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How to Evaluate a Business Before Buying It

One of the best ways to grow your company is to buy someone elses. Acquiring another company gives you access to a new market, gives you new products to sell to your current market, and helps you become more efficient by combining strategies and personnel. When the new company meshes with your old one, synergy takes your business to the next level. However, a bad match can lead to financial disaster. Lets look at how to evaluate a business before buying it.

When you’re deciding whether or not to buy a business, always look at financial factors. At the same time remember that intangibles — such as company culture and customer relationships — will have a significant effect on future performance.

Some merging companies go so far as to hire graduates of organizational psychology programs, who are professionals trained both to evaluate the companies’ cultures and to help businesses harmonize after the purchase. Even without a consultant, you’ll make the right acquisition decision by combining sound financial acumen with some organizational psychology of your own.

An Investment in Your Future

In your eagerness to grab a great opportunity, don’t fail to negotiate a smart purchase price with the seller. Look to keep your loan payments low during the first few years, when cash flow is likely to be slower.

Before you buy, take another look at the company’s reputation, history, location, product mix, patents, marketing strategy, and sales patterns. If you see a good mix of products and people, then go ahead and close the deal.

The Financial Picture

Always hire an accountant to review the company’s financial statement history and its tax returns. An accountant has no emotional stake in the purchase and can provide an objective analysis. Ask your accountant, and possibly your attorney, some questions in addition to doing your own legwork.

What’s the probable value of property, plant, and equipment? In addition to providing a balance sheet, give your accountant a list of individual assets including furniture, office equipment, land, buildings, and anything else important. Ask your accountant whether the business is appropriate in valuing its assets and what investments, if any, you might have to make through improvements or in purchasing new assets. Consider involving OSHA to make sure that you’re not buying unsafe facilities.

How have company owners managed expenses? If you’re purchasing a small or medium-sized business, look at tax returns to see whether owners have used business funds for their personal needs. If they’ve been taking their families to Hawaii for “trade shows,” then you’ll increase efficiency by ending those practices.

Is payroll competitive within the current market? If the company is overpaying its top managers for what they contribute, you should think carefully before bringing those managers into your business.

Are the sales and operating ratios consistent with other companies in the industry? Look at sales performance and break it down by product type and by payment type (cash, credit, etc.). Also, look at sales for the company’s largest accounts, and find out whether those clients would stay after the acquisition. The operating ratio will tell you how much the company spends for every dollar that it earns. If the ratio is high and you can turn it around, you could increase profitability.

Does the business have significant receivables and liabilities? A large number of old receivables from clients who aren’t creditworthy can significantly drag down the company’s value. Accounts payable could be associated with liens or credit problems, so find out as much as possible. Additionally, look for off-book investments that could lead to significant rewrites of old financial statements after the acquisition.

The Internal Picture

If you’re purchasing not only the company’s clients and IP but also keeping its employees, you need to choose a company that matches your culture and your values. Also, don’t expect overnight profits; instead, plan for a reasonable transition period. Ask the sellers if they’re willing to stay on as consultants while you get the new merged company up to speed.

The new employees joining your company probably feel anxious about the transition. Involve them in planning and communication, promise them job security — as much as you can — and make changes at a slow pace. Finally, know what your new staff brings to the table, and show them that their contributions matter to your company.

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