It is a big deal when an interested buyer makes a decision to purchase an existing business. Buying an existing business can have a great deal of benefits associated with it, but there can also be risks. The risks faced by buyers can be reduced if they are aware of common pitfalls faced when purchasing a business. There are numerous pitfalls buyers need to be aware of. If the buyer is aware of pitfalls that exist, they can be prepared and protected in their quest to acquire the business. This article will address the common pitfalls buyers need to be aware of when they are in the process of purchasing a business.
Buying a business can be muddled in mess if it is not done correctly. Buyers can reduce the stress and risks of the acquisition process by being aware the common pitfalls they will face. Knowing these pitfalls will make the buying process a much better experience. Below are common pitfalls buyers need to be aware of when they decide to buy a business:
- Acquiring the Wrong Type of Business – Buyers need to be aware of the type of business they are purchasing. Buyers need to acquire a business that is suited to their skills, knowledge, interests, and personality. This is true whether the buyer intends to have a hands-on or hands-off approach. If the buyer makes an acquisition suited to their personal strengths, it will help ensure a greater likelihood of business success.
- Signing your Name – Buyers often make a big mistake and sign their own name to contracts, loan agreements, and leases. By signing their own name, the buyer is assuming personal legal responsibility for the business. Before signing any legal documents, the buyer needs to establish a corporation or LLC, in compliance with their state’s laws. Once an LLC or corporation has been established the buyer can act as an agent of the company and sign legal documents on its behalf. This will protect the buyer’s personal assets if something should go wrong.
- Going Solo – Often when a buyer is interested in purchasing a new business, they will often act on instinct. The problem with this type of action exists because many buyers are unsophisticated buyers, which puts the buyer at risk of making a bad business decision. To avoid making a big mistake, buyers should hire attorneys, business brokers, and an accounting firm to help with the process. Hiring these types of professions will help the buyer make the best purchase decision to further their ultimate goal.
- Failure to Prepare – Buyers need to prepare when they decide to a business. Part of this preparation should include: why the business is being sold (is the owner retiring or is there a lower-priced competitor moving into the neighborhood); the image of the company; the social and cultural nature of the business; and the business community. Buyers need to understand the business they are interested in acquiring, failing to so could cost them dearly.
- Buyers also need to do their due diligence and investigate the company they are wanting to acquire. Just because a business appears to be successful and profitable does not mean there are not problems. Buyers need to know what assets are actually owned by the company and what assets are borrowed or leased. Furthermore, the Buyer needs to know what outstanding money is owed, including: unpaid rent, unpaid vendors, and other outstanding debts.
- Poor Purchase Agreement – The buyer will need to negotiate the final purchase price and details with the seller. Failing to negotiate properly could lead to a poor purchase agreement. In order to obtain the best possible purchase agreement, the buyer needs to bring in the use of his/her experts, including a business attorney and a broker. If the buyer goes it alone or hires inexperienced experts, the buyer may come out with a poor purchase agreement. The purchase agreement needs to include the following: property, assets, trademark rights, intellectual property rights, and stocks (both issued and unissued). The agreement will also need to cover who gets what in terms of stocks, and who is responsible for outstanding bills.
- Agreements with Seller not in Writing – The buyer and seller will often make certain agreements, especially when it comes to outstanding bills. The buyer needs to make sure to get these conditions in writing. Failure to obtain agreements in writing leads to defaults on the agreements, which can cause great a substantial burden to the client.
- Failure to Know Actual Value of Business – Sellers provide buyers with the documentation on the value of the company. The buyer needs to take the time to investigate the financial data and other documents used to assess the value. If there are certified documents from independent CPA firms, the buyer should contact the firm to verify the documents and the assessment. The buyer should never just take the seller at their word. The buyers should also request at least three years of tax records for the company. The buyer should employ their own accountant to verify financial records and tax documents to ensure they understand the real value of the business.
- Inadequate Assessment of Available Capital and Personal Finances – The buyer needs to be certain they have the resources available to run the company. It is not uncommon for a buyer to obtain the funds to acquire the business, but to not enough funds to run the business while they are waiting for their revenue to kick in. Buyers also need to be wary of taking on too much personal financial liability for the company. The buyer needs to avoid over extending their own finances, and should avoid using personal assets to run the business altogether.
- Unrealistic Expectations. Acquiring an existing business allows the buyer to have initial revenue. However, the buyer needs to be realistic in their expectations. The buyer should not assume the business will turn a large profit in the first year or two, even if it is an established business. Businesses often lose customers when they are sold, and the buyer needs to take this into account and not set their expectations too high.
- Failure to Promote Business – Buyers often make the mistake of thinking they do not need to promote their new business, because they purchased an already established business. Unfortunately, the sale of a business can lead to a loss of customers. As a result, the buyer needs to make an effort to promote the business after they acquire it in order to re-attract former customers and gain the attention of new customers.
- Buying on Emotion – The buyer needs to be diligent to ensure the business is being acquired for the right reasons. Loving a business is good, the buyer needs to be passionate about what they are doing. The pitfall arises when the buyer is so infatuated with the business that they are unable to see the economic realities of the business. The buyer should be conscientious of this fact and include their broker in the process.
Acquiring a business is a wonderful experience if the buyer is well-informed. However, if the buyer is not well-informed, the experience could horrible. Having the buyer keep these pitfalls in mind will give the buyer the best opportunity to make acquiring a new business a superb experience.