Inspect All Recent Tax Returns
Insist upon seeing tax returns from recent years. All too often, you will be told, “Well, of course we underreported our sales . . . doesn’t everybody?” No, not everyone underreports income. I don’t! And it makes me mad that I am carrying on my back others that do!
Be suspicious of sellers who give you this line. Not only do they lie on their tax returns, despite the risk of severe penalties, but also there is a greater chance they will be less truthful in representing their business for sale as well. Get independent verification of everything they tell you. Of course, this includes verifying that the sales were allegedly underreported!
Furthermore, you need to be sure that you are not getting stuck with any financial liabilities as a result of their underreporting on their taxes. All the more reason to discuss with your attorney how to structure a potential transaction so that you are just buying the assets of the business, not the liabilities.
Unfortunately, so many small businesspeople, especially in small cash businesses, underreport on their tax returns. So, if you are buying a cash-type small business, you may not be able to simply rule out buying from someone who underreports income, although it is still a red flag.
Hold on to Key People
Unless you completely understand a business “cold,” work strong financial incentives into your buy/sell agreement to keep key people in place during a significant transition period. This is particularly important for businesses in which contact with major customers, such as through salaried salespeople, is a major means of selling products or services.
Try to get the selling owner to stay with the business for a period of time—months, if not years. Ideally, structure a payment plan so that the seller either receives payments over time (so you make sure you are getting the business that was represented to you) or, even better, there is an incentive plan structured with increasing payments geared to better performance of the business over time.
Ignore Pressure to Close a Deal
Sellers and business brokers love to pressure potential buyers by mentioning that other people are seriously looking at the business. A number of these “potential buyers” are probably just window-shoppers. When I sold a six-month-old map business, with total sales under $15,000, I had almost 50 inquiries but only one serious offer. Even the smallest of businesses often take many months to sell and may not have many serious buyers.
Dig into Nonquantitative Factors
Profits are realized, in part, because some nonquantitative aspect of the business appeals to a broad customer base—the service, the product, or the sales team, to name a few. Make an effort to pinpoint both the positive and the negative nonquantitative aspects of the business you are considering purchasing.
At some point in the negotiation process, you should get permission from the buyers to talk with their key customers. These people often have interesting insights into the business. Compare “your” products or services with those of the competition. Also, be sure to look into the overall market projections for “your” product or service. Will there be a market for the product or service tomorrow? Five years from now? Always?
If talking to key customers is highly sensitive, you might suggest to the buyer that you will tell the customers that you are a consultant, not a potential buyer. This practice is not uncommon, especially with the selling of midsize companies.
Advantages to Buying
Despite the many caveats to consider before buying a business, remember that buying an existing business is, generally, a much safer and faster route to profitability than starting from scratch.
Get a Noncompete Agreement
Include a noncompete agreement as part of the purchase and sale agreement to guarantee that you won’t soon be competing with the seller. A typical agreement is for one to five years. It may set specific geographical boundaries. You might also want to consider a “No solicit” agreement, so that the seller agrees not to solicit any customers for any new business, and also a “No recruit” agreement so the seller agrees not to hire any existing employees for a new business.