Why it’s never just about the usual numbers
Recently we raved about the beauty of small business in Australia. So we thought we might follow up with a look at what you need to think about if you’re looking to join the ranks of Australia’s small business owners. But from the perspective of buying one.
If you Google ‘What should I think about when buying a business, you’re likely to be hit with a raft of articles (a billion of them to be precise) mostly suggesting the same things. i.e. that you look at particular numbers, ratios, and percentages. Things like;
- Revenue (money in) – expenses (money out) = profit (what’s left at the end of the day)
- EBITDA – earnings before interest, tax, depreciation and amortization
- ROI – return on investment
- ROE – return on equity
- Asset valuation – i.e.: how much the assets of the business are worth (less any outstanding debt)
- Price earnings ratio (P/E ratio) – the value of a business divided by its profit after tax
- Asset turnover
- Staff turnover
As accountants, we look at all of those things when clients ask us to review a business they’re thinking of purchasing. And they’re important considerations. However, these are not the only things that make for a great business purchase.
All things being equal (ceteris paribus – we financial folks love a good Latin term) other critical factors should guide your decisions on ‘the one’ business for you that aren’t necessarily ‘financial’ per se.
Now you might be thinking, “Wait, what? I thought buying a business was all about getting the numbers to stack up.” Yes, it is. You’re right, the numbers do have to stack up. But there are other things you must check out and tick off, even if the numbers look amazing. Because if these other factors are missing, those glorious numbers could go south rather quickly after you purchase said business.
1. Do you have any experience in, knowledge of, or passion for said business/industry sector?
The number of times I’ve heard disaster stories about people who’ve purchased a business they’ve no real experience or interest in seemingly knows no bounds. Quite simply it is a recipe for disaster. The barriers to entering into business these days are lower than ever, but that doesn’t mean running a business is easy. It’s not. You will need not only some access to cash to pull through a down period, but you’ll also need to dig deep and stay the course. And that’s so much easier if you like what you do and have an inkling of what’s going on/what to expect in the sector.
- Do you know how, and have time, to run the business you’re buying properly?
This is almost a continuation of the point above. You need to know how to run and have the time to run said business. I’ll give you an example. A friend of mine was telling me about someone she knew of who ran a marketing business but then purchased an ‘online e-commerce business’ complete with a heap of stock, to run as a side gig. The buyer met the business seller through a Facebook group and the owner assured the buyer it was like shooting fish in a barrel – the money just rolled in. What she neglected to tell the buyer was that she spent considerable time, effort, and money advertising/social media(ing) that business. And whilst the buyer knew how to market, she didn’t have the time to put into it to make it work. It failed rather spectacularly and the woman ended up selling all the stock (at a loss) to someone to sell at markets. But the failure cost her a bomb!
3. How dependent is the business on its current owner?
If the business has a staff, management team, etc., then that’s a good start. The more people that share the business knowledge, the better. What you want to avoid is the business relying on the current owner for key process knowledge or relationships that leave when they do. If there’s too much of a reliance on the owner, what are you buying?
Even if you’re happy having an operational role in the business, you’ll likely want others in place who know how the business runs to ensure you can have a holiday when necessary (and trust me, it will be necessary!).
And if you’re looking for more of a senior management role/chair type role in the business, you’ll want to ensure there are suitable future leaders awaiting ascendancy when the current owner leaves. Otherwise, you’re stuck in operations.
- What does the business pipeline look like?
It’s all well and good to look at the revenue and declare the business to be robust. However, a business without a solid focus on sales is a business that’s going to need life support at some point. Ideally, you want to see that any business you’re interested in actually has a replicable sales process and a real new business pipeline. You want to look for a system that knows how to acquire new business leads (and where from). Plus that system then needs to move those prospects through a series of supportive steps of staying in touch over time edging them closer to a ‘yes’ decision. And even if the person says no or not now, you want to see a process to continue to follow up. What you don’t want to see is a business that relies on a particular person’s contacts, especially the current owner, to bring in business. Or a ‘system’ that largely lives in someone’s head.
- Is due diligence easy?
Whether it’s you, your accountant, or your solicitor doing background checks on the business, what you want to see is that the business can easily supply whatever has been requested. In other words, you want to know if the business has good governance.
You’ll want to check client contracts, staff contracts, financial statements, leases, property/asset/IP ownership, etc. A business that has a sound paper trail/quality filing system (be it paper or on the cloud), is likely to be better run than a business where those documents aren’t easily or quickly forthcoming.
For example, a business that has its books in a shambolic state, probably isn’t one you want to buy, even if it looks bright and shiny on the outside. Why? Because you will never be quite sure of what you’re buying. If the numbers are in a state, how do you know that the profit that’s being touted is correct? Hint: You don’t. And if the books aren’t in an immaculate state (which should be given in a business sale), how do you know if the business owns the IP behind its assets, website, logos, imagery, design, etc., which is often much trickier to ascertain?
In summary: whilst the financials must stack up on any business sale, the above five points are just as important for ensuring that you’re making a move that’s right for you in the long run. As with all things financial/tax/business, we encourage you to seek advice from a qualified, licensed professional.
Of course, if you need good, qualified advice if you’re looking at a business to buy or if you’re looking to sell and need to get your financials immaculate in the lead-up, or possibly you just want to transition your books to cloud accounting to make your life easier come BAS time, we’d love to help.
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