Economics 1

Seven Secrets of Buying a Business

By: Clifford W. Lazar (Forensic Business Consultant)

1. Buy From A Terminal Widow With No Heirs You may negotiate a covenant not to compete, but you should set aside a legal defense fund. It is a huge mistake to buy a business from seller still active in the business. He can set up a partner next door before the five or seven years are up. He can open next door after the time limit. This happened to my brother.Definitely don't buy from a seller who will remain active as a potential competitor in a nearby region. He has the good will of your customers and, if distance isn't a real issue you will suffer major attrition of your customer base.
2. Buy a Business that You Know Yes, you can sign a training agreement with the previous owner, but it will be vague and inadequate. Don't expect the employees to be instantly loyal to you. Their ties are with the old management. 
3. Sever Financial Relations with the Previous Owner If you don't pay cash for the business, try not to have the previous owner hold the paper. He will have an incentive to have you fail so he can repossess the business and pocket your down payment. 
4. Buy the Accounts Receivable at a Deep Discount Service businesses often bill membership in advance and service in arrears. Buy both income streams clearly. Have the seller guarantee the amount or deeply discount the value of the accounts receivable. Have all the payments mailed to you and not to the previous owner, who will be tempted to convert them. 
5. Do Your Due Diligence Check the seller's bank statements to assure that they match the P&L or income tax forms he has offered you. Tax forms can be cooked. Get him to sign an IRS 4506 to confirm his tax forms. See the actual cancelled checks to the IRS that match the payments called for on the 1040's. Visit as many of the customers as possible. You will be sold dead clients. And I mean dead. I bought eight clients who were deceased. In a service business there is often barter that made sense for the seller, but won't make sense for you. Discount the value of those clients. Buy a business that is trending in the right direction, not one in a dying industry. Look for Sign. Look at two years of bank statements for bounced checks, reduced income trends and slow paying. Look at the inventory for dust and obsolescence. Look at the employee restroom for anti-management graffiti. Look for deferred maintenance. Look at the rate of purchases for a slow down. Don't be impressed with a lot of foot traffic. It could be friends and relatives. 
6. Have Deep Pockets After you have closed the deal you should have cash reserves to cover at least three months of expenses. You can anticipate the unexpected. There will be delays in collections. There will be unexpected labor costs. Equipment will break down and disappear.
7. Buy a Business that Doesn't Depend on Winks, Friends or Tax Evasion The income stream from skimming the cash box is unpredictable. If profits depend upon not paying legal wages or withholding overtime, any employee can become disgruntled and turn you in for a reward. If the business survives by violating a zoning code or a health code, you will have bought potentially nothing