Software of the Month Club 1997 March/Software of the Month Club 1997 March.iso/pc/dos/lg/sba/f216.sbe

Text File | 1996-08-23 | 9.3 KB | 186 lines

@156 CHAP 3

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       │TRAPS AND PITFALLS IN BUYING AN EXISTING BUSINESS│
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While there are definitely some 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 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 owner has been robbed several times lately,
      and she 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 compelling 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 between 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 arrangements 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
      blindly 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 accountant), 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!).
           To be on the safe side, ask the seller's CPA to
           transmit copies of the returns directly to you,
           along with some kind of written assurance from
           the CPA firm that those are the actual returns
           that were filed, as last amended.

       (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 drawer 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 THE THINGS THAT MAKE 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
      drastically 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 encumbering 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 corporation, 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 or assume
      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 important
      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 potential
      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 business 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.