At its core, the entire process of searching for and buying a business is centered on asking questions and gathering information. How else can a buyer make an educated decision about whether or not to buy a particular business?
While there are literally hundreds of questions buyers will ask throughout the process, here are 10 key questions every buyer should make sure they get answers to.
When you’re reviewing a business’ financial statements, it’s important to understand how revenue is accounted for. You’ve probably heard terms like cash accounting, accrual accounting or GAAP – but what do they mean? What it all boils down to is simply understanding when a business records revenue. Do they record revenue when they complete the work, invoice the customer, receive payment, or maybe some other method? There’s not necessarily a right or wrong answer to this question, but it is critical to understand how it’s done.
Always ask for the business’ accounts receivable aging report. This will give you a clear indication of whether or not the business has a problem collecting revenue from its customers. If there is a substantial amount of revenue that is beyond 60 days outstanding, the owner should be able to explain why that’s the case. Understanding A/R aging and collections is a key piece of being able to determine the amount of working capital a business needs.
This is referred to as customer concentration, and it’s extremely important to analyzing a business. Understanding a business’ customer concentration helps you evaluate risk. If a business has one customer that accounts for 50% of its revenue, that equates to much more risk than a business that has five customers accounting for 50%. If those two businesses were to lose their top customers, the first company would be in serious trouble, while the second would be able to recover much easier. However, customer concentration is not a full proof tool. There are circumstances that can mitigate the risk of a large customer, such as a guaranteed contract or a long-term relationship. Nevertheless, it’s important to ask this question.
In businesses where equipment and other assets are relied upon to produce the company’s revenue, it’s critical to get a feeling for the remaining usable life the equipment has. Depending on the type of equipment, age might not be as important as you’d think, so make sure you research how long these assets typically last. Along this same line, find out how the owner has maintained the equipment – has there been a regular maintenance schedule, or are they just repaired when they break down?
This is a significant piece of information you need to understand about any company. Where does the money come from? Is it regular recurring contracted revenue? Is it repeat, loyal business? Is revenue heavily tied to referrals? Is revenue project-based and every job has to be estimated and sold? Is revenue largely seasonal and driven by the calendar? Is revenue driven by an aggressive outbound marketing program? By understanding what drives revenue, you can determine if the business has a replicable model that will continue to drives the top line.
You need to make sure you’re clear on how employees get compensated. Actually, the first thing you need to know is if they are employees at all, or contractors. Are they paid hourly or salaried? Do they get commissions, bonuses or raises? Is there health insurance or retirement benefit plans offered? What about expense accounts, auto allowances or other perks? Not only do you need to understand these specifics so you can analyze the business properly, but you also need to know what the employees will be expecting when you take over the business.
This information can help you determine several things about a business. Do the employees appear to be happy working there? Does the nature of the work the business does just drive people off quickly? Is it difficult to find talent for this type of business? Does the business need more staff to help lessen the burden on everyone? There’s so much information employee turnover can help you uncover about a business. It’s also important to keep in mind that every industry and every business has it’s own unique employee challenges, and a high turnover rate doesn’t necessarily point to a problem with the company.
Whether or not you plan to replace the owner yourself, or you plan to replace the owner with a new hire, you have to clearly understand what responsibilities the owner has in the business. You need to know more than just how many hours they work. What is their daily routine? What weekly, monthly, annual duties do they have? What do they do that no one else in the company is trained for? How much do they micro-manage the operation.
Before you even begin to look for a business, you should know exactly how you will fund the purchase. You should know how much cash you can inject, your ability to qualify for a loan and whether or not you’re going to require a seller to carry a note. Since you already know what you can and can’t, or will and won’t, do, it’s important to know where the seller falls on these topics. If you’re adamant that the seller should carry a note but this particular seller will not, then walk away. If you’re willing and able to pay all cash for a business and that’s the seller’s request, then you can be confident moving forward.
This is certainly the simplest question to ask, but it’s definitely not the least important. In a perfect world, every business owner would be 80-years-old, selling their absentee-run business they started 40 years ago so they can retire. But that’s rarely, if ever, the case. With that said, there’s really not a wrong answer to this question, but there are answers that don’t appear to make sense. It’s up to you to use your best judgment to determine if a seller is sincere about why they are selling, or if there is a problem with the business they are trying to avoid.