The Mistakes You Must Avoid When Buying a Business

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Katie Fleming

Co-founder and COO of Owner Actions

A person sits at a desk with an open portfolio wondering about the mistakes he might make when buying a business

From overlooking key issues to making missteps in negotiations, most first-time business buyers make mistakes when buying a business. In this article, you’ll learn about some of the most common mistakes buyers make. You’ll also find some actionable advice you can use to navigate around the pitfalls.

Let’s dive into some common mistakes:

1

Entering the process without a clear objective

Often, prospective buyers begin their search because they’ve heard of others’ successes in buying an established business. While there are clear advantages to this approach, it’s important that you take the time to assess whether buying a business makes sense with your goals and your ability to invest the time and resources you’ll need to succeed.

 

This guide can help you firm your objectives:

2

Underestimating the work that goes into buying a business

Many buyers find that it takes up to 12 months to source the right business. Some search longer, for two years or more. If you’re determined to buy a business, you should recognize that the process can be long and complicated. Plan to spend months reviewing business listings, signing non-disclosure agreements, and reviewing the financials and practices of multiple businesses before settling on a target and completing your acquisition.

 

These two articles can help you set yourself up for success:

 

3

Forgetting to think like a seller

Buyers can fair far better in negotiations by considering a seller’s needs and goals alongside their own. Put this concept to work in your negotiations by considering a seller’s attachment to his or her business. Avoid harsh criticisms and shows of disrespect when discussing the business’s drawbacks.

 

You should also try to connect with the seller and build a positive working relationship. This could serve you both well as you discuss confidential matters and negotiate terms. By establishing a good working dialogue, you may access better information about the business. You might also open the door to discussing the business’s blind spots and ways to work around them.

 

This guide can help you learn more about this part of the acquisition process:

4

Accepting the success of a business at face value

It’s a broker’s job to present a seller’s business in the best possible light. Here are two tactics many take to do this:

  1. In some cases, they may make adjustments to the earnings and include add-backs to improve the financial picture of the business.
  2. They may coach the seller through some pre-sale moves such as selling off excess inventory or temporarily slashing prices to boost the attractiveness of their business.

 

By working with an accountant, you’ll be able to spot these moves and other irregular financial behaviors that may signal trouble in a seemingly good business.

 

Learn how to find a great accountant with this guide:

5

Failing to assess the seller’s base of customers

Many small business owners turn their personal contacts into clients. You should be concerned if a business’s sales depend on relationships that exist between the seller and the business’s customers. Here’s why: that customer base may disappear when the owner exits the business.

 

Avoid this mistake by asking sellers to disclose the percentage of customers who have personal connections with them. Then, assess whether the customers who remain generate enough sales volume to proceed with the transaction.

 

Our article on due diligence can help you spot other red flags.

6

Trusting the accuracy of the seller’s data

In every transaction, a seller will present balance sheets, income statements, and other financial documents that demonstrate a business’s strength and viability. Of course, these documents should never be accepted at face value. You’ll need to study and verify the business’ financials. Hire an accountant to assist in the assessment and ensure that there are no red flags, questionable line items, or evident problems in the business’s cash flow or performance.

7

Relying on numbers alone

Sometimes, buyers complete their evaluations of a business without considering external factors. Here’s why they should. Customer reviews, employee satisfaction, competitive positioning, environmental concerns, legal claims, and regulatory issues can impact a business’s long-term success and sustainability.

 

Be sure to conduct outside research, too, to build a clear picture of the business before proceeding with your purchase. An attorney may be able to help.

 

Learn about why you should have an attorney on your team with this article:

8

Missing the mark in valuations

Buyers tend to overestimate the value of businesses. Many miscalculate the magnitude and frequency of future capital expenses. Avoid this mistake by accounting for the business’s working capital needs and the investments you’ll need to boost infrastructure, upgrade technologies, and maintain equipment. An accountant can help you with these projections.

 

You can learn more about valuations in this guide:

9

Forgetting to set aside money for working capital

Some buyers raise funds for acquisition without setting aside money to cover operational concerns and emerging needs. Often, these buyers must take on more debt or put off improvements the business needs to succeed.

 

Here are two ways to avoid this mistake. First, set up a contingency fund that equals approximately 10 percent of the purchase price of your business. And second, create a working capital account that can cover at least three months of expenses.

 

Interested in ideas for raising capital? This guide will help you explore your options:

Many of these mistakes can be avoided by connecting with legal and accounting experts who are familiar with the small business acquisition process.

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