Buying Business – why and what makes a business attractive
The primary reason someone people are buying business is to get a return on the investment. Each potential acquisition will be judged on the level of future profits the buyer believes the business can generate, the level of risk attached to reaching these targets and the attractiveness of the industry in which the business operates.
The first criterion a potential buyer will look for is a sound financial history. Ideally, the business will have recorded a steady increase in profit for the last two to three years, with a similar increase in revenue over the same period. If the profits and revenue figures are inconsistent or showing a downward trend, it may be better for the entrepreneur to delay putting the business on the market until the financial results improve.
Attractive or valuable businesses can demonstrate a proven track record of success. They ideally have an established customer base, sound internal systems, market awareness and credibility, an operational framework and good cash flow.
Potential buyers are reassured if they see the business has solid systems and processes in place. The goal is to eliminate reliance on any one business owner (or key person) to the extent that the absence of the previous owner will have almost no effect on its operations. A good starting point is for a business owner to look at what he or she does for the business and identify other staff members who have the potential to take over specific responsibilities.
Industry trends also influence buying decisions and business value. For example, businesses that operate in a growth market will usually be more valuable than businesses that operate in a less buoyant industry as they have a higher chance of continuing to earn the same or more profits.
A business that manufactures and sells ecologically friendly products for example would have struggled 20 years ago. But in today’s environment, there is a great deal of marketing mileage to be made from an ecologically responsible product or service.
Negating risk factors
Buyers assess any business through the filter of risk. If the business is well organized and driven by strong systems that make employees accountable, it becomes less risky for a new owner.
One of the first questions a buyer will ask is, ‘Why is the vendor selling?’ And, a vendor needs to be able to provide a genuine and consistent answer.
There are many legitimate reasons for exiting a business. These include wanting to sell to someone with more resources who can take the business to the next level, selling to someone who is younger and more energetic, or lifestyle reasons such as spending more time with the family or dealing with health issues.
Buyers decrease their risk by carrying out a thorough due diligence investigation and sellers improve their position by being prepared for the scrutiny that prospective purchasers will put the business under. The more prepared the seller, the higher the ultimate price they may negotiate.
One of the biggest issues for buyers is how reliant the business is on the current owner. Research shows this is a legitimate concern, with 40% of business owners claiming the business totally depends on them and a further 44% saying it does to a major extent. However, 71% believe another person could readily take over the business if necessary.
If it appears the goodwill of the business rests largely with one individual, the risk attached to buying the business increases markedly. An exit strategy needs to include a plan to separate the business owner from the day-to-day operation of the business.
Using a tool that will help you understand your Business Attractiveness will give you a score. You must always consider the reason the buyer wants to invest in your business when calculating your score. This may weight certain criteria in the Attractiveness Index to be more important than others. Attractiveness will be relevant to the type of buyer and the reason they are buying.
For example, an owner/operator acquires a business to essentially buy themselves a job. The average spending of these buyers would be $100,000 to $1,000,000 and any business for sale over this category may be unattractive.
A multinational or large company that buys a business for strategic reasons will rarely spend under $1,000,000. A multinational would not look at a business unless it had enough profit and upside to justify the stringent due diligence, legal and accounting fees.
Within the owner/operator category, there are essentially two types of buyers. These include buyers who are purchasing for leisure and hobby reasons and those who are buying to get ahead.
The former will be made up of people who are reasonably well off and are either in the twilight of their careers or are looking to take it a bit easy. They are essentially looking at buying a job in an industry in which they enjoy working. They want good profits and a job that is not stressful in a situation where they don’t need to work too hard.
Owner/operators who are buying to get ahead will be after maximum returns. Their choice of an industry is dependent upon growth, profitability and their experience. They are not concerned about working hard or long hours as long as there are solid returns.
A strategic investor (a large business that buys another business) is generally looking to either expand or eliminate a competitor. They might see the strategic benefits of the following:
- Products or services to add to their base
- Intellectual property
- New distribution channels
- Locking in supply
- New ways of approaching customers
- Management expertise
- Brand expansion
- International expansion
- Competitor buyout
- Employee skills
Author: Kathleen Dale, Business Advisor and Founder of Compass Business Advisory.
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