@156 CHAP 3 旼컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� 쿟RAPS AND PITFALLS IN BUYING AN EXISTING BUSINESS� 읕컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� @Q "Trust in Allah. But always tie your camel." @Q -- Ancient Arab proverb @Q @Q "Never, ever, trust anybody named Larry, Sammy, @Q or Lenny." -- Jenkins' Sixth Law of Business @Q Survival While there are some definite advantages in buying an estab- lished business, as compared to starting up a new business from nothing, it can also be a lot more complicated and in- volves many potential pitfalls that you must avoid. The watchword in buying any kind of business should be CAVEAT EMPTOR -- Let the buyer beware! Common pitfalls you want to avoid include the following: . WHY IS THE BUSINESS FOR SALE? This is probably the first question you should ask. However, take the answer with a grain of salt. Often the res- ponse will be that the owner wants to retire or is in poor health (never that he is having to work 80 hours a week just to break even). Or the real rea- son may be that the business is in a declining neighborhood, the owner has been robbed several times lately, and he wants O-U-T. Or the owners of a profitable little corner grocery store may be anxious to sell out while they can because they have just learned that a major chain store super- market will be opening on the next block in a few months. Pity the poor buyer who swallows the "bad health" story in the latter case! One of your toughest jobs in deciding whether to make an offer to buy an existing business will be to be- come a sleuth and find out the REAL reason the sel- ler is selling. Just remember that a good and profitable small business is not something that most people walk away from, in most cases, unless there is a strong personal reason, or the price that has been offered them is ridiculously high. . WHAT KIND OF REPUTATION DOES THE FIRM HAVE? If it has a good reputation, this may be the most impor- tant thing you are paying for. On the other hand, you may be much better off starting your own busi- ness from scratch than acquiring one that has a poor reputation because of shoddy merchandise or sleazy service. It could take you years to over- come such a reputation. . IS THE REPUTATION TRANSFERABLE? Even if the pre- sent owner has an excellent business reputation, you will want to know whether that goodwill is based on personal relationships built up between the owner and customers (that will not be easy to transfer to you) or not. This is particularly important if the business relies heavily on a few key customers or suppliers with whom the owner has very favorable business arrangements. Those ar- rangements could evaporate when you attempt to take the owner's place and you could wind up pay- ing for a handful of air. . HOW PROFITABLE IS THE BUSINESS NOW? Unless you have some very good reasons to believe you can run it more profitably than the current owner, stay away from a money-losing business or one that does not produce a satisfactory profit. Thus, it is of crucial importance to find out what the business has actually earned for the last few years, since the figures the owner shows you will invariably be inflated to make the picture look rosy. Even if the owner has audited financial statements, don't blindly rely on them. You can be sure he will have used every possible means to make recent ear- nings look good, from deferring maintenance to cap- italizing every possible expense, and so on. Here your job (with the help of a good financial advi- ser, probably an accountant), will be to unpaint the carefully painted picture, to find out how the business has REALLY been doing. HINTS ON FINDING OUT ABOUT WHAT THE BUSINESS EARNS: (a) Insist on having the seller make the business's financial and business records available to your accountant and lawyer at an early stage in the negotiations. (b) Insist on seeing income tax and sales tax re- turns for the last few years, not just financial statements. (You can be sure the owner will not have overstated his income on his tax returns!). To be on the safe side, ask the seller's CPA to transmit copies of the returns directly to you, along with some kind of written assurance from the CPA firm that those are the actual returns that were filed, as last amended. (c) Whatever you do, don't buy the old line that the seller reports such low income on his tax returns because he takes a lot of the profits right out of the cash receipts drawer without telling Uncle Sam. He may be telling the truth, but why should you expect that he's telling you the truth when he admits he's cheating on his taxes? Particularly since there is no way to tell how much, if any, he has been skimming. . ARE YOU GETTING THE THINGS THAT MAKE THE BUSINESS TICK? One of the key things you have to do in in- vestigating a business you intend to buy is to find out what makes it tick, and make sure you are buy- ing that, whatever it is. For example, if it ap- pears that the business has well-developed customer lists or mailing lists, those should ordinarily be included in the sales agreement; if there are favor- able leases or other contracts, make sure they can and will be assigned to you as the new owner; if patents, trademarks, trade names or certain skilled employees are vital to the business, be sure that you will get them as part of the package. And, in many cases, you will want the seller to sign a non- competition agreement, so he or she won't simply continue the business across the street under a different name, financed with your money! . ARE THERE ANY TIME BOMBS? You need to carefully assess the assets you are acquiring and the liabili- ties you are assuming if you buy the business. You should personally inspect the premises, looking for things like obsolete or unsalable inventory, out of date or rundown equipment, or furniture or fixtures you may soon have to repair or replace. Review the terms of any leases. One reason some businesses close or sell out is the imminent expiration of a favorable long-term lease, if the landlord plans to either raise the rent drastically or not renew the lease at all when the current term expires. Also, go over receivables with a fine-tooth comb, looking for significantly past due accounts. You may even want to run credit checks on a few major customers, if they make up a large part of the receivables. The bankruptcy of one of those customers could also bankrupt you. . OTHER LIABILITIES. Not all liabilities of a busi- ness show up on its accounting records. There may be any number of hidden claims against the busi- ness, such as security agreements encumbering the accounts receivable, inventory or equipment, unpaid back taxes of various kinds, undisclosed lawsuits or potential lawsuits, or simply unpaid bills. If you are going to assume liabilities of the business, the written agreement of sale should specify exact- ly which liabilities are being assumed and the dol- lar amount of each. . BE WARY OF BUYING STOCK OF A CORPORATION. If the business you are about to buy is incorporated, you will usually be well advised to offer to buy the business assets from the corporation, rather than buy the stock of the corporation itself, since the latter approach will subject the business to all hid- den or contingent liabilities of the old corporation, whether or not you have agreed to pay for any liabil- ities of the corporation that pre-dated the sale. Also, you will frequently incur a tax disadvantage if you buy the stock, since you will not get a free step-up in the basis of the corporation's assets, un- like a direct purchase of the assets. (One important exception would be where the corporation has unused tax loss or tax credit carryovers that could be used to shelter some future income from tax. However, the '86 Tax Reform Act has severely restricted the use of such carryovers where there is more than a 50% change of ownership of the stock of a corpora- tion in a 3-year period.) . AVOID PAYING TOO MUCH. One of the biggest potential disadvantages in buying an existing business is that you may pay too much for it, compared with what it would cost you to start a new business from the ground up, or compared with what someone else is likely to be willing to pay you if you decide to sell out. Even if the business turns out to be a good one, if you overpay significantly it may take you years of hard work to recover from this exces- sive "hidden" cost of doing business.