Things to do before buying a business
There’s a ton of information out there about buying a business. But much of it skips the most important part: an analysis of your own capacity to buy and run a newly acquired company.
Calculate your own value (net worth) and cash flow
Before buying a business, get a handle on your own capabilities and areas of possible extra risk. Take a few minutes to list the values of the following:
- • Your liquid cash: Any and all money you have immediately available.
- • All your current assets: Include all categories of tangible and intangible assets. Highlight those that would most obviously contribute to the deal’s success.
- • Your yearly sales: Make a note of whether your sales are consistent or erratic and whether they’re trending up or down.
- • Your operating cash flow margin: This can be calculated by simply adding your net income to your noncash expenses, like depreciation and amortization, and finally, by adding your year-over-year change in working capital.
Knowing your current business’s value — on its own — sets you up for success.
“I will ask a prospective buyer how much money he/she has to invest, and every time (and I mean every time) that prospective buyer will tell me the amount of cash they have PLUS an amount they think they can get from friends and family,” writes broker Jim Cumbee, about financial readiness. “I always hear the words ‘I have X amount but I have an investor who can go up to X million more.' But guess what? That X million more never materializes, so most people spin their wheels looking at businesses they can never afford to buy.”
You, on the other hand, now have a good idea of your own current value and the rhythm — or timing — at which your cash moves. These details will help as questions arise about your eligibility to buy a target business.
What questions, you ask? Well, you’ll need to prove your ability to pay for ancillary costs, like business valuation fees, any broker commission (typically paid by the seller, but occasionally the buyer pays a percentage around 10%-12% of the sale), and recovery costs. You’ll also need to prove your financial ability in a formal “financing analysis,” which requires the above details.
And finally, mastery of your own financial position puts sellers at ease. Remember that business sellers go into deals with many more memories and emotions tied to the transaction than buyers. Sound financial records help vet buyers and relieve their concerns.
Assess your strengths and unique challenges
Next, it’s important to decide your goals and motivations. Success means buying a business that needs exactly what you have — and vice versa.
When Disney bought Pixar, it was because Bob Iger became obsessed with the technology, talent, and culture Steve Jobs had amassed and developed. Iger wanted it. When the two joined forces, they became unstoppable.
Source: the New York Stock Exchange via Google Finance
Or maybe you see a product your sales team could easily peddle at a faster rate than the business that currently owns it. That is what happened when, from 2010 to 2013, IBM scooped up 43 different businesses and applied their sales teams to selling the newly absorbed products. Within two years of being acquired, many of those entities’ revenues had grown by 40%.
Another reason you may want to nab another company is that your business, or their business, or both, are in a state of decline. Most business owners make deals when both businesses are in the final stages of the traditional five-phase lifecycle:
One of your goals may be to experience a quick, simple sale that doesn’t require a ton of research or haggling — one with your choice of assets, and no unwanted liabilities, included. This is entirely doable, but you must be clear on this to make it happen.
As you think through your goals for a business acquisition, comb through your own business for inefficiencies and demand gaps. Who knows — maybe buying a business can do more for your original company than you’d previously imagined.