The Biggest Mistakes Business Buyers Make
The biggest mistake made by buyers is not seeking professional representation and guidance before closing the purchase transaction. Without an experienced broker or attorney on their side, a buyer is prone to making numerous mistakes, some of which can jeopardize the viability of the business.
Even in those transactions that involved a business escrow and SBA financing, I have seen disputes and even litigation between buyers and sellers result from the buyer and seller leaving significant terms “to be determined” after closing, or failing to address significant legal issues prior to closing. For example, buyers and sellers often agree that the seller will providing consulting services to the buyer after closing, but some buyers and sellers close escrow before agreeing to the details of such an arrangement.
Once the seller has pocketed the sales proceeds, he has little reason to negotiate such an arrangement on terms favorable to the buyer. With respect to legal issues, buyers also occasionally fail to obtain an assignment of all of the seller’s rights under important contracts, including leases, prior to closing. Landlords, vendors, or customers operating under contracts with the seller may, under some circumstances, refuse to do business with the buyer, and this can be fatal to a business.
I asked other business brokers, advisors and intermediaries what they thought about this, and here are some of their responses:
As with seasons, the mistakes buyers make change with the economic climate. Two years ago, the biggest mistake buyers made was waiting too long to purchase a great business. Often they would procrastinate on solid business only to have someone else jump on the opportunity.
Today, the climate has changed as has the buyer’s mistakes. First, buyers are so fearful of the current economic climate they fail to see the bargain prices of most businesses. 2 years ago solid businesses with historical proven cash flow were retrieving prices of 3 times cash flow. Those same businesses aren’t getting 2 times cash flow today. A smart buyer knows these businesses are bargains and knows the economy will turn and the price multiples and income levels will return to past amounts.
Second mistake is going into deal thinking the landlord is going to reduce the rent on a profitable business. The landlord has ZERO incentive to reduce the rent when a business is making money, regardless of whether rents have declined in the area. The buyer must enter the deal expecting to pay the current rent amount. Oh, go ahead and try, but don’t expect a decrease.
Finally, another mistake buyers are doing is thinking they can negotiate large discounts off prices that are already discounted or worse yet thinking the seller is going to carry a large percentage of the deal. Perhaps this happens, but it is rare. And the buyer misses-out on a great business as a result.”
Perhaps the biggest mistake that a Buyer makes when buying a business is inadequate preparation.
One aspect of preparation is understanding the type of business that the Buyer is interested in. This is a process that will entail doing some research on the industry through such sources as books, Internet articles and communicating with people who are all ready in the field.
Once a Buyer has identified a particular business an important next step will involve an analysis of the income and expense statements. This is where most people fail. A Buyer needs to understand the numbers. They need to look at the history, the present and future prospects for the business. It is advisable that Buyers consult with professionals who understand the business and who can interpret the data. The list of contacts should include accountants, people who own similar business and business sales professionals with expertise in the field.
I have seen many business owners who did not do their homework prior to purchasing their business and have found themselves in a quagmire. All of these business owners have great hindsight but their predicament could have been avoided with a little foresight.
The biggest mistake business buyers make is not to negotiate with sellers. Over the 23 years I sold businesses I saw a substantial number of buyers who liked the business I showed them but said the price was too high and walked away. I explained to them that I never know how a seller will react to a lower offer. I have had sellers that said the price was firm and then reduce the price substantially. Those buyers that made a lower offer and negotiated in a sincere and friendly manner got the business and at a below listing price. If a seller likes the potential buyer the price will go down.
Another factor that buyers should remember is that listing prices are generally on the high side of the business value. It is the job of the Business Broker to get the highest price possible for his client. Both Broker and buyer expect a buyer to negotiate.
The second biggest is not demanding to see three years of financial statements and two years of tax returns.
A number of business brokers tell a buyer to make an offer and then they can see these documents. How can a buyer make any kind of a sincere offer with no information?
Having been in the business of selling businesses for the past 27 years I have seen many mistakes made by Buyers when purchasing a Business.
Some of the most frequent are detailed below:
1. A Buyer does not take the time to review his personal skills, education and experience to determine what type of business will fit his capabilities and meet his financial goals. Many Buyers just look at a projected net profit and go forward without determining if they have the skills and capabilities to run and grow that business in the future.
2. A Buyer wants to see everything that is on the market before he decides what he wants. This type Buyer usually winds up getting so confused about the various businesses and their pluses and minuses — he spends all his time looking and never buys a business, or if he does so””does it out of frustration and may select the wrong opportunity.
3. A Buyer knows it all – even before looking at a business or hearing all the facts about the particular business.
Many Buyers hear the gross sales and asking price and immediately decide the Seller wants too much for the business.
If the Buyer would take the time and effort to investigate he may find that there is additional recurring income included or maybe the premises lease is well below market value which will go direct to his bottom line or some other circumstance that makes it worth the asking price.
4. A Buyer that decides he can do it by himself without the aid of a professional broker usually winds up spending much more time and effort to locate what he is looking for. Working with an experienced Broker will usually save the Buyer lots of time and effort in locating the business and may even save him money in the negotiation for the purchase. A Third Party during negotiations usually keeps the emotions of Buying or Selling out of the negotiation and this allows for a smoother transaction without personality clashes. Experienced Brokers have seen many businesses of all types and can provide advice as to the business value, the necessary skills to run the business, discuss possible ways of growing the business and will assist the Buyer throughout the Buying and Escrow process.
5. A Buyer thinking he is getting a bargain by not using an Escrow to purchase a business. Escrow is necessary to insure that there is a proper contract between the parties, search for liens and encumbrances against the business, insure proper transfer of licenses and Franchise Agreements, publish Bulk Sale Notice to protect you from any claims of unsecured debts and handle disbursement of monies.