Business mentor: Consult experts before you buy

Q. How do I tell if a small business I want to buy is a good investment?

Peter Taylor of BDS Chartered Accountants replies:

A. First, understand the reasons for sale. Make sure you are satisfied with them, what is being sold and the proposed timing of the sale process.

For a purchaser, good reasons for sale might be low profitability, where the purchaser can see they can add value using their expertise, or that the owner is just burnt out, retiring, seeking new opportunities or wishing to sell for family reasons.

If you're comfortable with the reasons for sale and you are satisfied you can find the asking price, personally or using a third party, you should request a qualified professional to work with you to do an appraisal.

This removes the emotion from the buying process and replaces it with an objective approach for assessing the business's relative worth.

Most business owners have an inflated opinion of the value of their business and generally start too high. In evaluating the business you must confirm that the investment will produce an adequate return, given the nature of the business and the degree of business risk undertaken. We strongly recommend against buying a job!

A business appraisal would normally cover the following as a minimum:

* Comparison with similar businesses for sale.

* Review of the competition and the market. Who are the main competitors and where is the business in relation to them? Is there an opportunity to expand market share and how can this be done? Why hasn't it been done?

Is the business vulnerable? Compare with other technologies and market growth for the industry in general. Is it in a mature industry?

* Specific financial information. A review of the accounts for the past three to five years, interim management accounts, budgets and projections where available.

* Review of management, key staff, suppliers, leases and debtors to assess risk in maintaining current levels and ability to grow.

* A valuation using a formula that demonstrates a connection between past performance and future potential.

Ensure that you are clear about what you are buying. Is it shares in an existing business or just the business? Does it include intangibles such as business names, registered designs, patents and trademarks, client lists, systems manuals, global, national or regional rights to territories, use of premises etc. Your solicitor will assist you here, but you will need to ask the right questions to ensure there are no ambiguities.

Your advisers will usually comprise your accountant, bank and your solicitor. Together they will all play a part in evaluating or supporting your purchase. You may need to seek specialist advice for valuations of intellectual property or with a franchising opportunity, and don't be afraid to seek opinions from trusted family members and friends.

It is normal for an accountant to be involved throughout the review.

Anything a vendor has said can be included in your sale and purchase agreement so be sure to include any promises or warranties, such as time to assist in the handover and with accounts and payroll support. We also recommend that you request the vendor to leave money in. Payments can be withheld if the seller misrepresents information. While you can rely on the due diligence process to flush out any obvious nasties and any warranties embodied in your agreement for some protection, the cost of litigation often makes this course of action prohibitive.

If you've got this far you're ready to make an offer in the form of a sale and purchase agreement with the help of your solicitor. Seriously consider whether you really want to buy the company, as you are buying all the skeletons in the closet, including ACC and IRD exposures. You may elect to buy the assets of the company only, considerably reducing your risk.

With expert professional advice, you are well on the way to a successful business purchase.

* Peter Taylor is managing director of BDS Chartered Accountants, specialists in business development working with small to medium-sized businesses. You can contact him on 0800 829-627.

* Send Mentor questions to: ellen_read@nzherald.co.nz. Answers will be provided by Business in the Community's Business Mentor Programme.