Seven Questions You Should Always Ask About a Business Before Buying It

In the world of mergers and acquisitions, the adage, "knowledge is power," holds particularly true. This essential process involves meticulous investigation, analysis, and assessment of various aspects of the target company. It is critical to conduct thorough due diligence for multiple reasons, as it helps ensure buyers are making an informed decision and mitigating potential risks. Asking the following seven questions will help assess if the business is the right fit and potential synergy:

1. What is the financial health of the business?

Buyers should request balance sheets, profit and loss statements, tax returns, and lease agreements for year-end over the past four years. Examine trends over time and scrutinize any fluctuations. If the seller cannot provide financial data, that may indicate the business's state. Several financial ratios can be reviewed to gauge a company's overall economic health and to judge the likelihood that the company is viable. The general trend of financial ratios, whether improving over time, is also an important consideration. The four main areas that should be examined are liquidity, solvency, profitability, and operating efficiency. Having a good idea of these ratios will give a comprehensive view of the company from different angles and help spot red flags.

2. Why is the owner selling the business?

Understanding the seller's motivation can provide valuable insights. Are they retiring, facing financial difficulties, or pursuing other opportunities? For example, if the seller discloses that the company's finances are the reason for selling, that is an instant red flag. However, if the seller seeks retirement, it could be ideal. Have an honest conversation with the seller. This may seem obvious, but many people never ask more profound questions about why the owner is motivated to sell the business.

3. What is the business's competitive position?

Analyze the competitive landscape of the industry. Understanding how competitors operate, market dynamics, and industry trends is crucial to assessing the business's long-term viability and growth potential. Determine the market share and the business's unique selling points to understand how the company stands out. It is ideal to seek a business that offers a product or service that others do not.

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4. Are there any legal or regulatory issues?

Investigate whether the business is involved in ongoing legal disputes, lawsuits, or regulatory compliance issues. Review licenses, permits, contracts, and leases to ensure they can be transferred to the new owner. A legal dispute or lawsuit can lead to substantial financial liabilities and damage the company's reputation, while regulatory compliance issues can result in fines and penalties.

Also, determine if an employee union is in place, as it can affect labor relations, employee benefits, and the work environment.

5. Who are the key employees, and what is the turnover rate?

Identify key employees and assess their importance to the success of the business. Determine the employee turnover rate and if any potential employees will leave due to the sale. Buyers can review employee contracts, benefits, and qualifications to assess the workforce's stability and potential integration challenges. Salary increases may be warranted to maintain critical employees if their roles change.

6. Is the company's success tied to the owner?

If the business's success heavily depends on the owner's skills, knowledge, and personal relationships, there may be a risk of disruption once the owner departs. This could result in a decline in performance or even failure of the business post-sale. Ask if the owner plans to stay and work in the area after the sale. If the seller does, it could potentially make transitioning clients difficult. In this case, asking the owner to stay post-sale for a transition period may help. Consider phasing out the previous owner gradually during the transition period, learning their role and responsibilities full-time. Eventually, they will not be necessary to be present at work any longer; instead, they will only need to be available for phone calls and consultations.

7. What is the business's growth potential?

Evaluate the business's growth potential, considering market trends and potential expansion opportunities. Consider whether you have the skills and resources to capitalize on these growth opportunities. Even if you hire a manager, you must still be present to ensure its success.

Also, determine the industry's future and evaluate its resilience over the next five years. Think of it as deciding to invest in a cassette tape manufacturer right before the advent of digital music streaming; investing in a declining business is seldom an appealing option. In this case, research potential product and software releases for the industry.

In the intricate world of mergers and acquisitions, these seven fundamental questions are a compass for buying a business. Armed with financial insights, an understanding of the seller's motivations, and a grasp of the competitive landscape, a potential buyer will be better equipped to make a decision that aligns with their goals. Scrutinizing legal and regulatory matters, assessing the stability of the workforce, and gauging the owner's influence will all contribute to a comprehensive evaluation. Ultimately, foresight into the business's growth potential and industry trajectory can determine the success and legacy the new owner will leave behind. By asking these seven questions, a buyer can embark on a path toward informed decision-making and the potential for a prosperous future in business ownership.

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