Buying a business
A guide for business operators in South Australia
www.statedevelopment.sa.gov.au/smallbusiness
Table of Contents
01 Overview ................................................................................................................................... 3
02 Trade-offs when buying an established business ................................................................. 4
03 Information required to access a prospective business purchase....................................... 5
04 Evaluating the purchase of a business .................................................................................. 6
05 Tips for negotiating the purchase ......................................................................................... 18
06 Goodwill .................................................................................................................................. 20
07 Summary................................................................................................................................. 21
08 Notes ....................................................................................................................................... 22
Buying a business
Page 2 of 23
01 Overview
There is much more to buying a business than answering an advertisement in a newspaper. It
takes time, planning and meticulous attention to detail.
Despite the risk, many people enter into this type of transaction without adequate investigation.
Often a buyer is tempted to make a quick offer for a business based on emotive rather than
objective reasons. It is easy to be overcome by the excitement of purchasing one’s own business
and overlook the basics. That can spell disaster!
Purchasing a business is a complex and intricate operation. It is best performed with the help of
professional advisers.
Readers are advised:
• The purpose of this guide is to provide general introductory information.
• The guide does not purport to contain all the information that would be relevant to any particular
business opportunity.
• The guide is provided to interested persons on the basis that they will be responsible for making
their own assessment of that opportunity with the assistance of the information provided.
• All figures contained in the guide should be regarded as estimates only based on general
samples and may be subject to error.
• The information in the guide should not be relied upon in substitution for professional advice
and individual investigation.
• Persons interested in pursuing any particular business opportunity are strongly advised to fully
inform themselves by taking professional advice as to the extent of their rights and obligations particularly in relation to any proposed investment.
• The guide is provided subject to the terms of the formal disclaimer, which appears on the last
page.
Buying a business
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02 Trade-offs when buying an established business
If you are thinking of buying a business, consider the following trade-offs you may have to make.
ADVANTAGES
• Proven track record lessens risks, increases the likelihood of success and may make finance
easier to obtain.
• Immediate income available from sales to existing customer base.
• Proven location.
• Stock is already in place; suppliers are established.
• Equipment already exists; its capabilities are known.
• Present employees may provide invaluable assistance.
• Vendor may provide experience and possibly finance.
POSSIBLE DISADVANTAGES
• Hard to assess goodwill; could be paying too much for it.
• Possibility of being misled and ending up with a ‘lemon’.
• May inherit a poor public image.
• Loss of past owner’s rapport with customers may affect trading performance.
• Existing location may not be adequate.
• Premises may not be modern enough.
• Difficult landlord.
• Stock may be out-of-date, damaged or obsolete.
• Employees may be unsuitable or poorly trained.
• Equipment may have been poorly maintained or possibly obsolete.
• May be difficult to introduce change.
• If the business is run down, unexpected expenses may arise.
WHAT CAN ONE CONCLUDE FROM THIS COMPARISON?
Two things—firstly, the advantages of taking over an existing business probably outweigh the
disadvantages. Secondly, it is generally less risky to purchase an existing business than to start a
new one from scratch.
Buying a business
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03 Information required to access a prospective
business purchase
FINANCIAL HEALTH
Financial statements—balance sheets and profit and loss statements, preferably audited, for at
least the past three years.
Income tax returns and assessments for the same three-year period, including a reconciliation of
taxable income and profits for each year.
Present value of assets e.g. real value of freehold.
Details of any liabilities not included in the latest balance sheet e.g. long service leave.
Financial statements since last year end; if not available, alternative financial data to allow analysis
of trend of operations.
RESOURCES
Source and availability of raw materials or products.
Tenure of leased premises and prospects of renewal.
State of buildings and equipment and anticipated requirements for replacement.
Source of labour and likelihood of it improving or deteriorating.
Capabilities, experience and age of key personnel, including compatibility with you, the purchaser.
MARKET FACTORS
Market situation and influence of competitors.
Location of customers and method and cost of delivery.
Whether the industry in which the business operates is a growth industry.
Where there is reason to doubt the authenticity of information supplied, an effort should be made to
carry out an independent check. In many cases, your accountant or business adviser will be in the
best position to attend to this task.
Buying a business
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04 Evaluating the purchase of a business
MAJOR ASPECTS TO EVALUATE
Proper investigation of these six factors will take considerable time and effort. You may be tempted
to act quickly so that the opportunity is not lost. However, this is a time when sound professional
advice is vital.
1
Reasons for selling
2
Profits, sales and expenses
3
Assets of the business
4
Liabilities of the business
5
Taxation matters
6
Other factors
This guide tells you what to look for in your evaluation of these six factors.
Buying a business
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04 Evaluating the purchase of the business
1
Reasons for selling
ISSUES AND QUESTIONS TO ASK
PRACTICAL ACTIONS AND TIPS
May be due to any or a combination of the
following:
Seek to determine as early as possible
exactly why the current owner has the
business on the market.
Declining business.
Although it may be difficult to determine,
it’s a good idea to find out the vendor’s
level of motivation to sell.
Changes in character of neighbourhood.
Answers to these questions will indicate
how much scope you have to negotiate
price and terms.
Lack of competitive strength.
The way to find out is to ask a series of
well-structured questions. If you feel that
you are not getting straight answers, ask
the questions another way.
Impending loss of business due to new
competitors.
Be wary of sellers who are deliberately
evasive.
Obsolete products.
Poor selection of merchandise or materials.
Highway construction or re-routing.
An expiring lease or franchise.
Obsolete facilities.
Inability to collect accounts receivable or
problems with creditors.
Owner’s bad reputation which may stay with
the business.
Labour problems.
Marital problems.
Ill health.
Retirement.
Buying a business
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04 Evaluating the purchase of the business
2
Profit, Sales and Expenses
ISSUES AND QUESTIONS TO ASK
PRACTICAL ACTIONS AND TIPS
Profit
Determine why.
Is the business making a profit or a loss? How
much?
Exercise caution with a business doing
poorly up to the last profit and loss
statement when a good profit is shown.
What trends are apparent in the gross profit
margin and how does it compare with the
industry norm?
If showing a decline, it may indicate any of
the following:
• incorrect stock figures
• proprietors may be living out of the
business
• prices may be heavily discounted
• correct margin may not be added to the
cost of goods
• there may be a high level of pilfering.
What is the trend in net profit?
Identify reasons to explain any trend—
sales lower, expenses higher?
Does the vendor claim to take a certain
amount of cash out of the business as
undisclosed earnings?
Calculate the net profit margin on sales.
Are profits adequate to warrant taking the risk?
Remember at all times that a business can
only be truly assessed on figures that can
be verified. Ignore ‘black money’ or
undeclared income which the vendor may
claim is taken out of the business
regularly.
Buying a business
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04 Evaluating the purchase of the business
Profit, Sales and Expenses...continued
ISSUES AND QUESTIONS TO ASK
PRACTICAL ACTIONS AND TIPS
Obtain a detailed breakdown of sales.
Seek explanations. Did 20 per cent of
customers account for 80 per cent of
sales? Could this be improved under your
ownership? Verify figures by:
• inspecting invoices and statements from
suppliers.
• inspecting daily cash books, bank
statements and income tax assessments.
Sales
• asking employees how many customers
they serve daily and what the average sale
is.
• asking neighbouring businesses how
busy the operation is.
• surveying numbers of customers
patronising the business over a given
period.
What is the sales trend?
Old slow-selling stock for which invoices
are ‘hard to find’ can often be included in
the stock figure at inflated prices.
Is the product or service likely to maintain or
improve its marketability or is it in danger of
becoming over-sold, out of style or obsolete?
If so, allowance will need to be made for
possible warranty commitments.
Are sales keeping pace with inflation?
Declining? What is selling? What is not? Who
is buying? What is the conversion rate of
inquiry to sales orders?
Does declared turnover of the business solely
represent income derived from normal
business operations?
What is the trend in stock levels relative to
sales?
What amount of stock is normally carried in
relation to turnover of the business?
How many stock-turns a year are achieved?
Are stock figures accurate and not inflated?
Have the goods been supplied with warranty?
Buying a business
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04 Evaluating the purchase of the business
Profit, Sales and Expenses...continued
ISSUES AND QUESTIONS TO ASK
PRACTICAL ACTIONS AND TIPS
Expenses
Be specially alert to expenditure shown for
telephone, wages, motor vehicle,
advertising and insurance—they are areas
of frequent abuse.
What is the trend in expenses?
If advertising expenditure shows an
upward trend, find out why.
Have any private expenses of the vendor been
shown as business expenses?
A high level of repairs and maintenance
could mean the business has an amount
of old or unreliable equipment.
Are advertising costs in proportion to business
turnover?
Make allowance for this in your financial
projections.
What is the level of expenditure on light and
power relative to sales?
Do repairs and maintenance contain any oneoff expenditures? Has salary drawn by the
vendor been included in wages? Have
drawings by the owner been variable or
irregular?
Are there any additional expenses that would
have to be incurred under your ownership?
Has the vendor received any unpaid
assistance in operating the business?
Buying a business
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04 Evaluating the purchase of the business
3
Assets of the business
ISSUES AND QUESTIONS TO ASK
PRACTICAL ACTIONS AND TIPS
Stock
Best performed by an independent party.
Arrange for a physical count to be undertaken.
Examine stock for age, quality, saleability,
style, condition, balance, suitability and
freshness. Be alert for ‘use by’ dates.
Are some goods on consignment, with the
right of being returned for full credit?
Building, furniture, fixtures and equipment
What is their market value?
Arrange independent appraisal where
necessary. An independent assessment
may be justified.
If there are items you do not want, be
prepared to negotiate on this.
Does the condition of the building and
equipment satisfy local council and health
regulations?
Check repairs and maintenance
expenditures in profit and loss statements.
How modern, efficient and usable are they?
Are they in good repair? Will any be useless or
soon have to be replaced?
Are they the
type you really want in the business?
Have this checked by a solicitor.
How much has been spent by the vendor to
keep the facilities in good condition?
What major changes will be necessary?
Are all fixtures paid for, or are there moneys
owing under hire purchase or lease
agreements?
Are any assets located elsewhere and, if so,
are they subject to a lien?
Has the depreciation policy been realistic?
Buying a business
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04 Evaluating the purchase of a business
Assets of the business...continued
ISSUES AND QUESTIONS TO ASK
PRACTICAL ACTIONS AND TIPS
Accounts receivable/debtors
You have no obligation to do so. If you do,
ensure that customer lists, business and
credit records and mailing lists are
included in the contract of sale.
Are you proposing to take over outstanding
debtors? How long have the accounts been
outstanding? How successful has the vendor
been in past collections?
Make an assessment of your prospects for
collecting based on the quality of debtors
and the prevailing economic climate.
Is an excessive volume of business coming
from credit customers with slow payment
records?
Determine the average collection period
from financial statements.
What are the implications for working capital?
If you implemented a more strict credit
policy, what would the likely outcome be?
Supplier and credit relations
Assess whether supply sources are
satisfactory and whether they are likely to
continue on favourable terms. If not, is the
business committed to them by contracts
for a lengthy period?
How are business relations with suppliers?
Determine whether they should be
increased or cancelled.
What future deliveries are scheduled?
Personnel
Assess how adversely the business is
likely to be affected if key personnel were
lost.
Will key employees continue to work for the
business under your management?
Be alert to potential liabilities for
redundancy payouts.
Will existing employees be an asset or liability
to you as the new owner?
Are you contemplating any changes?
Buying a business
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04 Evaluating the purchase of a business
Assets of the business...continued
ISSUES AND QUESTIONS TO ASK
PRACTICAL ACTIONS AND TIPS
Business reputation and clientele
It may be prudent to allow for a probable
loss of a certain percentage of clients
when preparing budgetary projections.
Does the business have a good reputation and
an established, satisfied clientele?
Take this into account when determining
the price you are prepared to pay.
Are there many customers who do business
with the vendor out of personal attachment,
but would leave if ownership of the business
changed?
Determine whether they are transferable
to you. Have any contract of sale checked
by a solicitor.
Are there contracts in place with key
customers?
Does the contract of sale prevent the vendor
from re-entering business in competition with
you? For how long a period of time?
Trademarks, patents, copyrights and other
intellectual property
Seek professional legal advice.
Are they included in the contract? Are they
transferable?
Determine whether they will be as
valuable in the future and take this into
account in resultant negotiations.
Franchises
Contact the franchisor to ascertain transfer
requirements.
Are exclusive franchises transferable to you?
Ensure appropriate provision is made in
the contract of sale.
Assess the Franchise.
Pay particular attention to its terms, how
long it has to run and its value to you.
Buying a business
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04 Evaluating the purchase of a business
Assets of the business…continued
ISSUES AND QUESTIONS TO ASK
PRACTICAL ACTIONS AND TIPS
Lease
Seek professional legal advice before
signing a lease.
Do the terms of the lease enable the activity
envisaged to be carried on?
Is it transferable to you?
Is it included in the contract of sale so that the
legal obligation to purchase depends on
availability of the lease?
Are all terms and conditions acceptable to
you?
Buying a business
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04 Evaluating the purchase of a business
4
Liabilities of the business
ISSUES AND QUESTIONS TO ASK
PRACTICAL ACTIONS AND TIPS
May be extensive and hidden and can include:
• unpaid bills
• chattel mortgages
• back taxes
• liens against assets
• back employee benefit payments
(holiday pay, long service pay, sick pay)
• pending legal actions
• other creditors’ claims
• superannuation commitments and
redundancy payments.
Seek professional advice from your
accountant, solicitor or business adviser.
Any liabilities which you agree to take over
should be included in the contract of sale.
A clause should be included in the
contract to say that all claims not shown
and revealed in writing at the date of
purchase will be the responsibility of the
vendor.
Buying a business
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04 Evaluating the purchase of a business
5
Taxation matters
ISSUES AND QUESTIONS TO ASK
PRACTICAL ACTIONS AND TIPS
Are there any current disputes with the Tax
Office?
Refer to the depreciation schedules.
Are PAYE, BAS, superannuation and other tax
payments up to date?
Seek professional advice from your
accountant, solicitor or business adviser.
Is the market value of plant and equipment
different from its written down value?
Any liabilities which you agree to take over
should be included in the contract of sale.
Does the business have significant goodwill?
A clause should be included in the
contract to say that all claims not shown
and revealed in writing at the date of
purchase will be the responsibility of the
vendor.
Are there any accrued holiday pay or long
service leave entitlements?
Are any of the vendor’s book debts likely to
become bad?
Do any repairs need to be done?
Do retirement payments need to be made?
Do you need to borrow to finance the
purchase?
Buying a business
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04 Evaluating the purchase of a business
6
Other factors
ISSUES AND QUESTIONS TO ASK
PRACTICAL ACTIONS AND TIPS
What are the past and future trends of the
business and industry?
Determine how many businesses have
been there. What types? How successful
were they?
How does the business compare with
competitors and similar firms?
This can offer a source of leverage in
subsequent negotiations.
What is the history of the location over the
past few years?
Must be adequate to cover working
capital, repairs, modernisation, new
equipment, new stock, debtors, reserves
for taxes, insurance, opening expenses,
legal fees, stamp duty plus, say, 10 per
cent for unexpected expenses.
How long has the business been for sale?
What will the total capital requirement be?
How does the total capital investment relate to
profitability?
You should now appreciate that the successful purchase of a business depends heavily on an
exhaustive study of the business from many angles. It should also be clear that, during the course
of a purchase, you will be confronted with many complex commercial, legal and taxation issues.
Appropriate professional advice from accountants and solicitors, as well as from bankers,
insurance brokers, trade associations and neighbouring business people, should be sought at each
stage in the process.
If the vendor cannot or will not provide required information, it is a warning sign. An honest vendor
should be willing to provide sufficient information, including income tax returns, records of bank
deposits and purchases and sales data.
Analysis of these factors should indicate the potential of the business and enable sales, profit and
cashflow projections to be made for at least the next 12 months.
Buying a business
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05 Tips for negotiating the purchase
Very few businesses sell for the asking price. It takes negotiations between you and the vendor to
establish price and terms so that both parties feel satisfied.
What makes for a successful negotiation? Here are a few handy tips.
THE DO’S:
Gain the vendor’s confidence.
It is important that you establish a positive negotiating position. The first objective should be to gain
the confidence of the vendor. Over a short period of time, you will be asking for considerable
information, much of which will be confidential as far as the vendor is concerned. It is easier to
obtain the necessary information if a positive relationship and trust have been developed between
the parties.
To enhance credibility and build favourable rapport, you may wish to:
•
Consider giving the vendor a personal resume;
•
Enter into a confidentiality agreement in relation to all information provided by the vendor;
•
Offer to provide a signed statement that the terms of the sale will be kept confidential.
Utilising as many sources as possible, determine why the business is on the market and for how
long it has been listed for sale. The vendor may give ill health or retirement as the reason for
selling but this may mask the real reasons—something that could make it extremely difficult for you
to make a success of the business.
If you ask for a lot of information, all in the first meeting with the vendor, it can sometimes
represent a hurdle to securing the vendor’s co-operation.
It is often better to obtain the vendor’s approval to deal direct with his or her accountant for the
information you require. In this way, you avoid vendor resistance.
You should make any offer very carefully and in conjunction with your solicitor. If the offer is
rejected, the vendor should be asked to justify the asking price. This will hopefully put reality back
into the situation and enable negotiations to move forward.
You must always remember that the vendor has an ego. Therefore, guard against ‘making
changes’ in the business until you own it.
If you constantly describe all the things that are wrong in an attempt to weaken the vendor’s
bargaining position, it may destroy the negotiating climate.
Buying a business
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05 Tips for negotiating the purchase
THE DON’TS:
Don’t view the purchase in emotional rather than objective terms.
Don’t look at the opportunity of owning the business without considering the problems.
Don’t accept the vendor’s representations on face value. You need to be cautious, even sceptical,
and ensure that sales and other important data are verified.
Don’t think that a problem business can easily be turned around. It takes money, energy and time
and never happens overnight.
Beware of changing some things quickly. Move with care. Customers may not like the changes and
may respond negatively.
Don’t use all of the available cash for the purchase. You need to leave some cash reserves and
credit lines for working capital and contingencies.
Don’t create conflict with the vendor during negotiations.
Don’t be afraid to seek concessions in price or terms. Most buyers pay too much for businesses.
Don’t assume that major customers will remain after the purchase is completed.
Don’t make a career out of looking and investigating, without getting around to buying.
Buying a business
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06 Goodwill
Goodwill is the success factor of an established business. It is a set of intangible factors that
creates the earning power of a business. If an owner has developed a successful and profitable
business, with excess earnings over and above a fair salary, then goodwill value exists. However,
if a business simply returns a modest income to the owner, goodwill may in fact be limited or nonexistent.
Aside from published profit, other factors which affect the valuation of goodwill include the lease of
the premises, the potential of the business (which might include the location of the business),
competition from other businesses, the business name and the special skills of staff.
The value placed on goodwill is usually the most contentious area of business valuations and is
best handled by your professional advisers.
Buying a business
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07 Summary
1
A major advantage of buying an established business is that it has
a proven track record which can be evaluated.
2
Whether or not there is a downside to buying a business depends
on such factors as location, reputation and image of the business,
condition of physical facilities and the asking price.
3
When evaluating a business, the key considerations are reasons
for selling, what has happened in the past, what is the present
condition of the business and do past and present trends indicate
a favourable future.
4
Throughout the assessment of a proposed business purchase, you
should strive to maintain objectivity and conduct all investigations
in an orderly manner.
5
The real reason for selling a business may vary from what the
owner states.
6
If you are contemplating the purchase of a business, use your
most important tool at all times—common sense.
Buying a business
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08 Notes
Buying a business
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Department of State Development
GPO Box 320
Adelaide SA 5001
T: +61 8 8226 3821
E: DSDSmallBusinessStrategy@sa.gov.au
W: www.statedevelopment.sa.gov.au/smallbusiness
DISCLAIMER
The Government of South Australia gives no warranty and makes no representation, whether
express or implied, as to the accuracy of information contained within this guide or the suitability of
the information for any purpose. Any use of the information contained in this guide (whether
authorised or not) is at the users’ sole risk and the Government of South Australia disclaims
responsibility for any loss or damage incurred as a result of such use. The information is provided
solely on the basis that users of the information will make their own assessment of the accuracy of
the information and users are advised to verify all information contained within this document. Any
information about the law in Australia or South Australia is provided as general information only
and is not legal advice. This guide is a starting point only and is not a substitute for legal or
professional advice. While the Department has attempted to ensure the information is accurate at
the time of publishing, no responsibility will be accepted for any errors or omissions and the
Government of South Australia will not be liable for any loss or damage incurred by any person as
a consequence of any use, reference or reliance on this information. Any such use, reference or
reliance shall be at the sole risk of that person who should seek their own legal and/or professional
advice if required.
COPYRIGHT
Produced by the South Australian Government
© March 2015
Buying a business
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