by Dustin Brown
Buying or selling a business can be daunting. There are many items to consider such as 1) the structure of the transaction (e.g. stock or asset sale/purchase) and the related tax implications of this decision, 2) the risks associated with the business, both macro and micro, and 3) the general fear of the unknown both internally and externally (i.e. will I succeed, will the business succeed, etc.). This is not a simple transactional task like buying groceries from the supermarket; it is more akin to having or adopting a child – a process that takes a significant amount of dedication and resources and that will have a lasting impact on your life.
Because of the significance of buying or selling a business, understanding the financial and operational characteristics of a business is paramount. The buyer should be aware of all of these aspects in order to ensure a smooth transition of the business. And, while owners know their business inside and out, they do not always have a well-developed method for relaying that information to a potential buyer. This is why it is absolutely crucial to be organized and plan ahead.
Below are some items to consider for buyers and sellers that can ensure a smooth transition from one owner to the next.
Understand the Financial Well-Being of the Organization
You have to understand the financial position of the business at all times and how it relates to your financial needs.
Current Owners/Sellers: If you are knowledgeable in all of the details related to the financial position of the business, it results in greater confidence to external parties in the event the owner wants to sell the business. Being able to discuss various financial metrics/details, including the profit margin, the current and quick ratios, average and annual growth rates, etc. provides potential buyers with some of the basic knowledge that they will need when determining whether buying your business is a reasonable decision. In addition to discussing the various financial metrics, it is also important to have, maintain, and be able to provide receipts from expenses, backup files of all tax returns and financial statements, any and all legal documents/agreements, etc. Being able to provide all of this information will allow for a smoother transition. Additionally, having all of these items will result in less time for the transaction and fewer fees from attorneys and consultants who may be facilitating the transaction.
Future Owners/Buyers: Understanding the cash flows of the business is essential to ensure the profit generated from the business can support your livelihood and pay any debt you may have incurred during the transaction process (business loans, legal fees, etc.). You also need to understand the various financial metrics that can be used to assess the financial health and stability of the business itself. Knowing and understanding these financial components will allow you to make an educated decision on whether purchasing the business is a smart decision. Not all purchasing decisions are made solely on the profits of a business, but it is still important to understand what you are getting yourself into!
Being able to review and analyze all the current and historical financial, operational, and legal documents including tax filings, profit/loss statements, balance sheets, legal agreements, employment contracts, etc., are all a part of the due diligence (research and analysis) process. Having all of this information readily available will instill greater confidence in the overall transaction for both parties.
Current Owners/Sellers: Plan early and implement a system for document maintenance and retention. Having a system in place for document retention is not only helpful for you as the owner, but also as a seller. The due diligence process can be lengthy, so it is important to have all business information/documents easily accessible and available to reduce the due diligence timeline.
Future Owners/Buyers: During the due diligence phase, it is your job to make sure you receive all of the information necessary to make an educated and informed business decision. You should be asking for all the financial and operational information as well as having discussions with the current owner about nuances within the business down to the most minute detail. These can include conversations on the hierarchy of employees, unique situations with suppliers, subcontractors, and/or distributors, etc. During this stage, you need to determine how you may operate the business and what decisions you are going to make in the first month, third month, twelfth month, etc. Start your strategic plan sooner rather than later using all of the financial and operational information you receive from the current owner.
Research the Market
Current and future owners need to have an understanding of the market, both locally and nationally, in which the business operates. Understanding the effects of a recession and/or expansion on the business, how to mitigate losses if there is a downturn in the economy, and what to do with additional profits should there be an upswing in the economy is crucial in the sustainability of the business as well as the growth as a whole. This research may not always be documented by a buyer/seller, but it does need to be considered as it has a direct impact on the success of the business.
Current Owners/Sellers: If possible, share what you can with buyers about the marketplace and any research you have accumulated over the years. Trends in sales/revenues, expenses, labor, equipment, etc. are all great pieces of information that you may know and a current buyer may not. Provide details on things to look for which may lead to various changes in the industry (i.e. if gas prices change, material expenses increase, profits decrease, etc.).
Future Owners/Buyers: Do your homework! Research the market conditions and competitors, understand the current economic and political environment, and analyze any upcoming changes in technology and how these items may impact the business. Reach out to business consultants/brokers and ask for assistance with industry and market analyses to help you in the strategic planning process.
Understand the Operational Well-Being of the Organization
The operations are just as important as the finances because a business cannot make money if it is not operating efficiently and effectively.
Current Owners/Sellers: The buyer wants and needs to know what you have been doing in order to decide whether that is the direction they want to continue moving or if they should move in a new one. Plan ahead and have operational details ready. Provide details on clients/customers and any current contracts, prospects/new clients and how to continue conversations with those individuals, and the overall flow of the internal operations as well as any business development strategies that have been successfully utilized in the past.
Future Owners/Buyers: Make sure you know how the business operates. What is the final product or are the primary service lines? How is the product sold/distributed or how are the services performed? When do you make profits? What terms do you sell the product (or service) on or what are the terms of significant contracts? How are current customers treated? These are just a few of the questions that need to be asked. There are many more that will be more specific to the business itself as well. Take a step back and put yourself in the shoes of a current employee, a current customer/client, or an outsider such as a surety, loan officer, or attorney. What questions do those individuals want to know? Those are all the questions you need to ask and have answered as well.
Internal Dynamics & Culture of the Organization
The internal dynamics and culture of the organization can be one of the largest and most difficult areas to understand and analyze. The internal dynamics of any organization generally include managing people and opinions versus numbers and facts. Without employees, the business does not operate and therefore will not exist, so it is important to have discussions on the human elements involved in operating the business.
Current Owners/Sellers: The buyer will want and need to know the employees including titles, compensation, benefits, etc., as well as a lay of the land regarding employee relationships. If you know that there are certain employees who are looked up to and/or revered because of their years of service, their attitude, or their overall knowledge of the business/industry, make it a point to share this knowledge with the buyer. Make sure to have a listing of employees, notes, and files on those employees and their history with the company, and discuss how those employees operate on a daily basis.
Future Owners/Buyers: Ask sellers to share everything they can with you about the day-to-day operations, and use this information not only to understand the organization but also to develop internal relationships more quickly. What employees are exceptional? Do any employees give you concerns? Businesses have a lot of moving parts and they all need to work in tandem for the business to operate. Trying to manage and understand the employees and their roles in the organization will instill confidence with these employees as well as with the seller.
Consider a Consultant
Many buyers and sellers do not consider all the aspects involved in purchasing or selling a business because they do not have the prior experience needed to know the right questions to ask. Similar to having your first child, there are so many things that are often learned by experience! This is why it is so important to consider advisors out there who already have the experience and can walk you through every part of the buying or selling process. If you have questions about buying/selling a business, please contact your local Blue & Co. advisor today.