When medium or large size companies are purchased or sold their owners usually get help from an investment banker, lawyer or accountant.  If you are trying to buy or sell a small business (let’s say something less than $3-5m in revenue) it’s a different ballgame.  You are likely on your own even though you can list your business for sale on some popular websites.  You can get help from your accountant or attorney but expect to do most of the work yourself.  Here are some tricks of the trade you can use to help reduce your risk as a buyer or maximize your benefit as a seller.

How to Buy a Small Business:

Validate the Profits you are being shown:

Financial Due Diligence is a fancy term for understanding the financial statements and earnings of the business you are evaluating for purchase.  When you are thinking about how to buy or sell a small business, financial due diligence is critical. The seller is likely running a combination of personal and business expenses through the company to lower their taxable income.  You’ll need to understand what these are to make sure they aren’t actually expenses you’ll need to keep paying on an ongoing basis.   Once you identify and remove the seller’s personal expenses from those of the business, you’ll have a better understanding of how profitable the business really is.  Also, be sure to look for one-time benefits that might have temporarily (but not repeatably) improved the profitability of the business.  You will want to remove these as well since your goal is to understand the real underlying profits of the company.

Follow the Cash Flow:

Accounting can be done in many different ways, but cash is cash.  Take the period you are looking at from the company’s accounting and reconcile that against the cash inflows and outflows from the company’s bank account over the same period of time to make sure you can account for both the revenue and expenses of the business.

Ensure you’re Buying what you think you are:

Carefully define the business you are buying, include all of its key assets including the people that make it tick.  In small businesses, this could very well be a husband and wife team, or a cousin or relative that is really essential to the business but not upon first glance.  Make sure you know which pieces of equipment, inventory, buildings, contracts, domain names etc.…are included in the definition of what you are actually buying.  This will also help the seller avoid ambiguity or be left with assets that are no longer useful to them. Make a list of disclosed assets – these should include physical assets (equipment, fixtures, etc.), intellectual property (intangible assets), employees, etc.

Don’t inherit problems you didn’t anticipate:

In most cases, these will be things like unpaid taxes you’ll want to make sure are the responsibility of the seller.  In addition, you’ll need to have them disclose any potential or in process lawsuits, so you don’t walk into a negative surprise.  Also make sure there are no violations of labor laws, or hidden components of labor contracts you were not made aware of during the purchase process.

How to Sell a Small Business:

Do yourself a favor and anticipate the items above!  Make a clean set of financials that can be easily bridged to the ones you produce from your native accounting system or from your taxes.  This will save many hours (or even weeks) of time and help you get ahead of the game.  Often times, a buyer who sees this level of organization will feel more comfortable paying your asking price because they will feel less at risk of not knowing what lurks within your expenses (fact vs. fiction)

Identify all of the items that are being disclosed / sold.   The earlier you do this, the sooner you will know what you are going to part with.  For example, do you intend to keep the real estate and have the buyer pay you some predetermined amount of rent?  Do you have people or other resources that are shared between one or more businesses?  If you do – this is the time to identify them and figure out how you plan to handle the eventual questions that come from a seller.

Be open to structures that you did not originally contemplate.  You might find a buyer who is open to purchasing a majority of your business with some predetermined earn-out that gets you to the purchase value you were looking for – think about how to protect yourself in these cases.  Make sure that a certain percentage of pre-tax income must go to you in the event that certain targets are hit.  Earn outs are difficult, but a well-structured earn out may let you participate in the upside of the business you’ve sold in the future while a badly structured earn out may set you up for disagreements and lawsuits. 

Remember your objectives:

No matter if your goal is to buy or sell a business, you’re after a smooth, fair and collaborative experience.  It’s important that you keep fairness and open communication at the forefront of what you do.  Buyers are parting with hard earned dollars and sellers are parting with something they have put their blood, sweat and tears into building.  Working together towards a mutually beneficial outcome is critical and if you need to, remind yourself of that as either or both of you are experiencing any frustration (which is totally normal and should be worked through!)