cDespite stringent disclosure rules which aim to even things up between the supposedly rapacious seller and the innocent purchaser, it’s very easy for a buyer of a small family business to be caught by buying a dud.

If you’re stuck with a dud business as a result of being deliberately deceived you certainly can take them to court. But you don’t need me to tell you of the costs of litigation, the time it takes (years!), and the very real chance you may not succeed anyway.

This article is the final in a series of six on how to detect the traps and uncover the secrets the seller may be hiding from you.

Why is the Vendor Selling?

This is often the first question asked by a purchaser and it can be very revealing. Sickness in the family is a favourite, wanting to slow down is another, moving away to the country is good, as is just wanting to do something else.

My guy chose the sickness in the family. His widower father-in-law had terminal cancer and his wife had to look after him, so they needed to move upstate.

“Fine”, I said, “so in that case you will have no problem signing a Covenant not to Compete?”

Trap 18. Not Insisting on a Covenant Not to Compete:

A covenant not to compete prevents the vendor from setting up in opposition to you for a set period of time. Depending on the type of business it might say they can’t set up a similar business within a radius of (say) three miles (5 Kilometres) and not for three years.

In a service business or profession the seller may have to undertake not to approach their customers or clients for three years, and you should ensure you get a list.

A manufacturer may be barred from setting up again anywhere if there is an established worldwide market for the product range.

Trap 19. Making the Covenants too Onerous:

The danger is in making them too punitive. If I demanded that he could not buy or set up another GRB type business anywhere in the country for twenty years, a Court would probably say that was unreasonable and overturn it.

“I don’t see the point really as we will be far away from here doing something else”, he replied. I pressed him, but then he got angry and said I was being unreasonable and if that was how I felt I could just forget the whole thing!

Trap 20. Not Knowing Center Management Plans:

I knew he wouldn’t sign it. For I had found out that the shopping mall was going to be demolished and converted into a housing estate……………..

Trap 21. Not Knowing the Seller’s Real Intentions

………… and that he was down as the GRB Shop owner in the new mega shopping mall being built nearby.

It all sounds like a detective story, doesn’t it? But all these traps are not fiction – every one is based on a true story. And I am sure there are plenty more out there that many of you will have experienced. Here are a few more that apply to other industries.

Trap 22. Not Being Aware of the Seller’s Fame and Following:

Hairdressers are particularly prone to this one, but it can also apply to any service or professional business where the personality and skills of the owner in dealing with clients and customers is important. As soon as Mr Personality sells out the customers go with him or go elsewhere.

I know of a male hairdresser who had a devoted following in the gay community. When he sold out half the customers disappeared. It took the new owner months to figure it out

Trap 23. The Seller is Also the Landlord:

If the seller owns the business premises it is very likely they will not be paying themselves rent at a commercial rate, or even any rent at all. So speak to a Real Estate Agent and adjust the rent figure shown to what it would be if you were renting comparable premises nearby.

Also make sure that they are prepared to enter into a formal lease and on what terms. This should be made a condition in the contract to buy the business.

Trap 24. Relying on Existing Employees’ Skills and Knowledge:

Many business owners rely on key employees to provide the technical skills and experience necessary to properly run the show. A gourmet chef in a high-class restaurant is just one example.

If you, without such skills, acquire a business on the basis that you need these people to stay, you make yourself very vulnerable.

There is no practicable way you can force them to stay. Very often both the seller and the employees will assure you they will stick with the business, only to pick up sticks as soon as the purchase is settled. Hidden inducements by the seller are sometimes the reason for this, and in others they may be friends or relatives.

The real answer here is that you should make sure you have training and experience in these types of businesses before taking one on.

Nobody should even think of buying a business like a restaurant without doing at least some hospitality industry training and working for a while in the kitchen. Some industry associations run their own training courses for new owners. Always attend!

Remember, just because you like good food doesn’t mean you can run a restaurant!

Trap 25. Unknown Local Authority Requisitions:

Any business that handles food is subject to stringent hygiene and pest infestation control regulations. Check with the local authority to see if there are any breaches notified or outstanding. The business could be in danger of being closed down.

If there are any insist they be rectified at the seller’s expense before settlement.

If it is a WIWO (Walk In Walk Out) situation, deduct the rectification cost from the purchase price.

Trap 26. Beware of Seasonal Effects:

There is some seasonal effect in nearly all small businesses. There are summer businesses and winter businesses, and there is Christmas and Easter, Mothers Day, Fathers Day, vacation periods etc.

Some are obvious, but others are more subtle. If you don’t know the industry you may not be aware of them and get caught. You could end up paying extra for a business because of a recent rush of sales that you naively thought was permanent.

Or it may be that you are reliant on a certain level of sales to pay back the bank, and everything goes quiet as soon as you take over.

Sellers want to sell at the end of the peak season, but purchasers want to buy at the beginning. You may be able to turn this to your advantage by buying cheaper at the end of the season if the owner is desperate to sell. Just make sure you have the cash to ride out the quiet times.

Final Comments

All the traps explained in this six-part article are designed to empower you, not deter you. In all likelihood the businesses you check out will not have any of these traps, or at worst only one or two of them. And a lot of them simply won’t apply to your prospective businesses, for various reasons. And when you do discover something using these techniques, it does not necessarily mean you should abandon the deal. Very often you can use what you have found to negotiate a better price.

This article was written by Brian K Fitzgibbon CPA.

Brian is an experienced accountant and small business consultant. He runs his own business, lectures extensively on small business topics and has checked out and valued many hundreds of small businesses for buyers.

Brian is also the author of the highly acclaimed and invaluable
"How To Value A Business And Buy It Without Fear"
A do-it-yourself guide for first-time and experienced buyers alike.

To download a FREE Chapter from Brian's book please follow this link: "HowToValueBusiness.com"

August 3rd, 2009 | Tags: accountants valuation, business valuations, buying a business, buying a dud business, checking out a business, checking the figures, checking the seller, dangers of business valuations, disclosure rules on buying a business, diy business valuations, due diligence on a small business, goodwill valuation, how to buy a business, how to value a business, tips on buying a business, traps to avoid in buying a business, valuing franchises | Category: articles | Subscribe to comments | Leave a comment | Trackback URL  |