a tough negotiation, as it is not likely the seller will accept your first offer-but try.

If you buy the company, you will be wise to be sure the balance sheet asset values are real and not hyped. Look carefully at the accounts receivable and the payment history of the customers. Be suspicious of any past due amounts over 90 days. Be aware that the older the customer debt the less the chance you will have of collecting it. If the business has inventory, watch out for dead stock. Merchandise that has been sitting on the shelves gathering dust is there for a reason- it is not selling. Look at the inventory records and review the sales history. Don't pay face value for merchandise that is not selling.

Spend time and check out the condition and estimated value of long-term assets such as machinery and rolling stock. You don't want to be stuck with replacing assets before you are settled in and are sure you can earn a profit. Obsolete or worn out physical assets can turn into a surprise cash drain.

If the business is occupying leased space- ask to see the lease. Have your attorney review the terms- as the new leaseholder what are your renewal options. A "lost our lease" sign may mean you have lost your business.

Now to the liabilities- spend some time reviewing the firm's credit worthiness. Does it have a history of paying its debt on time? If you are fuzzy about financial analysis, ask your accountant to calculate the company's current ratio. If the current assets are equal or less than the current liabilities- you are buying into a cash flow crisis. Once the owner, you are responsible for all the liabilities. Have your attorney draft an agreement protecting you from any undisclosed debt or legal action.

Your customers are the future of your business. Know who they are and know your market. If you are buying a retail business, study the traffic flow and daily sales trends. If it is a wholesaler, professional services, or manufacturing concern, look at the customer list. Put these questions to the seller: How many customers? Is the base growing or shrinking? Is the business dependent on a few customers, or does it a broad and stable base? Ask about the largest customers sales history. Demand good faith protection, have a provision in your contract with the owner, barring the seller from owning or working in a competing business- if so, you may lose your customers.

These are but a few checkpoints to investigate before buying an existing business. Be cynical, don't assume all sellers are honest; it is up to you to verify earnings, sales, assets values, liability obligations and the market place. If you error and buy a failing firm with bloated assets and a falsely painted rosy future, remember, it is "buyer beware." As you start checking things out, if the owner hides behind a verbal smoke screen or refuses you information, for whatever reason. Save your money-and look elsewhere.

Editor's note:
If you are thinking of buying a business, be sure to check out our free guide, Buying a Business in Canada.

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