Things to consider when buying a business

Income

How much is the total income to owners, including any company profit?

Ask for five years’ accounts
Have these accounts been prepared by a qualified accountant? If not, how do you know how the figures have been put together?
If not supplied, insist on having the balance sheets. They provide a wealth of information including indicating whether the following may have occurred :-

An attempt to manipulate the figures
Bad debts not being written off
A business in financial difficulty

Profit arises only after a fair wage has been paid to the owners. Many businesses for sale do not make a profit. The income they generate is barely sufficient to cover the owners’ wages. This ought to mean there is no goodwill. However, many people buy businesses and pay goodwill even though the wages they will earn are low. Sometimes they see opportunities to make a greater profit but often they are merely buying a job.

When buying a business, look at what you are going to get out of it and deduct a fair wage. Is what is left over a sufficient return for the risk you are taking with your money? Commonly, you should expect get at least 25% per year back on the money you outlay. The percentage varies and needs to include an allowance for risk.

Never overlook the very real possibility of losing your money.

Sales

What is the trend of sales over last five years? Are sales steady or fluctuating? How does the future look?

Check the sales over the last few months. Compare this with the same time last year. Are sales going up? Go by money banked rather than vendor’s records. Remember bankings could include non sales income.

GST returns can be useful for additional evidence of income. They contain all sales including equipment so are not 100% reliable. Use the IRD assessments as well as the copy of the GST returns to help you guard against the figures being altered.

Owner runs a second business

Ensure the owners do not run a second business. If they do, they can inflate the income of the business they are selling with sales from the other business.

Some suggestions to help minimise risks

Take a security (like a mortgage) over the business assets. If the business goes broke you will have a prior claim over ordinary creditors. This is very useful if you still owe money to the bank. Alternatively, the security can be in favour of the bank.

Avoid guarantees like the plague. Negotiate where ever possible. Try and limit your guarantee. Refuse to allow your spouse to be a guarantor. Renegotiate previous guarantees whenever you have the chance.

Agencies

Beware of dependence on one source of income and the ease with which it could be removed. Look out for expensive demands, when you take over, by the firm granting the agency.

Make comparisons

Shop around and make comparisons with similar businesses for sale.

The following may be signs of a good buy

Retirement – outgoing owner may have been undercharging and you can put up the prices.
Trouble with the landlord. You may be able to negotiate a good lease.
Owners fighting amongst themselves including matrimonial
Vendor prepared to leave substantial money in at a favourable interest rate
Business has excessive overheads which can be trimmed.
Ratio of staff wages to sales out of kilter compared with normal for industry – may indicate inefficient use of labour or under pricing.
Illness
Dependent on key employee who has just left

Set up yourself

Look at the option of setting up a business, instead of buying.

Competition

What is competition or possible competition in the area like? Could someone set up in opposition to you?

Hours of work

Calculate the number of hours of work needed, including family time.

Interest

You pay interest on borrowed money. This will reduce your profit.

If you use your own money to buy the business, you will no longer get interest. Allow for this.

Health requirements

For food businesses check to see health requirements are up to date.

Lease

Check the terms of the lease. Will the rent be going up shortly? When does the lease expire? If renting premises, check the lease with your solicitor. You need substantial rights of renewal. You do not want the landlord able to take over the premises when you have paid goodwill to be there. You could make it a condition of purchase that you obtain a fresh lease acceptable to you.

ACC

If you take over someone else’s business you may be given the experience rating of the previous owners. This can mean you could face a loading on your ACC. Check with ACC, in writing. You don’t want a subsequent misunderstanding on this matter.

Equipment

Does money need to be spent on it?

Product life cycle

Is this a growing, mature or dying industry? Do you really want to own a business in a dying industry?

Sale and purchase agreement

Most assets (but not goodwill), can be depreciated for tax purposes. Therefore, when buying a business list the assets and state the price paid for each. Negotiate for goodwill to be as small a share of the total price as possible.

Vendor warranties

Anything a vendor has said can be put into your sale and purchase agreement. If promises have been made, you can include them.

You will want a warranty by the seller concerning the level of sales. Include a requirement for the vendor to supply you with a copy of the final accounts for the business, when they have been completed, so you can confirm the sales were as warranted.

You can include in your agreement figures for liquidated damages. This means the agreement states by how much the selling price will be reduced if certain conditions have not been met. This may save you arguments later.

Skills

If special skills are needed, the market for the business is limited to those who have the skills.

Stock

Is some obsolete? Don’t buy the other person’s purchasing mistakes. The level of dust settled on the stock can indicate its age.

Finance

Will vendor leave money in? If the seller misrepresents information to you, you can withhold payments.

There are several ways of financing a business. We can help you.

Staff

Any risk of staff leaving and competing with you?

If manufacturing, would it be better to use sub-contactors and out-workers?

Make yourself familiar with the basics of the Employment Relations Act.

Put legal advice on your list. It’s worth paying your lawyer for a few minutes to explain employment risks to you.

See us about tax issues, including KiwiSaver.

Threats

Consider possible threats from:-

Customers – e.g. Do it yourself market
Competitors
Economic changes
Government regulation – e.g. changes to parking or one way systems
Law Changes
Technology change
Social changes

Hidden benefits

Costs shared between business and private (e.g. car registration, insurance etc.)
Sometimes cheap accommodation
Better way of life being your own boss
Less fear of redundancy

When you have bought

Take over as quickly as possible. A person who has sold a business loses interest rapidly and their service to the customers deteriorates.

Require the owner to assist you fully, as you require. This should be a condition of purchase. EG to be available to work for the new owner without charge for up to 20 hours a week for the first month after purchase. You may find you only need a few hours of instruction and it is better to get rid of the old owner as quickly as you can. Some people can be reluctant to give up the reins and they get in the way.

When to use your accountant

For advice when buying
To get your accounting systems right from the start and save costs
For working out ways with you to make your business more profitable
For tax advice including Income Tax, GST, Fringe Benefit Tax, Entertainment etc.

Cash under the table

You may be told, as the business takes a lot of cash, “we do, of course, take money out of the till”. These statements are not always true. Sometimes there are ways of determining whether this may be true and perhaps getting an idea of the degree of dishonesty. As you can never be sure of these statements it is best to disregard them.