Hard sell: The warning signs to look for when acquiring a business

Given the rapid growth and established customer base that purchasing another business can deliver, it’s no surprise that merger and acquisition (M&A) activity is on the radar for many companies.

So much so, that according to Mergermarket’s M&A Activity Trend Report, M&A activity in early 2017 was up by more than 50% on the previous reporting period, with 107 deals completed worth a cumulative total of $28.3 billion.

While it sounds impressive, the sheer volume of M&A activity doesn’t reflect how many of these deals were actually shrewd business decisions.

As with anything in business that involves outlaying a large amount of capital, undertaking comprehensive due diligence will go a long way to ensuring you don’t make a bad decision.

In order to avoid the pain of paying too much for another business, here’s some common warning signs to look out for.

1.  Not all financial information is disclosed

Generally speaking, if you’re having difficulty getting your hands on all the financial records for the business, this may be a warning sign that the current owner(s) or management have something to hide. While there may be good reasons for the information being withheld, if these aren’t made clear to you then proceed with caution. Remember, if the business is successful, there should be few barriers to sharing financial accounts, profits and expenses for the business. 

2.  The business has a poor reputation

There are a number of ways to establish whether or not the business has a good reputation. For consumer-facing businesses, a quick online search is likely to provide you with valuable customer feedback. While these reviews may be one-sided, they should give you an overall feel for the businesses’ reputation and success. For B2B operations, asking for references or checking-in with known customers will likely give you an insight into its standing.Finally, consider undertaking a ‘secret shopper’ experience to establish the levels of service and staff enthusiasm for the business.

A poor reputation in itself isn’t a reason not to buy the business, but consider carefully how it will impact on the value you are seeking from the purchase. For example, if your purchase decision is based on a strong and loyal customer base, and your research uncovers that doesn’t exist, then it’s reason enough to walk away.

3. The sector or business is on the decline

While you’re likely to have a clear reason for wanting to buy the business (which may involve operating in the same or a similar industry), it’s important to understand if the sector, industry or company has plateaued or is on the decline. For example, a traditional manufacturing business may no longer be a viable proposition due to cost structures, or brick and mortar retail store may be falling behind as consumers move online to purchase similar products or services. Consider where the industry or business is likely to be in the next 5-10 years. Also, look at competitors to understand the health and prosperity of the sector.

4. The business has outstanding debts

You want to avoid inheriting a business that has large, outstanding debts, or a poor credit history. As a first step, it’s a good idea to conduct an online credit check to understand the credit behaviour of the business. This will build more of a picture of for you, and highlight any potential red flags, such as the business not paying suppliers on time. The same applies to employee benefits or entitlements. If the business owes benefits to its staff, such as wages, it could mean you’ll not only inherit these costs but potentially a disgruntled workforce as well.

When you’re looking to purchase another business, the likelihood is that you know the business or the industry well, and have a good reason for buying it. But remember, looks can be deceiving and sometimes until you scratch the surface, there is a range of problems that you are unaware of. Remember, the business is on the market for a reason. It may be as simple as the current owners wanting to exit the industry to focus elsewhere, but it may also be due to something more sinister.

If you feel confused or unsure of what to look for, remember that an accountant or business advisor will be able to help you through the due diligence process.

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