This is a Great Business to Buy
What’s a good business to buy? I get asked this almost as much as, “What’s my business worth?” With nearly 20 years’ experience as a business broker, I've sold hundreds of businesses, and these businesses have proved to be successful time and time again.
Buying the wrong business can be a costly mistake. Here's how to avoid it and what to look for. If a business has all these points, it’s probably a great business to buy. This works for almost any industry and almost any business type.
What are the financial metrics that truly matter when buying a business? This is one of the most important aspects of a business for sale and, although as a buyer you will consider many additional things about the business, this is arguably the most important one. When you buy a business, you will usually take on debt from borrowing the money to buy the business, you will likely have a mortgage on a house, and all the other general expenses it costs for you to live. You will be relying on the income from the business to fund your life, so financial performance is critical. The business must make a reliable, consistent and repeatable profit.
How do you compare the profitability of different businesses effectively? Simple business valuations look primarily at the EBIPTDA, which is Earnings Before Interest, Proprietors wage, Tax, Depreciation and Amortization, or what is often referred to as cash surplus or sellers’ discretionary earnings. Businesses are commonly valued based on the profit they are generating because buyers will use this to assess the financial viability and compare profitability between businesses. This earnings-based method assesses the total value of the business based on the profit it is generating.
How can you ensure a business's financial records are reliable and transparent? This is where most buyers should start as they begin their due diligence. But as the more in-depth analysis is performed, look at growth trends for both revenue and profit, expense ratios, inventory controls and productivity, and more. A transparent seller will make this task as easy as possible by having current financials and an easy to navigate management system, which brings me to the second part of the financial performance, the books. Complete, thorough, and orderly financial records are critical to the sale of any business. If a business’ books are transparent and easily understood, they will give a buyer and its advisors a sense of both clarity and comfort insofar as orderly books suggest that there are no hidden surprises and suggest an orderly business.
How likely is the business to grow in the future and at what rate? Look at the business’ financial performance over the past few years. Has the business been growing steadily? Assuming it has, at what rate? Has that rate of growth been equal to the rate of growth in the general economy? If the business is only growing at inflation rates, it will struggle to fund a buyer’s life. Worse still, if the business is not growing at all, move on to a business that is.
What level of dependency is acceptable in a business you're considering buying? If a business is dependent on one or two employees, customers or suppliers, then the value of each of those to the business is extremely high. It may well be that if any one of them is lost, the business will almost certainly suffer. However, as a buyer you should take the view that the business will suffer because of the presumed risk that such dependence adds to the business’ long-term viability. For example, if a business relies on one key employee, what is the risk to the business if that employee becomes ill, is recruited away, dies, wins lotto or retires?
What are the risks associated with buying a business that's heavily dependent on its owner? Buyers need to be reassured that the business will survive a change of ownership. When customers call, are they calling for the Owner and is the Owner the key performer, or the only one to provide the service or product the customers demand? Can the Owner take a four-week holiday and feel satisfied the business will run smoothly? This would indicate that there are solid systems in place that cover the day-to-day operations or technical aspects of the business. Look for a business that can run without the day to day input from the owner. The business should be able to operate independently of the owner on a daily basis.
Why are well-documented systems and processes crucial for a business's value? No buyer will want to buy a business if they think it will collapse the moment the owner leaves the business. It is important to look for a business that is smarter than the owner. What does that even mean? How can the business be smart? This smart business is usually seen in the form of systems, procedures, manuals etc. Ensure that there is an operations manual that details the current daily operation of the business and ask the owner to demonstrate that staff can handle the day to day tasks because of their training and the information contained in those operations manual. Make sure all systems are documented and linked to procedures etc. This makes staff easier to replace should they leave and the business is less likely to suffer if staff are on holiday as others can step into the roles easily.
Recurring revenue is defined as predictable revenue that can be expected to continue in the future. However, some types of recurring revenue are more valuable than others, so what should you look for in a potential business purchase? Here are some examples of the most valuable types of recurring revenue:
Contract Revenue: Think of your cell phone. Telco’s generally sell their services using contracts of one to three years. When a customer walks out with a new iPhone, whoever is providing the service received not only the one-time revenue from the sale of the phone but also guaranteed recurring revenue for the next 12 to 36 months, depending on the length of the contract. One sale and the money rolls in for the next couple of years!
Subscriptions that Auto-Renew: Do you pay Netflix monthly, I sure do!! Microsoft One Drive, Adobe, Sky TV, Amazon Plus and the many other similar services? These, and other similar services generate what is referred to as “evergreen” revenue; revenue that is most likely to go on and on and on.
If a business has all of the points above, it should be a great business to buy and you should take a very close look at it. It wont stay for sale long.
Peter Nola is an Auckland based business broker, author and YouTuber with 20 years’ experience and over $100m of businesses sold, helping New Zealand business owners to buy and sell businesses.
Helping buy a business and sell a businesses without expensive mistakes
