How to Purchase a Good Business

Posted 02-09-2015 10:11 am by

When you are evaluating potential businesses to purchase, there could be hundreds of choices.  What should you be looking for?  How do you tell a good business from a bad one?  This article gives you some useful indicators that can help you narrow down your choices and pull out the good ones from the bad.

• Revenues.  The annual revenue amount gives you an idea of the size of the business.  Revenues that are too low may indicate a business that is too small for your goals, and revenues that are too high may indicate a business that is out of your budget.  Before you start your search, it is helpful to know the revenue range of the business you are looking to purchase.

• Number of Units Sold.  Is this a high volume, low margin business?  Or does the business make a few very expensive sales?  Knowing the number of units sold or the number of jobs performed can help you understand the business model. 

• Average Price of Units.  How does this compare to the industry?  Are their prices on the low-end, middle-end, or high-end of the market? 

• Gross Margin and Markups.  What is their gross margin and markups, and how does it compare with the industry average?

• Profit Margin.  At the end of the day, what is their profit margin?  A low profit margin may be a bad sign, indicating that the industry is tough to be in.  Or it might be a value-add opportunity if the average profit margin for the industry is much higher, and the seller simply has operating expenses that are too high. 

• Owner’s Discretionary Income.  Many business owners intentionally report a low net number on their tax returns to minimize their tax obligation.  To find out how profitable the business truly is, one should add back expenses such as depreciation, owner’s salary, and other expenses that are more personal in nature.  In many cases, the value of the business is based on a multiple of the owner’s discretionary income.

• Number of Employees.  Knowing the ratio between the number of employees and the annual revenues, and comparing this ratio to the industry average, can give you an idea of how efficiently the business is run.  A business that is too lean might experience employee burnout and high turnover, and a business that is not lean enough has payroll that is too high.  

• How Much Employees Are Paid.  Knowing the compensation structure of the staff can help you gauge the competitiveness of the business with other employers.

• Current Owner’s Advertising Methods.  How are current customers finding out about the business?  Knowing how the business is currently marketing itself can give you clues on the expansion potential of the business.

• Size of Customer Base.  A business with a lot of customers is more diversified, and therefore lower risk, than a business that depends most of its revenues on a few high-paying customers.

• How Well Customer Records Are Kept.  Does the business keep good records?  Having good customer records such as e-mail, phone number, and addresses will allow you to send additional promotional offers to the existing customers.

• Any Expansion Potential.  How easy would it be to grow this business?  Or is it “maxed out” in capacity? 

• Position Relative to Competition.  How many competitors are there for this business?  How easy is it for new competitors to enter the market?  What is the competitive advantage of this business, and how easy is it to copy?

• Location of the Business.  Depending on the industry, the location may play an important role in the success of the business.
• Trends in the Last 3 to 5 Years.  What trends can you see in the last 3 to 5 years?  Is the business trending up over the last few years, staying the same, or trending down?  What about the overall trend of the industry?  Is the industry growing, staying the same, or declining?  What about the area?  Is the area growing, staying the same, or declining?  

This is by no means a comprehensive list, but a useful starting point for business buyers to evaluate opportunities that suit their goals.  Having good advisors on your team such as a CPA, attorney, and business broker can help you search for and evaluate the opportunity that is right for you. 

Aaron Muller is a business broker in Washington State who has sold over 120 companies and facilitated over 40 SBA loans for his clients. Contact Aaron at (425) 766-3940 to inquire about buying or selling a business.

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