Michael Goldman & Associates, L.L.C. - Consulting & CPA Services

Kicking the Tires on a Business Acquisition

Starting a business and buying a business are the two choices for a would-be entrepreneur. When you buy an established business you buy customers, an operating organization, and cash flows. These eliminate many of the risks of starting from scratch, but you also compensate (in the purchase price) the current owner for having borne those risks for you. Nevertheless, buying an existing business may be the more affordable alternative when you factor in the time it takes for a start-up to generate positive cash flows. 

Every situation is unique, and there is no standard checklist for how to go about selecting an acquisition candidate. You will be searching for an entity created and cultivated by another entrepreneur that you can meld with your own style and abilities, considering such factors as type of product or service, size, location, industry volatility, and market demographics. 

Rev up the spreadsheet

Once you identify a candidate, take a close look at the numbers. A good purchase target provides a reasonably predictable cash flow, a minimum of existing debt, and an asset base capable of supporting your anticipated borrowings. Getting access to the numbers is usually more easily said than done, as small business owners are often either reluctant or unable to share this type of information. If you don’t trust the financial statements, other sources of often more reliable information include income, sales, and payroll tax returns; loan applications; bank statements; customer and vendor lists; significant contracts; UCC filings; shipping logs; and other documents that involve parties outside the company.  It is critical to perform a thorough due diligence process that includes: 

• Verifying the accuracy of the financial statements - the items listed above will help you with this.
• Explaining fluctuations in historical performance -beware of significant fluctuations that the owner cannot explain.
• Reviewing for overstated assets, understated or unrecorded liabilities (lawsuits, environmental issues, etc.) – check bank documents, UCC filings at the county courthouse, bank statements, etc.
• Make sure that the sales figures are consistent with shipping information, bank deposits, accounts receivable, accounts payable (did the company buy enough items to make all those sales?), etc.
• Reviewing working capital projections  - will you be able to keep the company solvent long enough to meet your growth expectations?
• Evaluating projections of future performance – are they consistent with the reality that you see today?
• Evaluating seller’s ability to perform on warranties, indemnities, etc. – this hinges on both character and financial ability.
• Evaluating tax issues – a thorough review of the tax returns and payments will help you determine if you have any liabilities here.
• Verifying that your own financial position is adequate to support the business’ needs, and vice-versa.

Growth Potential

The next thing to evaluate after the due diligence review is the potential for you to improve the sales and earnings of the business. Typically you will grow the business either by making operational improvements or by changing the financial structure of the business (leveraging assets, improving cash flows, etc.). Seek advice and guidance from industry associations, other companies who will not be your competitors (such as those in a different part of the country), potential customers and vendors,  retired executives, and other advisors to get a “reality check” on your thinking.  A tremendously useful tool is to present both the company’s historical results and your projections in either graphical format or percentages of a common base, and explain all significant trend deviations in sales, gross margins, operating expenses, and key financial ratios that show liquidity, leverage, etc.  Pay close attention to your projection’s deviations from both company history and industry averages. 

Remember that your forecasts for the business once it is under your control will probably be more optimistic than the current outlook for the business, and you should not pay the existing owner for the potential that you add to the company.

Negotiating the deal is an art in itself. Many owners, especially founders, are more emotionally attached to their businesses than to their families, and you should be prepared for the possibility that the owner may be unwilling to sell the business at a price and terms that make sense. The excitement of having first shot at the perfect opportunity may be quickly squashed by an owner who has not shopped his business around enough to have a realistic sense of its true value. You must be prepared to walk away if the price and value of the business are too far apart. Remember, even though you view this as the beginning of new life journey, it is first and foremost an investment, and the purchase must be evaluated in terms of sound financial analysis and your exit strategy.

© Michael Goldman 2000

For more information, please go to www.michaelgoldman.com 

Editorial material in these newsletters is intended to be informative, and should not be construed as advice. For advice on any specific matter, please consult your financial or legal adviser.

[ Home ] [ Up ]

Send mail to michaelgoldman@mindspring.com with questions or comments about this web site.
Last modified: March 31, 2007