29 May Three Questions to Ask an Owner Before Buying
How do you evaluate a business for sale and what should you ask an owner during the evaluation process? Due diligence requires you to really dig in when evaluating a small business or a franchise. After you sign an NDA and look closely at the financials there is still a lot of work to do. As a part of the work you want and should talk directly to the people, not just the owner, who have been running the business day to day for at least the past three years. Determine how the business operates daily, what decisions are made and how those people act and react to everything that creates value for that business. A word to the wise – do not delegate these observations to anyone but yourself and the intimate team that may run the business.
Here are three questions you should add to your arsenal when evaluating a business for sale:
1. What Is Motivating You To Sell?
This is not a superficial questions. Really listen and watch motivation, attitude and teams when you pose this question. Then compare it to the financials and if there has been a leveling off, a dip in sales or any changes that are reflective of this motivation or demotivation. Do you see any concerns or issues related to the sale of the business? What are you hearing and what are you seeing? Do you understand the motivation or lack thereof? How might this shift in attitude affect the business now and how might the trends affect you as the new owner? Lots of questions here within this crucial question. Don’t take the motivation to sell on face value but dig deeper to see all aspects of this and think about how it may affect you as the new owner.
2. Describe Your Compensation.
This is where you really need an intermediary or business broker. That does not mean you should neglect your accountant, their accountant, legal advice or any other analysis. But your business broker should be able to determine something called Seller Discretionary Income and that is not easy. You need to be aware of SDE but you also need to make sure you are listening for the subtle things that owners say. On a recent possible sale one owner walked me through the apartment he was leasing on the premises of the business he was selling and said: That is not really in the deal but it could be because I get like 900 a month out of it. What did he say? Why isn’t it on the books? Anyway let your business broker and team establish SDE and more in this important part of determining owner compensation. The cash draws and the W-2 earnings are essential but there are other ways the owner has profited from the business.
3. What Is Your Customer Concentration and Base?
This question means a lot and should mean a lot to you. One business we recently consulted with had a strong concentration in retail and the owner has started to reach out to more corporate contracts. This corporate customer concentration showed an upward trend of 3%, 5% and 9% over the last three years and will be an important potential for the business and its diversification. It may not be a trend that you will pay a premium for but knowing what has driven this change and finding out why it may need to go this way will be a key factor in you determining where you want to take the business or where you may need to take the business. Customer concentration also is critical when you look at how many clients or customers account for the business. If you have a 23% customer then you need to find out how much of a threat there will be to that customer as the business changes ownership. Steep customer concentration needs to be evaluated very thoroughly.
There are many other factors in deterring a business and its value. It cannot be an ongoing process that has no end as in any business sale time is of the essence but do not forget these three factors as you examine the business you may want to buy.