There are numerous advantages to buying a “going concern” that can make it less risky than a start-up endeavor. A few of those elements:
- Systems are in place. You don’t need to create policies & procedures for a successful operating business.
- Known market and customer base. Unlike a start-up you will have a solid understanding of sales based on past and current performance and a built in customer base.
- Proven cash-flow. It may be easier to secure bank financing for a “going-concern” and you know you’ll have cash flow for income and debt service.
- Trained employees. Buying a business means you have trained and knowledgeable employees that can help you integrate into the operation.
If you are a seller, keep in mind that these are real reasons that people would buy your business. If you are a buyer, don’t lose sight that these factors can greatly reduce your risks. Unfortunately, as a broker, a SCORE Mentor and business consultant, too often I’ve seen Buyers acquire businesses and then immediately throw away these inherent advantages! How do they do it?
- Fire or replace key employees. Some new owners may feel threatened by existing employees. They may feel that employees are too “loyal” to the previous owner or have better relationships with other employees or trade contacts. A new owner may believe they are asserting their authority by “cleaning house”, but the loss of experienced employees could have a negative impact on the business.
- Cut costs or strangle working capital. The strategy of cutting costs or expenses seems an accepted tactic to improve profitability but may have a negative effect on customer service, operations or employee morale. While a business acquisition may represent a large financial investment, prudent analysis of costs is required, not a knee-jerk cost cutting strategy. Profitability can be increased not just be reducing expenses; you can also increase sales to current customers, add products or services or generate new customers.
- New owner is not “in the store”. Most businesses are “Main Street” operations and the owner needs to be in the store! Period. If you are looking for a passive investment you should consider stocks or bonds.
- Over-leveraged acquisition. Too much debt can drain your businesses cash-flow, impede your ability to grow or react to market changes and delay needed investment. Money is cheap, so now may be a good time to borrow, but make sure the business isn’t hampered by burdensome debt.
- Pay too much for the business. For individuals, acquiring a business may be an emotional decision. If you are excited about an opportunity you may be willing to pay a premium or overlook normal valuation models. It’s frustrating to see hard working entrepreneurs acquire the right business but never have a chance to succeed because they paid far more than the business is worth. Buyers should understand basic business valuation before committing to an acquisition. As a quick gut check, the verifiable business cashflow should be enough to pay you a RoL (Return on Labor or fair market salary for your work), debt service (70% of price, principal and interest) and still have cash remaining for reserves for replacement and other capital expenditures. If you have to work in the business for 5 years without taking a paycheck just to make debt payments you probably need to review the price, terms and structure of the deal.
Don’t let these common mistakes derail an otherwise great acquisition!