Homework challenge Featured

9:48am EDT July 22, 2002

Most entrepreneurs go into business for financial freedom and the challenge. And for some, one business isn’t enough.

Still, whether this is your first or seventh venture, it’s important to do your homework when buying an existing business.

The benefits of buying an existing business are obvious: The business will bring with it established customers, suppliers, employees, a name and reputation. Failure rates for existing businesses are lower than those of new businesses.

However, as part of the due diligence process and before you jump into anything, make sure you inquire about why the business is for sale. Turnaround projects are always risky, especially if the purchaser doesn’t have experience in this area.

Before you even begin to explore opportunities, yput together a team of specialists, including an attorney, accountant and perhaps even a banker (if a loan will be needed to fund the acquisition), who can give you greater credibility in investigating potential acquisitions.

When you identify an opportunity, this team should review all of the financial information available on the business. In the best-case scenario, the new acquisition should pay a competitive salary for either the owner, if he’s going to be active in the business, or an operations manager, if the owner isn’t going to be active — plus a healthy profit.

The definition of a healthy profit should include a return that equals the long-term return of the stock market, (11 percent) plus 4 or 5 percent. This extra return should be sought because a privately owned business is illiquid, which means you should be compensated for that illiquidity.

Frequently, the return on the business is dictated by the purchase price, which needs to be determined by evaluating the financial statements and operations. To determine whether to purchase a business and what to pay for it, you need to obtain the appropriate financial information from the existing business owner.

This should include income statements and balance sheets, income tax returns for the last three to five years, accounts receivable and payable records, leases held by the business, customer and supplier contracts, patent or trademark information, insurance policies and employee fringe benefits. If the seller doesn’t want to provide this, it’s best to walk away from the negotiating table.

Generally a full-scale audit should be considered. Under the best circumstances, it should be performed by an accounting firm with experience in that industry but which doesn’t have any ties to either the buyer or seller. The audit fee could be split by both parties.

Financials aside, try to gain insight into how the company is run by volunteering to work in the business for a week or two. Also ask customers, other business owners, and suppliers about the company’s reputation.

After all, when considering to buy a business, the more information you have, the better.

Louis P. Stanasolovich, CFP, named as one of the best financial advisers in America the last four years by Worth magazine, is founder and president of Legend Financial Advisors, Inc., a fee-only Securities and Exchange Commission registered investment advisory firm located in the North Hills. Legend provides asset management and comprehensive financial planning services to individuals and businesses. Reach him at (412) 635-9210. The firm’s Web address is www.legend-financial.com.