Nine Issues Commonly Overlooked Before Buying a Business
Here are nine items to consider when looking to purchase a business:
- Employee handbooks are often overlooked when reviewing the human resources aspect of a business, and yet they are vital in protecting the small business owner from a host of issues as they articulate the rules of engagement while operating as part of the business.
- Trademarks, copyrights, patents and all claimed intellectual property need to be carefully examined to ensure they are legitimately gained, protected and used in the business. This is one of the rare areas that can pierce the corporate veil to reach the business owner.
- Social Media. This exploding area of human communication needs to be reviewed on several fronts to protect your investment. How are the employees using social media as it relates to the company, its products or fellow employees? How is the company represented through its online reputation with its competitors? Lack of attention to either of these points may cause internal lawsuits in the company or abrupt changes in sales if the online reputation of the company is attacked. One can purchase business insurance for the latter if deemed appropriate.
- Continued salary or benefits to disabled or injured company employees can create a substantial liability in a company. Unless a clear policy, correctly implemented, that addresses how workers will or will not be compensated in the event of a disability or injury is in place, and it is followed scrupulously in the event of an occurrence to someone in the company, the company may be liable the following consequences should an employee become disabled after a precedent has already been set. All employees, regardless of their value to the company will have to be treated the same as the first employee who encountered this issue in the company. The payments of salary and benefits can be construed as ad hoc payments and thus may not be tax deductible to the employer.
- Often in small business, business owners have to agree to personally guarantee in order to get favorable loans, equipment or real estate leases or terms with wholesalers. It is important to review every contract and agreement for these clauses so as to not pass existing these promises on to the new owners
- A small business usually has a few key employees, that without which, the business might meet a swift demise or serious setback in operation or cash flow. It is dearly important to meet, greet and solidify their continuance in the business to keep the goodwill of wholesalers, customers and employees to the business. One must also be concerned that a key employee leaving may try and set up a competitive business.
- Although five years of tax returns typically are standard in the review process, it is important to have a separate forensic evaluation of the tax returns. Taxes are an art! Each CPA is an artist that paints a picture of the business. There are many ways that a business can be portrayed in a more favorable light through the tax return. Depreciation perks to key employees or owners, and insurance premiums that should or should not be paid through the business are just a few of the areas that can be interpreted to the seller’s advantage to make a business appear more favorable than it really is. This one step can save the new prospective buyer millions in the future from tax issues and waste in the company that affects profitability.
- Many buyers go through a business broker to find that suitable business that fits their needs. Most business brokers include a valuation of the prospective business for sale as part of their fee. I believe that there can be a conflict of interest in accepting this valuation. The broker is typically paid as a percentage of the business sale price, thus it is to their advantage to value the business favorably. I strongly urge the prospective buyer to get an independent valuation of the business form a third part not related to the sale, preferably from an independent firm that just does business valuation to avoid overpaying for a business. There are many firms that provide this service and doing so can help avoid a tragic, costly mistake in this process.
- Here is a bonus tip. When buying a business that you hope will create income and stability for your future I would advise any of my clients to require the following of any person they are considering buying a business from: Personal credit scores, background checks and individual tax returns. Know who you are getting in bed with. Even though you may believe that once you buy the business, all dealings with the past owners are not your concern, the reputation of that previous owner can seriously harm your future business health. These three things will give you a flavor for the ethics and business savvy of the prospective seller that can help move the deal to completion or avoid a costly error.
This article is not meant to be an exhaustive list of all the diligence that a prospective buyer should consider in the transaction, but a potential list of areas that are not usually addressed which can cause issues for the business in the years and decades to follow after the sale.