There are basically two ways of buying an existing business – buying an existing business or buying a franchise (new or existing). With a non-franchise business there is less support than with a franchise business, but there are also no franchise fees and/or royalties to be paid. For the purposes of this blog, we will not be looking at manufacturing or inventory-based businesses, but more service-based small businesses.
One of the first steps that someone taking over an existing small business should consider is to do a review of its history and the way it operates. This means having a thorough look through its’ financial statements (this is best done by an accountant who knows what to look for). The buyer should also review the operating documents and practices. Some of the items to be reviewed include:
Accounts Receivable
- Reviewing the accounts receivable and accounts history will help to determine if the business is relying on a large customer base or a small group of loyal customers.
- If there is a large number of accounts that are overdue, by trying to determine the reasons for the overdue accounts, the buyer can establish the accounts receivable risks.
- Review the business’ credit and collections policies and determine if they are being followed or exceptions are made because of the high volume of business received.
- The buyer should contact some of the accounts to determine customer satisfaction and understanding of their credit needs.
Accounts Payable
- In order to find out the debts and credit ability of the business, the buyer should obtain a schedule of accounts payable and determine where most of the accounts payable are owed.
- It is also important to determine the age of amounts and if there any accounts past due for pricing or other reasons.
- Review transactions to determine undisclosed and contingent liabilities.
The Business’ Accrued Liabilities
The potential buyer should be provided with a schedule of accrued liabilities. Determine the accounting treatment of:
- What will be the unpaid wages at the end of the current period?
- What is the accrued employee vacation pay?
- Are there accrued paid sick days owing?
- How current are they with payroll taxes and source deductions? Are they due or payable?
- Does the business have accrued Federal and Provincial income taxes?
- Do they also have accrued EI, WSIB or CPP payable to the various agencies?
- Check other accruals like GST or HST that can either be submitted quarterly or annually.
- It is also important for the accountant to look for unrecorded accrued liabilities, such as severance pay that will be done when key staff do not stay after the sale.
Income Statements
The profit/loss statements for the past 2 -5 years are a good indication of the viability of the business and performance over that term. Tax returns can also give you an insight into profit and losses, as well as the earning power of the business. Knowing if the business has been audited or providing audited statements for compliance purposes can also help in determining its viability.
Other Business Considerations When Buying an Existing Small Business
Real Estate Holding or Leases
- Obtain a schedule of all property that is owned or leased.
- Are you in the right office space for lease that best facilities employees to properly service their customers?
- It is important to have the condition and age of the real estate appraised in order to establish the fair market value of each of the buildings and lease holdings.
- Use a title search firm to conduct a complete land titles’ search for any liens or encumbrances, even on a property that is leased.
- The buyer must also know if the business can be leased from the previous owner.
Staff and Key Personnel
When buying an existing small business, a buyer needs to know how many employees (if any) they are inheriting and what the details of their compensation and benefit packages are. A buyer also needs to know what key employees will remain with the company and what their job roles and responsibilities are. What are the future office needs for grown in personnel?
Intellectual Property Holdings
The seller of the business should have a prepared list of trade secrets, trade names, trademarks, logos, copyrights, patents, industrial designs, formulas and even domain names they own. In terms of patents and other intellectual properties that have expiry dates, it is important to know how much time is remaining before each expires in order to establish their value to the business.
Marketing and Business Reach
- A buyer must establish if there is a geographic restriction on the marketing and sale of the service because of franchise agreements or product royalty holder restrictions.
- The business owner should be able to provide market share facts as well as projected sales and future product/service improvements.
- Someone selling a business should be able to identify the company’s competitive advantages, and more importantly the disadvantages it faces.
- The current business owner should also know the current market trends and what impact, if any, they will have on the company’s future sales and market share.
Competitors and Competitive Advantage
Having a list and understanding of who the business’ competitors are and how they stack up in terms of market share as well competitive advantages and disadvantages, will provide a better understanding to a buyer of just where they fit in.
Conclusions
The more homework you do when considering purchasing an existing small business, the better you will know if it is the right decision and investment.