Cream of the Crop 1/Cream of the Crop 1.iso/BUSINESS/SBA62.ARJ/FSBA.EXE/F216.SBE

Text File | 1992-04-30 | 9KB | 164 lines

@156 CHAP 3

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          │TRAPS AND PITFALLS IN BUYING AN EXISTING BUSINESS│
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             "Trust in Allah.  But always tie your camel."
              -- Ancient Arab proverb

             "Never, ever, trust anybody named Larry, Sammy,
              or Lenny." -- Jenkins' Sixth Law of Business
              Survival

While there are some definite advantages in buying an established
business, as compared to starting up a new business from nothing,
it can also be a lot more complicated and involves many potential
pitfalls that you must avoid.  The watchword in buying any kind of
business should be CAVEAT EMPTOR -- Let the buyer beware!

Common pitfalls you want to avoid will include the following:

   .  WHY IS THE BUSINESS FOR SALE?  This is probably the first
      question you should ask.  However, take the answer with a
      grain of salt.  Often the response will be that the owner
      wants to retire or is in poor health (never that he is
      having to work 80 hours a week just to break even). Or the
      real reason may be that the business is in a declining
      neighborhood, the owner has been robbed several times
      lately, and he wants O-U-T.  Or the owners of a profitable
      little corner grocery store may be anxious to sell out while
      they can because they have just learned that a major chain
      store supermarket will be opening on the next block in a few
      months.  Pity the poor buyer who swallows the "bad health"
      story in the latter case!  One of your toughest jobs in deciding
      whether to make an offer to buy an existing business will be to
      become a sleuth and find out the REAL reason the seller is
      selling.  Just remember that a good and profitable small
      business is not something that most people walk away from, in
      most cases, unless there is a strong personal reason, or the
      price that has been offered them is ridiculously high.

   .  WHAT KIND OF REPUTATION DOES THE FIRM HAVE?  If it has a good
      reputation, this may be the most important thing you are paying
      for.  On the other hand, you may be much better off starting
      your own business from scratch than acquiring one that has a
      poor reputation because of shoddy merchandise or sleazy service.
      It could take you years to overcome such a reputation.

   .  IS THE REPUTATION TRANSFERABLE?  Even if the present owner has
      an excellent business reputation, you will want to know whether
      that goodwill is based on personal relationships built up be-
      tween the owner and customers (that will not be easy to transfer
      to you) or not.  This is particularly important if the business
      relies heavily on a few key customers or suppliers with whom the
      owner has very favorable business arrangements.  Those arrange-
      ments could evaporate when you attempt to take the owner's place
      and you could wind up paying for a handful of air.

   .  HOW PROFITABLE IS THE BUSINESS NOW?  Unless you have some very
      good reasons to believe you can run it more profitably than the
      current owner, stay away from a money-losing business or one
      that does not produce a satisfactory profit.  Thus, it is of
      crucial importance to find out what the business has actually
      earned for the last few years, since the figures the owner shows
      you will invariably be inflated to make the picture look rosy.
      Even if the owner has audited financial statements, don't rely
      on them.  You can be sure he will have used every possible means
      to make recent earnings look good, from deferring maintenance to
      capitalizing every possible expense, and so on.  Here your job
      (with the help of a good financial adviser, probably an account-
      ant), will be to unpaint the carefully painted picture, to find
      out how the business has REALLY been doing.

           HINTS ON FINDING OUT ABOUT WHAT THE BUSINESS EARNS:

          (a) Insist on having the seller make the business's
              financial and business records available to your
              accountant and lawyer at an early stage in the
              negotiations.

          (b) Insist on seeing income tax and sales tax returns
              for the last few years, not just financial
              statements.  (You can be sure the owner will not
              have overstated his income on his tax returns!).

          (c) Whatever you do, don't buy the old line that the
              seller reports such low income on his tax returns
              because he takes a lot of the profits right out of
              the cash receipts without telling Uncle Sam.  He
              may be telling the truth, but why should you expect
              that he's telling you the truth when he admits he's
              cheating on his taxes?  Particularly since there is
              no way to tell how much, if any, he has been skimming.

   .  ARE YOU GETTING WHAT MAKES THE BUSINESS TICK?  One of the
      key things you have to do in investigating a business you
      intend to buy is to find out what makes it tick, and make
      sure you are buying that, whatever it is.  For example, if
      it appears that the business has well-developed customer
      lists or mailing lists, those should ordinarily be included
      in the sales agreement; if there are favorable leases or
      other contracts, make sure they can and will be assigned to
      you as the new owner; if patents, trademarks, trade names or
      certain skilled employees are vital to the business, be sure
      that you will get them as part of the package.  And, in many
      cases, you will want the seller to sign a non-competition
      agreement, so he or she won't simply continue the business
      across the street under a different name, financed with your
      money!

   .  ARE THERE ANY TIME BOMBS?  You need to carefully assess the
      assets you are acquiring and the liabilities you are assuming
      if you buy the business.  You should personally inspect
      the premises, looking for things like obsolete or unsalable
      inventory, out of date or rundown equipment, or furniture or
      fixtures you may soon have to repair or replace.  Review the
      terms of any leases.  One reason some businesses close or
      sell out is the imminent expiration of a favorable long-term
      lease, if the landlord plans to either raise the rent drasti-
      cally or not renew the lease at all when the current term
      expires.  Also, go over receivables with a fine-tooth comb,
      looking for significantly past due accounts.  You may even
      want to run credit checks on a few major customers, if they
      make up a large part of the receivables.  The bankruptcy of
      one of those customers could also bankrupt you.

      OTHER LIABILITIES.  Not all liabilities of a business show up
      on its accounting records.  There may be any number of hidden
      claims against the business, such as security agreements en-
      cumbering the accounts receivable, inventory or equipment,
      unpaid back taxes of various kinds, undisclosed lawsuits or
      potential lawsuits, or simply unpaid bills.  If you are going
      to assume liabilities of the business, the written agreement
      of sale should specify exactly which liabilities are being
      assumed and the dollar amount of each.

      BE WARY OF BUYING STOCK OF A CORPORATION.  If the business you
      are about to buy is incorporated, you will usually be well
      advised to offer to buy the business assets from the corpora-
      tion, rather than buy the stock of the corporation itself,
      since the latter approach will subject the business to all
      hidden or contingent liabilities of the old corporation,
      whether or not you have agreed to pay for any liabilities
      of the corporation that pre-dated the sale.  Also, you will
      frequently incur a tax disadvantage if you buy the stock,
      since you will not get a free step-up in the basis of the
      corporation's assets, unlike a direct purchase of the assets.
      (One exception would be where the corporation has unused tax
      loss or tax credit carryovers that could be used to shelter
      some future income from tax.  However, the '86 Tax Reform
      Act has severely restricted the use of such carryovers where
      there is more than a 50% change of ownership of the stock of
      a corporation in a 3-year period.)

      AVOID PAYING TOO MUCH.  One of the biggest disadvantages in
      buying an existing business is that you may pay too much for
      it, compared with what it would cost you to start a new busi-
      ness from the ground up, or compared with what someone else is
      likely to be willing to pay you if you decide to sell out.
      Even if the business turns out to be a good one, if you overpay
      significantly it may take you years of hard work to recover from
      this excessive "hidden" cost of doing business.