What precautions should you look for when buying a business?

Because there are many advantages in buying an existing business over building one from scratch, many investors take this route when they want to invest in a business. Doing so offers access to employees, customers, goals, brands, legal rights, and brand recognition that could otherwise take years to achieve.
However, not all businesses are a good investment and many are in the market because they are no longer profitable. Because of this, learning to identify the important signs of a bad business to buy becomes a valuable investment technique for entrepreneurs looking to buy instead of investing or founding a company. Here are some of the most common precautions to help you see bad business before it's too late:
A changing market
You can't just see a business. Even if it is successful, the market and the neighborhood you are in may direct you to another direction. In this case, a smart owner may see the opportunity to sell their business before it is hurt by bigger economic or market reasons than the business itself.
This is true not only in a physical sense, but in the market sense as well. Going back to 1995, video rental locations were very large in almost any neighborhood in America, but visionary business owners could see physical rents going down with internet services. Is the business you are seeing similar in a market that may be heading for disaster?
Unfulfilled Tax Obligations
This is very large for a couple of reasons:

1. As soon as you buy the business, all past due taxes will be your obligation, with the past due taxes actually hidden payments in the purchase cost.
   
2. If the landlord was unaware of these tax obligations, this may also be an indication that there are also other financial or legal corners that have been cut which could cost more than the money you paid.
   

For these reasons, you should determine the tax obligations of any business you are considering buying to avoid costly mistakes.
Secrets in the closet
Take some time to see things that are not so obvious. Every business, neighborhood, and even building has some skeletons or secrets in the closet. It may sound like a script for a bad movie, but has there ever been a crime on the premises? Has the company been embroiled in scandals? Clients have long memories of this kind of thing. Additionally, is the location close to a waste hazard or other sites?
There are no things a homeowner will always know, but a little research on neighborhood and local area businesses should provide you with information on issues that you might not otherwise see that would have a major impact on your profitability.

Low owner discretionary income
What the owner can take home after making business payments is known as the Owner's Discretionary Income. Examine the IDP of any business you are considering investing for two specific reasons:

• Examine the amount and see if it is enough to support your family and lifestyle needs. If not enough, is quantity something that will work for you?
  
• Compare the IDP over the past several years to see if it has risen or fallen. This is a key factor in seeing if the business is growing or dying. If the IDP is down, it is a good sign that the business will be a bad investment.
  

Since many business owners who have dropped their IDPs will realize that this hurts their opportunity to sell the business, pay attention to see if the owner is playing any game with the IDP. Ask him to review the financial information and have your accountants review the numbers with you.
Still have questions?
Please call us for a free appointment with Miami Business Lawyer Yoel Molina in our Miami office at 305-548-5020.