Common Risks of Acquiring a Business

In our last article we outlined the most common benefits of buying a business. Although, taking the acquisition route can be highly rewarding, and there are several steps you can take to ensure that this is the case. It is very important to be aware of the risks and mistakes you can potentially make. Buying a business is a complex process with numerous matters to consider, including financial, legal and people considerations.

Here I have summarised the 5 most common mistakes made when buying a business.

Poor due diligence

It is vital that you understand as much about your target business as possible. Whilst a business may appear to be successful, and demonstrates strong financial performance, this does not mean that the target may be without problems.

You must investigate and understand all aspects of the business, including:

• Customer profile.
• Importance of key staff.
• Supply chain.
• Visibility of future income streams.
• The route to market in which the business operates.
• How the business is managed on a day-to-day basis.
• Any historical financial liabilities and current debt in the business.

Paying for potential

As a potential buyer, you are recommended to undertake a detailed financial analysis of the business to determine the appropriate price to pay. This includes reviewing profit and loss statements, balance sheets, key assets, contingent and actual liabilities, as well as cash flow statements. You may find that, as a result of this exercise, it is more cost-effective to start from the ground with a brand-new business.

It is also worth benchmarking your target’s performance against its peers to understand its competitive placing.

A vendor will typically set a price based on the future potential of the business. However, it will be your time, effort and energy that creates this future potential.

With this in mind, the value of the business should be based on the condition at the time you purchase it, albeit with an eye to the future.

Not having enough capital

Purchasing and running a business requires capital. Some businesses generate working capital, some don’t. This characteristic of the business can be established during the financial investigation.

If you don’t allow sufficient headroom in cash terms with both your existing and target business, then you will not be able to cover shortages when they occur. We would not advise buying a business until you have the necessary funds. These funds should provide enough headroom to both acquire the business and to manage the day-to-day working capital requirements post-acquisition.

We would always try to negotiate that sufficient working capital or cash is left in the business by the exiting owners to meet the business’ working capital requirements.

Underestimating the importance of existing management

The strength and profitability of the business can often lie within the management and the relationships that have been built up over time. Therefore, it is important to understand if the business can operate in a similar guise after an acquisition.

Often in acquisitions the management team will be replaced. It is vital to understand whether the new or retained staff will be able to maintain the level of past performance. If there is a risk that they are unable to, you should think about how this can be mitigated.

Making drastic internal changes

Most businesses have been established over many years. Customers are familiar with this and changing elements too quickly can be self-defeating since the brand and service levels may be integral to the value of the business.

Changes may be required, and part of the acquisition rationale, but it is important that these are undertaken in a consistent, measured, and timely fashion.

Interested?

At DTE Corporate Finance we have vast experience in researching, identifying, approaching, and successfully acquiring businesses. We have acted for a variety of companies across a wide range of sectors.

If you are interested in further exploring the benefits of buying a business or you would like to be added to our database of acquisitive companies, please contact me on 0161 819 1910 or .