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  • 9 Questions To Evaluate Before Purchasing A Business

    Apr 15, 2021

    IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities.  Periodically, we will post guest blogs from professionals with knowledge to share for the good of owners of privately held companies & family owned businesses.  The following blog has been provided by Howie Bick, founder of The Analyst Handbook ( https://theanalysthandbook.com/):

    9 Questions To Evaluate Before Purchasing A Business

    When it comes to buying a business, there are a variety of factors that are important to consider and evaluate before purchasing. Dealing with the way a business operates, the type of system or structure it’s created, and the relationships it’s built, is a task that comes with a variety of aspects. Seeing how a business creates value, the type of competitive advantage it might have, or the brand it’s built, are important to consider before purchase. The more due diligence you do up front with a purchase like a business, the better suited and prepared you are for the post-purchase time.

    The tricky aspect to buying a business is you’re trying to find ways to successfully drive another person’s car, or a car that someone else has created for you. That means understanding how to drive it, where each feature is located, and what each button does. While buying a business can be done on a variety of scales, it’s important to put in the time, work, and energy beforehand to get a full understanding of a full business’s picture, and to understand the different avenues or pathways available when purchasing a business.

    Where Is The Value? Or Where Does The Business Create Value?

    With each business, comes a particular value creation or value proposition offer. It can be in the way it manufactures it’s goods, the products or services it’s created, or the brand it’s built. The value a company possesses is ultimately in its unique selling proposition, or it’s competitive advantage. It’s how the business was able to separate itself from the competition, provide value to its customers, or find ways to do what other businesses struggled with or couldn’t. Most of the time, it involves digging underneath the hood, analyzing the market or space they operate in, what competitors are doing, and what customers or clients are looking for.

    In certain companies, the real value might be in the network it’s created, or the clientele it’s built up. All of it depends on the business in question, and what the purchaser is looking for. Some purchasers may simply be interested in a business’s clientele, it’s data, it’s products or services, or even the financials of a business. The value proposition a company possess going forward, depends on what the purchaser is looking for, it’s plan for the business, and how it plans to maximize it’s return on investment. Whether the business is in accounting vs finance, marketing vs real estate, or manufacturing vs wholesaling, each business will most likely create value in different ways, and offer prospective purchasers value in the way they choose to run the business.

    To Buy A Business or Create One From Scratch?

    When it comes to buying a business, there is always the option of building a new one from scratch. Each option offers a variety of positives and negatives, but it’s an important question to ask for a variety of reasons. First, it shows you the type of cost or price associated with an investment, and whether it might be a good investment. Second, to understand the type of costs associated with new entrants, or new competition. Companies with low cost to entry barriers, will often have lots of competitors, and lots of new entrants to the space over time.

    Certain businesses have costs to enter such as manufacturing equipment, business licences, or access to suppliers or distributors. Those barriers are often what deter other parties from entering the space, or make it more difficult to do so, increasing the value of underlying businesses within the market. Buying an existing business often means expediting the process, the time, and the work to enter into a space. You’re utilizing on another’s person’s or team’s work as a starting point. That means taking what they’ve done, and trying to find ways to grow or expand it, rather than building it from scratch. With building a company from scratch often means building it slowly, going through growing pains, and building relationships with customers.

    The answer to these questions depends on the party buying it. Do you have an abundance of capital and see a window of opportunity to capitalize? Or do you have limited capital, and are willing to be patient, and work through the difficulties of starting a business from scratch?

    What Is The Direction of The Business or Market?

    With each business, comes the future success and direction the business is headed in. Whether it’s the market factors at play, different advances in technology, or the gradual shift away from a particular business, analyzing the trajectory a business is headed in is important when considering a potential purchase. It has the potential to show you how well a company is positioned for future earnings potential, and whether it stands to grow or decline in size.

    Buying a business in a space that’s in a downward trajectory, often will make it tougher to generate returns and future earnings than in a growing field. In a growing field, you’re able to find new markets to enter, invest or allocate more capital back into the business, or find more potential customers or clients to work with. Analyzing the trend or direction a market is headed in, is an important element to consider when evaluating a potential business to purchase.

    What is the Company’s Business Model?

    Each company or a business has a business model they utilize in order to generate income, or the way they monetize. There are a variety of business models out there, and a lot of it depends on the products, services, and value they provide. Part of it depends on the space they’re in, the type of industry norms, and what they are able to offer. Certain companies are able to monetize the data they possess, while others monetize the services they provide, and others the goods they sell, a lot of it depends on what you offer to the customer, what customers are willing to pay for, and the value proposition a company possesses. Certain products or services provide value to companies on a monthly basis, and are offered through a subscription service. While others provide value to others on a one-time basis, or are one-off purchases. Depending on the nature of the business, and the value a business provides, companies will be able to create business models through the advertising they sell, the products they provide, or services they offer.

    Understanding a company’s business model is incredibly important when you’re considering purchasing a company, because it’s how they’re able to monetize. A company’s business model is essentially what you’re investing in, and the way you’re going to return the capital you invested. Seeing how the company is able to generate revenue, the type of model they have, gives you insight into how sustainable it is going forward, and where you need to focus to keep revenue incoming. Where you focus your energy, and where you invest your resources, depends on whether you need to keep finding more clients, keep your customers happy, or find ways to keep the business model running.

    What Has The Current Business Owner Done To Grow or Scale?

    Understanding what a company owner has done to scale the business, or grow it’s size, is valuable insight for a prospective purchaser. It has the potential to show you what’s been successful and what hasn’t. Prospective purchasers can understand what opportunities are available, and different ways they can further grow or scale the business. Without understanding what the current business owner has done, it makes finding ways to grow the business tougher. You’re able to see if there are channels they haven’t explored yet, that a new owner can invest in to grow the business?

    By having the insight into what a business owner has done to scale, you can utilize their past investments and experience to further grow the business. Companies who haven’t explored a particular avenue, whether it be social media, local advertisements, country-wide rollouts, or referral components, can give you pathways or avenues to expand the business in the future. It also has the potential to show a prospective purchaser  how they’ve achieved $X dollars in revenue, or $X dollars in recurring revenue. That insight and information can provide a framework for the new owner of how to grow down the line, and different opportunities that might be similar in nature.

    What Will The Onboard Time Be, and What Will It Cost?

    With each business, there is often a time it takes to fully understand the way a company operates, how the business is structured, and the type of systems that are currently in place. Transitioning to new leadership, often means learning the industry, understanding the market, and seeing how the company factors into the equation. Seeing how the goods, services, or products factor into the market, and what they need to do to keep the business moving, and running smoothly. Most likely it takes some time to become skilled at running a new business, building relationships with the key parties involved, and keeping the business going. There is often a cost associated with onboarding a business as well. It might be decreased revenue, a lag in onboarding a new system, or implementing new software or processes into the mix. Having an idea of what the onboard time might be for a new owner, how much it may cost, the possibility of lost revenue, or opportunity cost, can give you a sense of what to expect to fully onboard and run the company effectively.

    Who Are The Suppliers or Vendors? What Role Do They Play? What Power Do They Have?

    In certain businesses where you’re manufacturing, selling goods, or in a retail setting, suppliers play a very important role to the underlying business. Suppliers can source the raw materials to manufacture your goods. They can be the ones who bring you the goods and services you need to sell to your customers. Or they can be the ones responsible for helping you acquire inventory to keep your business going. For a prospective purchaser, understanding the relationship a business has with them, their dependability, and the costs associated with each is valuable information.

    In certain businesses, suppliers and vendors might be the party who helps a business create value, or the business might run through them. The relationships with the suppliers and vendors can make a difference in the time it takes to receive an order, the type of service you receive, and the goods you get. It’s also important to get an idea for the type of competition they have, or the other options available, that way you need to replace them, you can, or if they are the only game in town. Suppliers or vendors who are more prominent or important in a space or to a business, possess more power over the businesses they work with.

    What’s The Company Worth?

    When you’re buying a business, one of the important questions to consider is what the business is worth, and it’s price. Each company might be priced differently, based on the amount of revenue it generates, the number of income streams it has, or the type of value it possesses. Determining what a business is worth depends on the type of assets it has, what it’s worth to a potential party or purchaser, and what someone’s willing to pay for it. Certain businesses have the potential to be worth more to certain parties, as it offers them benefits or opportunities others don’t have. Looking at the businesses valuation from the perspective of what a financial analyst does, and analyzing the different possibilities, projections, and risks can help to figure out a particular number you’re comfortable paying or feel the business is worth. Ultimately, the price of a company depends on the price the owner is willing to sell for, the price of similar or other companies in the space, to the income or revenue it produces. It’s price or multiple depends on the space it’s in, the way people value companies, and what other parties or competitors are willing to pay for the business.

    Is The Current Owner The Best Person To Run The Business? Is There A Transition Plan?

    The current owner or operator is an important part of any business equation. Determining the type of skills they possess, the experience they have, or the knowledge they have, and how that factors into the businesses success is important to understand for potential purchasers. That way, you can have an idea of their value to the business, if they are unique and one of the main reasons behind the businesses success, and whether you need to create a transition plan. The current owner can also provide a framework for the type of person you might need to have run the business going forward, or what to look for. If the owner is willing to stay on to run the business, or have a transition period, then it comes down to how much are they willing to do it for? How long are they willing to work for? And will having less or no skin in the game affect their work ethic? All of these questions are important to consider when purchasing a business, because the current owner might have a larger effect on the businesses performance than initially expected. Figuring out a solution to this question depends on the company, the person in question, and the type of transition they are willing to be involved in.

    Conclusion

    When it comes to buying a business, or purchasing a company, there are a variety of questions and factors that are important to consider during your evaluation process. Analyzing where a business produces value, the value contained in its assets or relationships, shows you what you’re buying, and helps you determine whether it’s sustainable for years to come. Valuing a business, often means using comparable sales, analyzing the income it produces, and the type of return on investment it brings to your business to determine whether it outweighs the cost. It’s important to consider the direction a particular business is headed in, as it shows you the type of trajectory it’s on, and the type of future earnings potential, which is ultimately what you’re buying with a business. With each business, comes the business model they utilize, which shows you how they generate their income, and the different pathways available to scale the business in the future.

    Taking it a step further, understanding what the previous owner has done to grow the business, can provide you valuable insight into where there might be opportunity for a new owner, and what’s worked, or hasn’t worked as well. With any new project or adventure, comes the time and cost it takes to onboard, and to understand the way a company is structured, the type of systems it has in place, and the processes utilized in order to keep the business running. Suppliers and vendors play a key role in certain businesses, making it very important for prospective owners to understand the relationships a business has with them, the type of power their suppliers have, and the reliance the business has on them in order to understand the full picture behind a business. Certain owners or operators, are the best people to run the business, or the only people, which is why it’s important for prospective owners to have a transition plan in place, and to understand what’s needed to run the business from a skill, experience, and knowledge standpoint. All in all, when it comes to purchasing a new business, there are lots of questions that are important to consider, and factors that are important to evaluate.

    Howie Bick is the founder of The Analyst Handbook. The Analyst Handbook is a collection of 16 guides created to help current and aspiring Analysts advance their careers. Prior to founding The Analyst Handbook, Howie was a financial analyst.

    IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities on subjects relevant to the purchase & sale of privately held companies and family owned businesses.  IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.

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