Buying a Business: Ask the Right Questions.
When buying a business, one would be wise to recall the underlying theme of the 2004 movie “iRobot”, staring Wil Smith and the extremely cool Audi RSQ. That underlying theme was the need to ask the right question.
If you saw that movie, you might remember these two scenes in which the “doctor” answers Smith’s Detective Spooner’s question with, “That, detective, is the right question.”
When buying a business, it’s important to remember the advice the doctor gave Spooner.
Yes, buying a business entails LOTS of questions. From financial aspects to legal issues, buying a business can be a minefield of questions. If the buyer is working with a professional business broker, he or she will provide an information package that should be so complete that the only thing the buyer may have to do is verify the contents and claims of that package.
But there are less obvious questions that a buyer should ask – questions that are less “black and white” and will illustrate the business’s character rather than simply its profitability.
Let’s look at a few of them
“That, Detective, is the Right Question”
- What is the owner’s day-to-day role in the business?
When buying a business, knowing how much time the owner spends every day on the business will help a buyer determine how hands-on the buyer is likely to be with daily operational responsibilities.
The seller’s answer should give the buyer a very solid indication of how much of the business’s sales, operations and service are dependent on the seller, whether there is enough staff and whether that staff is well trained and competent enough to run the business without the owner’s constant oversight.
If the buyer is expecting to run the business remotely and the seller is spending 60 hours a week overseeing all aspects the business’s operations, something’s got to give; more employees may be needed, better training required and establishing systems to increase efficiency.
If that’s the case, the buyer will have to institute these changes to make the business run more smoothly and without constant oversight from the buyer.
This, in turn, will impact what a buyer is willing to pay for the business.
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- What systems, processes and procedures are documented?
The answer to this question will help clarify the answer to the previous one – and will help the buyer determine how smoothly the transition might be accomplished. Be sure the request this documentation. The buyer would be wise to consider whether such documentation is not only complete but clear – in fact, whether it’s actually useful.
- Why does your customer buy from you rather than your competitors?
This can be an awkward question.
Is it price? If so, how are the margins and profitability impacted? Is there room to raise prices?
Is it service? This might illustrate the quality and commitment of the workforce.
Is it convenience?
The answers should give the buyer a sense of the business’s competitive advantages.
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- What would the seller do to grow the business?
We hear all the time from the seller that, if a buyer did this or implemented that, revenue would increase by X%. Often the seller feels entitled to be paid for these “ifs”.
It’s the business broker’s job to explain to the seller that they would be entitled to the increased value such changes might have on the business only of the seller implemented those changes and positively impacted the business’s bottom line. If the buyer must do the work, the buyer should be the beneficiary.
- How much working capital do does the buyer need, and how was it calculated?
It is important to plan for sufficient working capital, as you’ll need capital for the acquisition, capital expenditures and day-to-day capital needs. Understanding how the seller calculated the necessary working capital is important in order to avoid coming up short on needed funds.
For smaller businesses, especially those with rapid inventory turnover, some people define working capital as the amount of cash the business needs to operate for a certain period of time – say one month or one quarter.
When buying a business – any business – the important thing to remember with regard to working capital is that there is enough cash in the bank and enough coming in to cover the operational expenses of the business.
Customers and Numbers
- Do the financials reflect all of the business’s income and expenses, or or some sales off-the-books?
A buyer will probably not have to ask this question because if there is undeclared revenue, the seller is likely to talk about how smart they are in keeping more of what comes in the door rather than send it on to the taxing authorities (who, not incidentally, have a well-deserved reputation for wasting a great deal of it).
But take any claim of off-the-books revenue with a grain of salt. And NEVER let it enter into any valuation calculations.
What does your customer base look like?
The seller should have a clear picture of the business’s customer; an avatar, if you will.
There should also be a clear description of how often the customer is communicated with, what manner of communication is used and who in the business is charged with making that communication happen – all information that should be found in the policies and procedures documentation mentioned above.
The customer database represents the real value of most businesses as it is what drives the revenue the business generates.
When buying a business, to assure that the buyer has the fullest, most complete picture of the target, the right questions have to be asked.
Like Detective Spooner in “iRobot”, buyers will get the most complete picture only be probing deeper than the financials, contracts, employee lists, inventory and the other standard stuff every seller will expect to be asked about. And buyers will need a professional business broker to advise them on these questions and how to approach the seller to get the answers.
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.