Ask the seller to disclose these items before buying
If you are excited about a new business opportunity that includes the purchase of an existing operating business…please take the time to do your due-diligence first.
I will describe the ideas presented above. When you finish this article, you should have a good idea on what to ask the seller during your process of due-diligence investigations.
Here’s an example: John always wanted to be the owner of a bar. One that offers him the opportunity to run a successful bar his way.
Where he can hang out with the regulars, sharing stories, and serving drinks. And earning a profit. This is one version of the American Dream.
He comes across this bar for sale for under $200K. It sounds like just what John is looking for. But is it?
What the seller failed to disclose is that they are 8 months behind on the state sales tax liability. You better know this because the state may come after you.
Or that the landlord just raised the rent 200%. And that the neighborhood is not great for bar patrons anymore.
Hopefully John performed a due-diligence investigation and discovered these red-flags.
Due-diligence first—the investigation begins
#1 — The 3 reports to get from the seller before buying and why
- The Balance Sheet minimum 3-years +
- The Profit & Loss Statement (Income Statement) minimum 3-years +
- The Statement of Cash Flow 3-year comparison
We have unfortunately heard that some sellers have told our clients things like:
“You do not need these. Here’s our Income Statement for last month. That’s shows how much profit we had.”
Or:
“I’m not showing your our books!”
This last one is a sign of proceed with caution on your part.
If they won’t budge on this…walk away. Why?
The business’s financial scorecard—the financial reports
Listed above are the 2 out of the 3 business financial reports that are a must for your due-diligence: the balance sheet and the income statement.
These are the way that all businesses track their revenues and expenses. Assets and liabilities. Their gross profit and net income. Owner equity or stock.
Without these you could be assuming undisclosed liabilities of the business. Or assets you thought were included but are not owned by the seller.
The 3rd, the statement of cash flow, shows how they are using their financial assets by the three categories listed (Operating, investing, & financing activities).
Questions to ask yourself before meeting with the seller to buy
Don’t fear the questions for the seller
Q. What kind of sale is this?
A. Asset, equity (stock), hybrid, merger, franchise,
Q. What assets are included?
A. Read the Asset section of the Balance Sheet.
Q. Are there any liabilities I assume?
A. Read the Liability section of the Balance Sheet.
Q. What is the Company Book-Value (CBV)?
A. Read the Balance Sheet: CBV = Total Assets – Liabilities
Q. How much depreciation has been used?
A. This will reduce Property, Plant, & Equipment (PP&E) Asset Book Value.
Q. What Goodwill are they asking for and why?
A. Intangibles such as implied value above CBV.
Proceed with caution before signing—in closing…
As you can probably already see, buying an existing business can be both risky and rewarding.
If you are not absolutely sure of what the seller is offering, it is wise to seek professional help.
A Lawyer & CPA just might save you thousands $$$
Look at it this way, if the price the seller is asking includes assumption of an $80,000 tax liability that you don’t understand…the $350–$600 per hour for a CPA to review the financial reports and an attorney to review the sales agreement…
…is well worth the $5000.00± professional fee expense.
And the potential monstrous loss from something that you did not understand.
Our C & M Bookkeeping division can help you put together the financial reports from QuickBooks Company Files—if you are given access.
It is worth noting that you can offer to sign a Non Disclosure Agreement if the seller appears reluctant to give you access to a complete accounting of the company.
The NDA is an agreement that says you will not disclose closely held financial information to any third party unless you state an allowance for a fiduciary like a CPA and lawyer.
The bottom line — It’s great to be excited about a new business opportunity through the purchase of an existing and ongoing business. But doing your Due Diligence Investigation is practically mandatory to protect your investment, your home, and your family.
UPDATE: The other story I’ve heard is that the seller was more of a hobbyist and did not keep any bookkeeping records. So, all they have is a bank account and bank statements. And probably tax returns.
In this case, are they willing to give you access to 3 + years of bank statements plus income tax returns?
And do you have the time to go through them, make notes on what does not make sense…like what expense was this purchase? Three years times 12 months is 36 months of deposits and withdrawals to go through.
You also won’t know if all of the business generated income went into the bank account. Did cash just go to the owner?
Or if the owner mix personal finances with business.
This is just another possibility when buying an existing small business.
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