Before you buy the business of your dreams, be prepared to thoroughly evaluate the business with both eyes open.
Evaluating a business is a complicated and subjective thing. An operating business has many different facets to consider, such as its profitability, revenue, operations, markets, and management. It’s important to have a comprehensive understanding of the existing business so you can understand its potential.
Below are 7 keys to evaluating a business when looking to purchase it.
- Understand the Asset Base
Get a handle on the assets used by the company. A detailed list of the company’s assets is a good starting point. Tangible assets are the items you can use, touch, and see – such as a building, equipment, machinery, and inventory. There are also intangible assets such as a customer lists, contracts, brand value, and other intellectual property. These assets may be more important to a business and its potential than the physical assets. Ultimately, it is the asset base that comprises the enterprise you are buying, and a solid understanding of a company’s asset base is integral to any purchase decision. - Company Liabilities
A company’s liabilities are its obligations to another party that are not yet paid for or completed. You need to determine what liabilities carry forward with the company and analyze their magnitude should you move forward with the purchase. Common liabilities are bank debt and trade payables. However, you also need to know about indirect or contingent liabilities, such as signed agreements where the company has made future commitments. Getting a good grasp of a company’s liabilities is a fundamental component to evaluation. - Understand the Financial Statements
Financial statements are an extremely important starting point in evaluating a business. If you aren’t good at reading and understanding financial statements, ask your accountant or advisor to interpret them for you. Understanding a company’s accounting policies is also critical to interpreting the results. Additionally, financial statements provide clues where you should be looking deeper, either for more detailed financial information, or at operational elements that influence a company’s expected profitability and capital requirements. - Review the Industry
It’s important you understand the industry the company operates in – its current state, and what the future looks like. What trends are impacting buying habits, and potentially impacting the company’s future sales? Industries have life cycles, and buying a business in an industry near the end of its life cycle has very different considerations than buying a business in an industry which is young and blazing new trails. - Determining Value
There are two basic approaches in determining the value of a business. One method is based on assets. The other method is based on earnings, cash flow, and future potential. This is a key area where the help of independent and expert advisors comes into play. Value can also be influenced by the other significant components of an acquisition, so looking at the whole picture is essential to determining whether you’re getting a deal, overpaying, or achieving a fair and balanced transaction. - Financing the Purchase
Have an idea how you going to pay for the business before you commit to doing so. You may wish or need to use debt to help finance the transaction. Equity or other funding from outside sources may also factor in. Vendor financing may also be a consideration. Having an idea of how you intend to fund an acquisition before reaching a deal is important so you understand your cost of capital used to buy the company, and how much future cash flow may be consumed in servicing that capital (for instance, through monthly debt repayments). - Do you want to be in this business?
After you’ve done your due diligence you need to ask yourself a very important question: “Do I want to be in this business?” It takes hard work and commitment to make a business successful, and it’s much easier to be devoted when you are excited about the opportunity. If you’re going to make a major commitment of capital, time, and energy to the business, be honest with yourself, and be certain this is a venture you want to undertake.
Buying a business is a big deal—it’s complicated and it involves a lot of moving parts. If you are considering buying a business, make sure you are getting the expert advice you need to ensure you have made the right decision at the right time. Rise Advisors Transaction Advisory Services team are here to help at every stage of the deal.