How to avoid buying a dud small business

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Most Australians start their hunt to buy a business with an online search.

That's the word from Noel Currie, certified business divestment and exit strategist from Australian Business Sales Corporation, who says at least 90% of buyers search the internet for their new business opportunity.

Still, finding the right business involves more than a few judicious mouse clicks; in fact, it's a time-consuming and an incredibly challenging process.

how to avoid buying a dodgy small business

How to find the right business

The first step involves finding a business that matches your experience.

As a writer, I make an inferior builder. When looking at target companies to buy, Adam Smith, chartered accountant and director of professional services firm Aurecon, recommends seeking out businesses that align with your skill set, background and expertise.

"These days, there are countless websites and brokers you can approach to help you identify the right business," says Smith.

"However, it's so important to conduct your market research and detailed due diligence. Thoroughly understanding the commercial environment you are operating in is paramount to business success.

"Generally, the worst and most expensive businesses to buy are the ones already listed for sale, because brokers can sometimes set unrealistic value expectations to justify their fees."

Do your due diligence 

Before buying a business, be sure to do your due diligence and research first. Researching the company that you want to buy will enable you to understand its reputation and potential.

Apart from understanding the financial records, operations and legal contracts, Smith recommends taking the time to meet customers, employees, suppliers and, where possible, competitors to gain a proper understanding of a business and how it is performing.

"Once you have collated and completed your due diligence, employ a professional to conduct an independent valuation (separate to the broker) to determine the true value of the businesses balance sheet position. If all is still looking good, the next step is working with your advisers to draft a letter of intent for the business."

Spotted a good deal?

First, make sure you have an experienced and reputable business lawyer and an accountant to help you navigate the process and the endless amount of paperwork associated with any business acquisition.

"Many aspiring business owners are fuelled with emotional optimism and may struggle to recognise the blind 
spots. The important thing is seeking out professional advisers to provide you with the facts," says Smith.

Noel Currie says the goodwill component of the business purchase is only a small part of the due diligence process. It is advisable that the buyer also deals with an accredited business broker who is a member of the Australian Institute of Business Brokers and their accountant to confirm the financials.

An eye on the future 

Smith says it is less about finding a great deal for today and more about ensuring you have the proper protections in place for the future.

"That means mitigating as many of the unknowns as possible."

how to buy a small business

What your money is buying

Other issues such as the level of stock on hand and the length of the lease can cause headaches for a new owner. According to Currie, this is a critical part of the purchase.

"Stock, for example, has to be accounted for on a cost, not retail, basis. Also check expiry dates, as in some cases this can be a trap in the value of the stock."

Income or genuine growth asset

Smith advises aspiring owners to evaluate and understand their needs and the type of lifestyle they wish to maintain.

"A buyer should consider how much time they will invest in making a business successful," he says.

"There can be significant advantages in paying more for an established company with a supply chain, strong customer 
relationships and proven operations."

Nevertheless, there can be disadvantages too when buying businesses at a discount.

"Especially if this requires the new owner to repair markets perception of the company, mend issues with disgruntled customers and winning over unmotivated employees."

Buying a franchise should also be an option considered by an aspiring business owner, says Smith.

"A franchise takes all of the guesswork out of how an established business should operate. If managed and monitored correctly, franchises can also deliver good passive income and capital growth."

Issues to consider at handover 

In some cases, the vendor may want compensation for the time they spend in the business during the handover period.

There is also the risk the vendor may consider opening a competing business in the same area.

"Handover periods are negotiated at the time of the contract preparation, and a lot depends on the type of business involved," says Currie. "There can be a minimum period where the seller provides some tuition without being paid.

However, if the buyer wishes to have more tuition, a fee can be negotiated at industry rates. As for the restraint of trade, 
this depends on the industry and location. There can be an international restraint or a regional restraint in place."

Smith says a smooth handover usually involves the vendor working for the business for up to 12 months.

"This may mean negotiating a slightly higher sales price for the business by incentivising the owner to stay invested for a fixed period. In some cases, it is in the seller's best interests to still be involved in achieving performance targets that may be linked to an agreed earn-out value of the business."

During the handover period, the seller can help the buyer to hit the ground running.

"This is so important with smaller companies where customers have both a personal and business relationship with the seller," says Smith.

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Anthony O'Brien is a small business and personal finance writer with 20-plus years' experience in the communication industry.