Buying a Business

If you are thinking of buying a business there are many things you need to check before you make a commitment to proceed. This process is generally called “due diligence”, which simply means doing all of the necessary checks to make sure your purchase will be a wise decision. It often happens that after carrying out due diligence a potential buyer will find that the business is worth considerably less than the asking price.

By the time you have gone through the due diligence process, you should know about the overall financial health of the business, its prospects, competitors and the market.

Although your solicitor and accountant can help, you will need to carry out many of the investigations yourself. Because a business purchase generally involves a significant investment of your assets you should be prepared to take the time to get it right. We assume that you will have carefully considered the lifestyle changes that owning your own business will bring.

If the vendor is reluctant to provide any relevant information, you should take that as a warning.

So what do you need to look at and why?

Confidentiality Agreement 

You may be asked to sign an Agreement that you won’t disclose any confidential information, such as financial statements, provided to you during the course of negotiations. You should have your lawyer check the Agreement because our experience is that some confidentiality agreements contain unfair provisions.

Check out the business environment in which you will be operating  

• Who are your competitors?
• Consider the growth of competitors, their strengths and weaknesses and how they might threaten your business.
• Research the industry in which the business operates and assess whether it is growing or slowing. Try and get information from industry associations, government departments and the Australian Bureau of Statistics. You could also get information or advice from industry associations, consultants and business brokers.
• Compare prices and costs if you can.
• Investigate whether any new competitors are planning to start up and potentially take away your customers. When you go to the Council to check the Development approval ask also about potential new competitors.

Look at the financial statements for the business

This is to make sure that the business will provide you with a reasonable income. You may be happy earning less working for yourself than you would in working for someone else (and receiving long service leave and superannuation) but that should be a conscious decision rather than an accidental outcome from poor research.

• Unless you have the experience to do it yourself, you should have an accountant look at the balance sheets, profit-and-loss statements, annual reports and any cash-flow statements of the business, going back for at least the last three years.
• If the statements have not been audited, you will have to discuss with your accountant how to obtain independent verification of the figures in the accounts. You may have to look at material such as sales and wage records, invoices, bank statements, loan documents and the relevant employment award.
• In checking these documents you should also consider the trend of the financial statements, that is, do the rate of growth for profit, sales and costs show an upward or downward trend? 
• Ask the existing owner whether there are new or increased costs you should anticipate.
• Ask if there are any cash flow or debtor problems? Are bills being paid on time? Who are the key creditors? Know the accounts back to front before you buy.

Check the tax records of the business

• The income tax returns should reconcile with the financial statements. If they don’t reconcile it may mean that income has been hidden and that the business isn’t as profitable as the vendor has indicated.
• Make sure that PAYG (pay-as-you-go income tax), GST, the superannuation guarantee levy and other tax obligations, such as payroll tax, are up to date.

Check the assets

• Make sure that there is a list of all of the assets you would expect to receive that are necessary for the business. Check whether the items are all there and what their condition is. If equipment has reached its life you will be able to plan to replace it, and build the replacement cost into the purchase price. This may involve obtaining an independent valuation.
• Check the condition of the stock, whether any is out of date and consider what stock you will want to take over.
• If any assets are leased or on hire purchase consider whether you want to take over the agreements.
• Are there a web site and domain name that you expect to take over?
• What email address will you need?
• Is there any other intellectual property used in the business? Will you need the rights to licenses, patents, trademarks and registrations?

What is the customer base?  

• Is there is a customer database that you can, or need to, take over?
• How much business is provided by each customer/client?
• How you will take over the customers and clients?
• Are there any customers that are key to the business?
• Are there any major contracts that the business is dependent on.

Suppliers

Get details of all of the suppliers. Are there key suppliers? On what basis will they continue to trade with you?

Why is the business being sold?

Some people say that you should ask why the owner is selling, but it is unlikely that you will get a full and frank explanation from the vendor. That is why your own due diligence is so important. 

• There may be genuine reasons why the vendor is moving on, but the vendor may be selling because:
  • the business is badly managed or run down, (which may in fact be an opportunity for a buyer);
  • its prospects are poor because of increasing competition.
• In any event, you should find out how long the owner has operated the business and how long it has been on the market.
• You might consider asking customers, suppliers or even competitors for any comments about the business or its problems.

Check the legal issues

No two businesses have the same legal issues, but here are a few guidelines:

• Visit the local council and get a copy of the development approval for the business. In one case a buyer purchased a pizza business where most trade was done after 10 pm at tables on the footpath. After the purchase was completed, the purchaser discovered that the development approval provided that the approved hours of business ended at 10 pm and no tables were permitted on the footpath. The purchaser could not successfully trade under those circumstances and lost the business and his money.
• Are there any government regulations that you need to comply with, for example, fire regulations, waste, fitout. Have all the relevant permits and licenses been obtained?
• If you are taking over existing employees, what obligations do Fair Work and State laws require you to take over for leave entitlements, compulsory superannuation payments, long service leave?
• Are there any employment contracts with employees?
• Check the obligations under any lease and see if there is an option to renew Would the business survive if you had to move?
• Your accountant and lawyer will advise whether you can make the purchase GST Free.
• You will need to pay stamp duty on the purchase price.

Helpful advice:

You will find information on the sale and purchase of businesses in the hospitality industry on the web site of Close Encounters www.closeencounters.com.au.