BUYING A SMALL BUSINESS - CHECKLIST

Evaluating the Opportunity:
Profits, Sales, Expenses
The Assets of the Business
Furniture, Fixtures, Equipment, Building
Accounts Receivable
The lease
Franchises
Trade Marks, Patents, Copyrights
Business Reputation and Clientele
Supplier, Credit Relations
Trained Personnel
The Liabilities of the Business
Taxation Matters
Handling the Final Transaction

This investigation should cover:

• The reason the business is for sale
• Business profit, sales and operating figures both past and projected
• The assets and liabilities of the business
• Return on investment
• Other evaluation factors such as the history of the business and location

Following are some important guidelines in analysing a particular offer. Proper investigation of these factors will take considerable time and effort and the buyer may be tempted to jump quickly so they will not miss a golden opportunity.

Reasons for selling:

May be –

• declining business
• changes in the character of the neighbourhood
• lack of competitive strength
• impending loss of business due to new competition including competition from imports resulting from changes in Government policy etc
• obsolete products
• poor selection of merchandise or materials
• highway construction or re-routing
• an expiring lease or franchise
• obsolete facilities
• inability to collect accounts receivable or problems with creditors
• owner’s bad reputation which may stay with the business
• labour problems

The reason for selling may be something that would make it extremely difficult for a new operator to make a success of the business

Profits, Sales, Expenses

Find out about past profits, sales and operating ratios. Attempt to project sales and profits for the next year or two. Obtain and analyse current reliable records of:

• The owner’s income from the business for each of the past three to five years. This can be obtained from the seller’s income tax returns or business records.
•  A detailed breakdown of sales and operating ratios for the past three to five years. These should be analysed to indicate trends. They should also be compared with trade averages if available to see if they are in line with other similar businesses.

The buyer should take care in examining books to look for drawings by the owner as salary and particularly for variable and irregular drawings.

Interim comparisons – surveys of these are often available.

The Assets of the Business

The assets of the business – both tangible and intangible – should be closely investigated to determine their value and to make sure they are transferable to the new owner. Assets may include:

   Inventory:    A physical count should be taken (preferably by an independent valuer) and
- examined for age
- quality
- saleability
- style
- condition
- balance
- suitability
- freshness 

Furniture, Fixtures, Equipment, Building

• What is their market value?
• How modern, efficient and usable are they?
• Will one be useless or soon have to be replaced?
• Are they in good repair?
•  Are they the type the buyer really wants in business?
• How much has been spent by the seller to keep the facilities in good condition?
• What major changes will be necessary?
• Are all fixtures paid for or are there monies owing under a hire purchase or lease agreement?
• Are any assets located elsewhere, and if so, are they subject to a lien?
• Has the depreciation policy been realistic?

Accounts Receivable (should be studied closely)

• Check their age
• Check the credit standing
• How successful has the seller been in past collections?
• Is an excess amount of the business coming from credit customers with slow payment records?
• Would this necessitate excessive working capital?
• If a stricter credit policy were established would key customers be lost?
• What is the current economic climate and how does it effect customers’ ability to pay?

Customer lists, business and credit records, mailing lists should be included in the sales agreement.

The lease

• Is it transferable to the buyer?
• Is it included in the contract agreement so that the legal obligation to purchase depends on availability of the lease?
•  Do the covenants of the lease enable the activity envisaged to be carried on?
•  What is the annual rent payable?
• Adjustment of rent at fixed intervals during the lease.
• Provision of tenant’s rights to sublet.
• The type of business that can be undertaken on the premises – (this will effect subsequent sale price).
• Lease provide with regard to the payment of rates and increases thereof.
• How long does it run?
• What are the terms?
• Is there an option for renewal?
• Is there a deadline for the exercise of this option?
• Does the lease grant the lessee the right of assignment?
• Will the buyer be liable, under the terms of the lease, for such expenses as insurance, cleaning, lighting, maintenance, etc?
• Does the rental include a proportion of the profits?
  

Franchises

• Are exclusive franchises (to sell certain products, e.g.) transferable to the buyer?
• Are they included in the contract?
• It is necessary to contact the franchisor to transfer the franchise?
• How long does the franchise run?
• What are its terms?
• What are its original cost, if any, to the seller?
• What is the effect of legislation e.g. – Commerce Act, what is the value to you?

Trade Marks, Patents, Copyrights

• Are they included in the agreement?
•  Are they transferable?
• Will they be as valuable in the future?

Business Reputation and Clientele

• Does the business have a good reputation and established, satisfied clientele?
• Are there many customers who do business with the seller out of personal attachment, but would leave if they did?
• Does the purchaser have to allow a probable loss of a certain percentage to the new owner?
• Does this affect the value of the business?
• Are there firm contracts with key customers and are these transferable to the new owner?
• Does the agreement prevent the seller from re-entering business in competition with the buyer?
• For how long a period of time?

Supplier, Credit Relations

• How are business relations with these sources?
• Will they continue and on favourable terms?
• Are the supply sources satisfactory?
• If not, is the business committed through contracts to them for a considerable time?
• What future deliveries are scheduled?
• Should they be increased – or cancelled?
• Are either the estimated average stock turnover or the length of time on trade debt greater than the length of time on trade credit?

Trained Personnel

• Will key employees continue to work for the firm under new management?
• If key personnel are lost, how adversely would this affect the business?
• Will existing employees be an asset or liability to the new owner?
• Will they want to make changes? If so, will there be liabilities for redundancy or loss of office?
  

The Liabilities of the Business

Liabilities maybe extensive and hidden. They may include:

• Unpaid bills
• Chattel mortgages – or security agreements – on equipment
• Back taxes
• Goods and Services Tax
• Liens against the assets
• Back employee benefit payments including holiday pay, long service pay, sick pay, and pending legal suits.
• Other Creditors’ claims
• Superannuation commitments, redundancy payments.

The liabilities that will be assumed by the new owner should be put in writing and included in the contract.

The contract should include a statement that all claims not shown and revealed in writing as at the date of acquisition will be assumed by the seller. Carefully following the paper legal procedure will help protect the buyer.

Other evaluation factors – think about the following:

(a)     What are past and future trends of the firm, field of business, neighbourhood community? How does the business compare with competitors and similar firms? What is the history of the location for the past few years? How many businesses have been there? What types? How successful were they? How long has this business been for sale?

(b)     The buyer should attempt to project sales, profit and cash budget for at least the next 12 months. This will determine working capital requirements, reserves, cushion for living expenses and seasonal demand factors.

(c)     Consider whether it may be more economical to set up a new business rather than meet the vendor’s price.

(d)     What will be the total amount of capital needed?

There must be enough for:
        - working capital
        - repairs
        - modernisation
        - new equipment
        - new inventory
        - cash to carry accounts receivable
        - reserves for taxes
        - insurance and depreciation
        - opening expenses, legal fees, stamp duty plus an allowance for the inevitable unexpected expenses
        - how does this total capital investment relate to profitability?
        - has buyer considered leasing certain equipment, fixtures and fittings to allow sufficient working capital?

A financial model will establish parameters for the above.

(e)     Does the condition of the building and equipment meet local legal building and health code requirements? The buyer should check zoning ordinances and building codes to determine the existence of non-conforming land uses or violations of building codes. Search should be undertaken for future rezoning, re-development, street or highway changes, highway relocation, limited street access, elimination of on street parking.

Taxation Matters – (applicable if buying stock)

• Have all returns of income been made and proper claims submitted for any incentives or grants?
• Check position regarding assessments and payments – are there any current disputes with Inland Revenue?
• If accumulated losses cannot be carried forward consider deferring depreciation claims, deduction of prepaid expenses, write off of bad debts (for continuing companies) and stock write downs etc.
• Review reconciliation between accounting and taxable profits and consider whether allowance should be made for referred tax liabilities.
• Are PAYE and GST payments up to date?
• Consider tax advantages available through lump sum retirement provisions, deductibility of interest on business borrowings, use of bonus issue provisions to reduce tax on distribution of retained profits.

HANDLING THE FINAL TRANSACTION:

Agreements should be in writing and cover all essential points.

(a)     Buying a business involves a conglomeration of assets – inventory, fixtures, vehicles and equipment, assorted contracts rights, leases and so on. It is important that the buyer be assured they are getting ownership of the particular asset.

(b)     What liabilities is the buyer assuming both present and future? Any statements of the seller that have to be accepted without support from other sources should be incorporated into the contract as warranties.

(c)     Advisable to obtain covenant from the seller, to ensure that he will not compete with the buyer in the same line of business for a specified length of time, within a certain radius of the buyer.

• Agreement should also be spelled out when the buyer is to take over the business; who is to pay various legal fees.

We at PKF Ross Melville can assist with:

• evaluating the opportunity;
• negotiations with vendor;
• choosing the appropriate business structure;
• identifying tax implications;
• drafting a Heads of Agreement;
• designing and implementing accounting systems.
• preparing brief for Solicitor to:
      -   form Company, Partnership, Trust etc;
      -   prepare formal Sale and Purchase Agreement;
      -   prepare Shareholder agreement;
      -   transfer leases, franchises etc;
      -   compliance with commercial laws.