Buying a business – is it for you?
Record numbers of Australian entrepreneurs are looking to sell up and move onto other things, figures released this week contend.
The BizExchange Index shows that the September quarter saw an 18% increase in the volume of businesses for sale, with the number of private businesses for sale reaching a record level of 29,060 for the quarter.
While sluggish conditions in several areas of our economy are apparently causing business owners to put up the ‘for sale’ signs, there are other factors at play.
As business advisor Marc Peskett points out, more than one in four small businesses are now in the hands of older people who are likely to want a lifestyle change.
As a result, 50% of all owners are actively planning the sale of their business; and 59% would seriously consider selling their business if approached.
This trend can be seen as a positive one for people wanting to own their own business, with an increased range of established, viable companies on the market.
However, if you’d rather buy an existing business than go through the trials and tribulations of starting up, there are several things you need to consider.
Here is the main groundwork you need to put in before you take the plunge and buy someone else’s enterprise:
1. Consider the best fit for your life
Why do you want to own a business? Are you looking for a lifestyle change that will see you into retirement or are you seeking a hidden gem that you can grow into an international behemoth?
The reasons for buying a business, as well as the ventures themselves, are hugely varied. Therefore, it’s important that you identify the right enterprise for your own circumstances.
If you’re looking for a sideline to your family life, for example, it’s best to not take on a complicated, capital and resource-heavy entity that will soak up your time and drain your finances.
Similarly, lofty entrepreneurial dreams may be frustrated if you take on a small shop off the beaten track with no market differentiation or growth potential.
Consider how your life will change by buying a business. Consult your family and friends and seek out professional advice as to your financial situation. Determine who will back you with cash and business and emotional help.
As with any new business, weigh up your own strengths and weaknesses. Are you committed and determined enough to make this work?
If you’re certain you have what it takes to be a business owner, ponder the pros and cons of buying a company as opposed to starting one.
Here a good rundown from Business Victoria.
Advantages of buying a business:
- Existing customers, contracts, suppliers, staff, plant, equipment and stock.
- Acquiring goodwill associated with the name and location of the business.
- Acquiring knowledge of current owner.
- Premises are set up and the lease on the premises already negotiated
- Financiers lend more readily to an existing business with a trading record
Disadvantages of buying a business:
- Customers and staff may leave when a new owner takes over the business.
- Paying existing staff entitlements such as long service leave payments.
- The business may have a bad image which is difficult to change.
- Business may be overpriced or not be easily transferable.
- Premises, plant or equipment may be inadequate or old.
- Difficult getting the lease assigned with existing entitlements, with landlord only prepared to offer a new lease.
2. Do your due diligence
It’s estimated that around 70% of searches for businesses for sale come via the internet, with many prospective buyers taking up to 18 months to select the right fit for them.
Once you find your ideal target, it’s time to do your due diligence. Speak to the business’ owner and employees about what kind of shape the venture is in. You may even want to volunteer to work in the company for a short period, to get to know its inner workings.
Quiz the owner on why he or she is selling up. Establish what contracts, supplier and employee agreements are in place.
Consider drawing up contractual safeguards, such as the transfer of payment for the business as it hits agreed benchmarks. You may also want to include a clause whereby the previous owner can’t start-up a similar business within a certain radius for a period of time.
Crucially, you need to know how the business is performing, as well as its reputation in the market. Ask for all the relevant documentation and use the ATO small business benchmarking tool to ascertain how it is faring compared to industry standards.
Vital items to clarify are, according to Business.gov.au:
- Sales – patterns, trends, customer base, current suppliers.
- Costs – fixed and variable costs, staff costs.
- Profits – analyse financial records, future cashflow and profitability.
- Assets – identify and check all assets, including intellectual property and leasing arrangements.
- Liabilities – outstanding debts, refunds and warranties.
- Purchase agreement – review carefully.
- Tax – GST, capital gains tax, stamp duty implications.
- Legal issues – leases, business structure.
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3. Weigh up the valuation
A business is only worth what you’re prepared to pay for it. But buyers are in danger of being ripped off without proper checks – CPA Australia studies show more than 80% of potential buyers would have paid too much for their business if they hadn’t carried out financial due diligence.
To independently gauge a valuation, consider tangible and intangible factors – goodwill among customers and the community, ongoing contractual work, intellectual property and equipment and premises.
“Business value will normally be measured by either its level of profitability, a value model specific to your industry or, in a very limited number of cases, a value attached because of the future potential of your business,” explains Greg Hayes, of business advisory firm Hayes Knight.
“Some industries have a specific industry valuation model. Typically these occur where there are a large number of participants.”
“Think about an industry or sector where you have a large number of similar type businesses and where the business model is reasonably consistent. Businesses like newsagents, pharmacies, cafes, real estate agents are examples of these businesses, and there are many more.”
“The good thing about these businesses is that value is relatively predictable.”
Peskett adds: “Make sure the value is transferable, not just retained all in goodwill. Are the systems and processes that the business has been built on documented and able to be followed by someone new or is it all tied up in the knowledge and relationships of the previous owner?”
“Does the business actually own the IP that you wish to acquire or is it licensed from a third party? Is the licence transferable?
4. How will the deal work?
Before you spend your money, you need to be certain exactly what you’re buying. Will you be purchasing the business entity or just its assets?
Once you do so, will you operate as a company, sole trader, partnership or trust? Will there be a cooling off period?
These are all questions you need to grapple with. Peskett says that it’s important to identify the level of liability you’re taking on.
“Buying the entity means you acquire its risks and liabilities such as debt, previous trading history, tax liabilities and responsibility for responding to customer action against faulty products or services,” he says.
“Will the warranties and indemnities of the business hold up against this? If not, buying the assets only might be a consideration as this generally carries less risk.”
5. Assess future performance
Focus on future profit, growth and cashflow. Is this business really one that will provide you with a springboard into bigger and better things?
Further to that, are the people in the business prepared to work for you? Will valued customers be perturbed by an ownership change? Do you need to shake up the culture of the business when you arrive?
Clearly work out what kind of boss you intend to be and how your arrival will impact the status quo.
Also, you need to be aware of the business’ reliance on its owner-operator. You may be stepping into a brand that was essentially modelled around one person, who has now left.
“If this business is reliant on the owner-operator, then it limits the potential owners to those that possess the key skills required by the owner-operator,” the BizExchange Index report points out.
“They will bring with them a perception of the value difference between their skills and those of the current owner-operator.”
“As such, this value will be highly subjective and the departing owner-operator is stuck between a rock and a hard place.”
“He needs to show that he has a business that is well run with a good reputation, at the same time as presenting a business that has the potential to be run better and go further with the new owner.”
“As a general rule of thumb, the less a business is reliant on the owner-operator, the higher the value of the earnings multiple.”