5 Mistakes To Avoid When Buying A Business
Updated: Nov 11, 2020
Most of my clients are individuals or small businesses. Several times a year clients ask me to help them with their efforts to buy a business. Consequently, I’ve had a ring-side seat observing these transactions and understand how people tend to approach purchasing a business. Unless they’re buying a business for a second or third time, most don’t have experience with how to negotiate, structure, or close a purchase transaction. And if they’re buying a business for a first time, they make mistakes that cost them either in the transaction itself or in operating the business later as owners.
If you are about to buy a business or are thinking of possibly buying one someday, here are five serious mistakes buyers tend to make if they are not careful:
Buyer arrogance. Buyers routinely believe they are smarter and better operators than the prior owner. This may be true, but most often it is not. Assuming you are buying a profitable, sustainable business, the prior owner has to have done many things right to get to the place that the business is for sale. I don’t know why buyers have difficulty giving the prior owner credit for all the prior owner has built and accomplished, but buyers routinely think they will do much better than the prior owner has done. This assumption seldom proves to be valid.
Too much focus on Purchase Price. The purchase price will be of considerable importance, but the way the deal is structured, and the way income and other tax aspects of the transaction are negotiated and handled has a great deal to do with the real cost of purchase, cash requirements for completing a transaction, and important operational and other details. Too often clients come to me with a purchase price already established, and lose the opportunity to gain benefits that could have been obtained if they had been more patient, given me an opportunity to help them understand structuring and tax alternatives and help them understand some of the non-purchase price costs that will be incurred after a closing.
The Buyer fails to understand the real costs of an acquisition. The purchase price for the business is only one of many costs that will be incurred if a transaction is closed. Here are some of the additional costs the buyer will incur: a) accounting and attorneys' fees; b) Broker or finder fees if a broker or finder is involved; c) Significant opportunity costs incurred as a result of pursuing a transaction – it takes time and resources to pursue and close a deal. If a buyer isn’t careful, the buyer’s business will slow down while the acquisition is pursued, which can result in significant lost opportunity; d) Significant costs will be incurred post-closing as the buyer takes over the business (Buyer personnel will be diverted from whatever they normally do to try to absorb and assimilate the acquired company, and the acquired company will lose momentum as the buyer’s employees try to understand the new owner’s objectives, culture, processes, and requirements).
The Buyer overestimates how the acquired company will perform after the acquisition closes. This goes with Buyer arrogance. Buyers tend to overestimate both revenue and profitability that will be achieved in the first two years of operation of the acquired company. There are many reasons for this. But suffice it to say that any projections should be vetted by professionals before basing a decision to buy on them.
The Buyer fails to understand how much cash is going to be needed to negotiate and close a transaction and to operate the acquired company. Time after time I see buyers make erroneous assumptions about how much cash will be needed to buy a business and operate it successfully. This goes hand in hand with all the above points, but you can see how erroneous assumptions can leave a buyer in a serious cash bind.
Although I realize that the above issues are really "business" issues and not "legal" ones, an experienced business attorney with a number of deals under his or her belt can sense when the business issues listed above have not been fully addressed, and thus can often help buyers avoid making these mistakes before it's too late.
Lindsay Spiller is the founder of Spiller Law, a San Francisco business, entertainment, and estate planning law practice. Mr. Spiller is a San Francisco business lawyer who serves clients throughout California and particularly in San Francisco and Los Angeles. You may find more information about Spiller Law's business legal services at https://www.spillerlaw.com/business-law.
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