Business Buyers - Be Aware & Beware

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Seeking Professional Guidance when Buying a Business is a Smart Move
Written By:   Mark Trail, Principal Intermediary for Crown Business Solutions


Buying a Business is a Big Decision – Be Careful!

I routinely read articles offering advice to potential business buyers on things to consider when embarking on the process of purchasing a business – as kind of a do-it-yourself guideline.  But I’m amazed at the lack of advice given to these buyers to use experienced professionals where applicable in the process instead of ‘going it alone’.

A question that I often ask potential buyers is: Would you buy a house without proper professional involvement and representation?  If not, then why would you buy something as potentially risky as another person’s business without proper professional assistance?

Buying a business is a simple process if you just want a write a check and be done with it.  However, what’s complicated about the process is whether to write the check and, if so, what amount should the check be written for and under what terms.   It is wise to recognize that making these decisions requires more skill and experience than any one individual typically possesses.

 What Type of Help Should You Have When Buying a Business?

Okay, so what experience or skill is needed to make a wise buying decision about a business and where can you obtain this assistance?

When purchasing a business, you should consider: the products and services offered by the business; the markets served by the business; the business’ management team, personnel and internal operations; the condition of the business’ books and finances; the nature of any  contracts, agreements, or other obligations that the business is bound to or possesses the right to; a fair market value for the business; and the purchase terms for the business that can be supported by the resources of the business and the buyer – just to mention a few.  To properly evaluate these things, a potential buyer will, at a minimum, require the expertise of an attorney, an accountant, a business appraiser, an experienced business broker, and a qualified business consultant.  Here’s how these various roles will typically apply to the process.

 First, The Buyer Needs Their Own Representation

First, a potential buyer should have representation of their own when purchasing a business.  This is not to say that someone cannot fairly and ethically represent both a seller and a buyer – just as a dual agent does in a real estate transaction.  However, to do so, the representative must be under contract by the buyer and seller.  If the representative is not under contract by the buyer, the buyer will not receive the same level of representation (time, effort, or diligence) in the transaction.  A competent business broker can prove to be invaluable in the initial stages of screening businesses to consider and in the process of negotiations and due diligence.  They are familiar with the purchase process and experienced in asking the right questions to determine factors that will favorably impact a business decision and negotiations.   Do NOT leave it up to a seller’s representative to tell a buyer everything that they need to know about the business.  It is not their responsibility.  They’ll only answer the questions that they are asked and sometimes in a way that doesn’t give all of the information that is desired or needed.  Buyers having industry experience at their side, and at the time that the questions are being asked, will have more thorough and complete information – information essential to make important decisions.  To find a professional broker in your area - visit BusinessBroker.net's Business Broker Directory.

 Second, the Buyer needs an Experienced Business Consultant

Second, buyers should have an experienced business advisor or consultant available as part of their ‘acquisition team’.  Just as it is important to have the buyer’s broker present during discussions with the seller and their representative, it is important to have the consultant there as well if at all possible.  Again, one answer will often lead to another question and having the insight of a business advisor at the time of detailed discussions can prove to be critical in the analysis of the business opportunity being considered.  There are several organizations in most communities that offer free assistance to small business owners or potential buyers through very competent, seasoned individuals.  These individuals, however, do not typically travel to businesses being investigated so their availability to provide the level of service needed may be very limited.  An optimum situation would be for the buyer’s broker representative to have the necessary skill to provide the needed consulting service.

 Third, Make Sure the Numbers Add Up!

Third, a potential buyer should have a qualified accountant on their team.  Most business brokers and a lot of business advisors do not possess the skills of an accountant – and vice versa.  Qualified accountants have the ability to review financial records and statements and point out recognizable and sometimes less obvious, flaws in the finances of a business.  Additionally, accountants can advise the buyer on the types of business structures and accounting procedures, for tax and operational purposes, for the buyer to consider before buying the business.  This information may help the buyer to determine future operating costs.  Typically a business broker is not capable of providing comprehensive advice on these items.  Conversely, most accountants have little experience in operating businesses outside of their own practice or preparing official business valuations.  Unless they are routinely involved in the entire process of selling their clients’ businesses, they have not been sufficiently exposed to the business brokerage community to represent a buyer.

Fourth, Have a Qualified Attorney Involved

Fourth, a potential buyer should have an experienced attorney that can review or prepare contracts or other business documents for the buyer.  These documents might include: real property leases, equipment rental or lease agreements, employment agreements, UCC-1 filings, promissory notes, asset purchase agreements, liens or judgments, or other pending legal action.  The service of providing a legal opinion on these matters generally requires a license to practice law of which most business brokers or advisors do not possess.

Lastly, Consider a Business Appraiser Value the Business

Last, a potential buyer should consider having a business appraiser prepare an official valuation for the business.  While there are various methods for determining the value of a business, many are simple ‘rules of thumb’ and do not conform to the business appraisal standards of The Institute of Business Appraisers or any other credible business valuation organization.  While prevalent among both the business brokerage and accounting community alike, these rules of thumb can be very misleading to a seller and a buyer.  The purpose of having a more credible valuation prepared for the business is so that the buyer can see a more quantitative approach versus a highly subjective approach.  Since this valuation will also be beneficial to the seller, it is possible that the seller may be willing to pay for some, if not all, of this valuation.

 Why Don’t More Buyers Seek Help?

If all this is so necessary, why don’t more buyers properly assemble this team of professionals?  The fact is, most buyers of businesses in the $1M or more range do.  Those buyers tend to understand the importance of their investment decision and the need to have these various skills working on their behalf to maximize the value of their investment and minimize the risk of a poor decision.  But, unfortunately, buyers of smaller businesses either believe that the cost is prohibitive or, worse, that they are completely skilled to make all of these decisions without experienced assistance.  A buyer following the latter reasoning simply reiterates their need for help, so I see no need to address that further.  The cost issue, however, may not seem that obvious, but it should be.

 How Much Does This Cost?

Most of these services (legal, accounting, business consulting, and business appraisal) are customarily paid on an as-needed, hourly-rate or fixed fee basis and don’t necessarily result in a tremendous amount of time on the professional’s part – unless, of course, there are real problems with the finances or there are a lot of legal considerations to review.  In these less usual cases, it is even more imperative that professional opinions are sought.  These fees are almost never refunded back to a buyer if a business transaction is consummated.

As for buyer’s brokerage services, fees are handled in a number of ways.  Some buyer’s brokers will work on deals just as a consultant would – by the hour for pay.  Other buyers’ brokers agree to provide services for a share of the commission to be paid upon the closing of the buyer’s business.  This works only in the case that the Seller’s broker will co-broker the transaction and pay an acceptable portion of the commission to the buyer’s broker.  In the case where the Seller’s broker will not co-broker the transaction, the buyer usually guarantees some payment to their broker for their services.  One problem with this scenario is described by the old adage “you get what you pay for.”  If a deal never develops due to conditions outside the broker’s control, the buyer’s broker is never paid and, with this possibility in mind, it is often factored into a broker’s motivation in working on deals.  Another way that some brokers work is a combination of the two prior models.  They are paid by the buyer for their services as the process takes place and then they credit back to the buyer all or a portion of the fees paid for services rendered upon the receipt of any commissions from a co-brokered transaction.  This motivates the broker to work diligently during the process and encourages the buyer to be more selective, and serious, about opportunities to investigate and pursue.  Depending upon the size of the transaction and the co-brokered commission to the buyer’s broker, it is feasible that the buyer broker’s services may result in no additional cost to the buyer.  This is a win-win situation for all parties.  Even if the buyer ends up paying some of their broker’s fees, it is highly likely that the broker’s services will have resulted in enough savings to the buyer during the negotiations and due diligence process that the buyer still comes out well ahead of the game.

 

Buyers should be aware that these representative resources are available to them and are often quite affordable.  If a buyer does not have the financial resources to cover these essential services, my suggestion would be for them to wait until they do before pursuing a business acquisition.  They are too critical to the buyer in the decision and negotiation process.  Now for the ‘beware’ part of this article – There are some Seller’s brokers in the industry that will refuse to communicate with a buyer’s broker stating that it is a confidentiality issue.  The fact is, both the buyer and the buyer’s broker can sign confidentiality agreements and be equally bound to keep all information confidential.  The reality is that the Seller’s broker would prefer to deal only with a buyer and not another experienced broker – and there is the red flag.  Unless a buyer who is working on their own knows to ask a Seller’s broker if they will coordinate communications with their broker representative, even though they don’t have one, how are they to know that this red flag exists?

The Bottom Line

The bottom line is that buyers need experienced help when investigating a potential business for sale.  Not assembling the appropriate skilled team or employing their expertise is an extremely risky financial situation.  The cost to do so is not only an essential cost of doing business, but it’s an extremely wise investment in the business.  Ultimately, it is the ability to recognize and make wise investments in your new business that will sustain it over the long run.

About the Author

This article was written and contributed to BusinessBroker.net's Blog by Mark Trail.  Mark is the Principal Intermediary for Crown Business Solutions located in Wake Forest, NC.   To contact Mark directly please visit his company website - Crown Business Solutions.
  • Author: Matt Maxwell
  • Date: August 17, 2012
  • Category: Buying a Franchise or Business
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