Common Mistakes When Buying A Business

Navigating the purchase of a business is never easy, but it can be especially daunting for a first-time buyer. From searching through listings (like those you can find on DealStream) to handling the moving parts of due diligence and negotiation, there's a lot to keep track of and remember. Nothing kills the feeling of accomplishment that comes from buying a business like an embarrassing or costly mistake. 

Acquisition mistakes typically occur across four main areas: personal, financial, operational and legal. Keep reading to learn more about some of the most frequent mistakes and how to avoid them. 

Personal Mistakes

Usually, a buyer's first mistake is related to personal planning, preparation and decision-making. Heading into the complex buying process requires addressing the following three points to avoid more significant, costlier problems at later stages of acquisition. 

1. Buying for the wrong reasons 

Buying a business is a long-term decision. You owe it to yourself and your future employees to consider why you want to buy a business. Determine your primary goals as well as the time, money and emotional energy you can (and are willing) to spend. Also define the smaller goals you are prepared to celebrate along the way to reaching big milestones. 

Profitability is essential, and we'll look closer at market considerations later on in this article. But buying a business just because you think it can make you money can result in quite the opposite. Along with performing market evaluations, entrepreneurs should look for a business that suits their personality, interests and skills. Sacrificing your ability to invest emotionally in a business can limit your success, regardless of your financial investment.

Once you've honestly evaluated your motivations, you should prepare for the search process —  finding a business investment opportunity can take time. You might be tempted to take the first option that presents itself. Or, if you've been looking for a long time, you might be ready to jump at the next feasible opportunity. Either of those decisions can put you at risk of a bad investment. 

Knowing in advance your genuine reasons for investing and how much of yourself you're prepared to dedicate to buying, transitioning and maintaining a business, will help you maintain the patience necessary for making a solid investment. Taking the necessary time to find the right opportunity brings you one step closer to the positive financial goals of any entrepreneur.

2. Not defining and pursuing a good fit

As a buyer, you should assess your skills and weaknesses to ensure the business is a good fit for your unique background and abilities. 

Are you a hands-on person or do you tend more toward management and delegation? Determining how to utilize your strengths best and fill the gaps in your weaknesses before you buy a business will significantly impact your success.

For example, if your background is primarily with large organizations with various departments and contractors available to meet the needs of complex technical and consumer-based situations, will your skills align with the requirements of a small business in which the owner is the primary marketing person or the most prominent face of customer service? Alternatively, if you have a very specialized marketing and communication skill set and purchase a business with an already strong marketing team, how will you bring your skills and ideas to the table without being disruptive and hindering overall success? 

Finally, remember that most businesses will have an established brand or image they've cultivated over the years. In the case of a small business, its image is likely tied to the local community or its brand might serve a niche purpose that is profitable but unique. The existing customer base and various vendors or local leaders will be familiar with the business because of those things. Make sure the current image of the business is a good fit with your goals, skills and personality. If you find significant differences in these areas, you might be looking at an acquisition that is not a good fit for you. Think long and hard about the negative impacts such a purchase could have on you, your employees and the business's overall success.  

3. Not understanding the industry

There's a big difference between being interested in a particular industry and being able to run a successful business in that industry. It's crucial to any business that the owner has the skills and knowledge to run it successfully. Having in-depth knowledge about the business you plan to buy includes understanding the fiscal, market and employment requirements and trends. It also means you know details about how other businesses in your industry manage their products or services. While it's not mandatory that you have working experience in the type of business you're buying (to buy a restaurant, you need not have worked as a server), it is vital that you have a deep understanding of the industry itself (to buy a restaurant you should understand the food service and hospitality industry). It's also helpful to know a bit about adjacent industries (when purchasing a restaurant, you might also know a bit about customer service, management structures and event planning).  

Financial Mistakes 

1. Overpaying

No matter how much you want to buy a business or how excited you are about finding "the perfect" business for acquisition, heading into the purchase without sufficient funds is a death knell for future success. If you begin your business journey already in deep debt, you will have to dedicate your time and mental energy to getting yourself out of the red instead of growing and marketing your business. This creates a vicious cycle in which you lack time and funds to grow your business and, therefore, your business will not pull in enough profit to alleviate debt and feed the marketing plan.  

When looking to buy a business, you are better off either waiting until you have the necessary funds to purchase without incurring significant debt or locating investors or members of a buying team who can contribute the capital needed for a successful, low-debt acquisition. 

You might consider exploring options for a holdback, escrow or earnout. A holdback allows for a portion of the purchase price to be retained until a preselected time or event has occurred. An escrow is similar to a holdback, with the difference being an added stipulation that the retained amount will be placed in escrow with a third-party agent. An earnout refers to a portion of the purchase price being deferred with the completed payment contingent upon the business meeting pre-determined milestones. Choosing one of these options could allow you time to fully understand the business, revenue structure, profits and any skeletons in the closet. Talk to your business broker and an attorney to learn more about the negotiation and legal requirements of pursuing options like these.   

2. Lack of reserve funds 

Often, new buyers forget that it takes working capital to make a business successful. Along with needing funds to cover the up-front costs of investigating and purchasing a business, buyers also need reserve funds. During the transition period, reserve funds are vital because there's always a risk of losing customers, vendors and other revenue generators who pull their business out of loyalty to the seller. Such decisions can have a tremendous impact on the cash flow of your business. 

Likewise, making any changes to the existing structure of the business, products, services or marketing requires reserve funds to cover the time it will take to enact those changes, attract new customers and implement new marketing plans. If you put all of your money toward acquisition, you will not be able to cover the costs of growth, changes or any revenue shortages that occur.  

Lacking reserve funds can put you on the fast track to bankruptcy. Do not buy a business until you have secured the funds necessary to buy the business and keep it open after the purchase.

3. Not knowing why the business is being sold

When someone sells a business, there are almost always two reasons: the reason they give and the underlying reason. It is up to you to take the time to determine all of the reasons for the sale and what the business landscape will be like once you take over. 

A business owner might simply explain that they are retiring or pursuing another opportunity in an adjacent industry. The owner might not tell you that there are employee or workforce issues, new competition moving in, potential litigation or even a planned infrastructure change that will disrupt access and severely impact business in a negative, long-term (or even permanent) way. Knowing these details can prevent you from making a mistake about potential profitability and help you during negotiations. 

To help determine any underlying reasons for a sale, spend some time with the owner outside of negotiations. Engage in casual conversation that will enable you to listen for little details and ask questions that will give you insight into the neighborhood, employee relationships and the owner's personal motivations and goals outside of the business. As part of the due diligence phase (more on that below), you can check the owner's background and credit rating, Better Business Bureau rating and more. 

4. Poor due diligence 

A business might appear successful and even show a profit, but that does not mean that it is without problems. Before buying a business, you need to engage in thorough and detailed due diligence to find out exactly what is owed, borrowed, leased and owned, as well as market trends, predictions and details about threats from the competition — both direct and existential. Today, performing due diligence requires checking social media accounts, online reviews and other online marketplaces for anything that can provide additional insight into the business you're buying. 

Being thorough in your due diligence means seeking a clear picture of how the business operates and verifying the seller's representations. Be careful not to take what the seller presents at face-value. Financial statements, tax returns and other accounting documents can be doctored. There may be outstanding customer or warranty issues, lawsuits, judgments or other significant legal or financial problems not reflected in the information supplied by the seller. During the due diligence period, you can also determine if substantial assets are in disrepair or on the verge of becoming obsolete. 

Investigate competitive products or services and new developments from your competitors. Remember to ensure you are thoroughly researching the competition during this phase, too. ‎As you perform other aspects of due diligence, you can set up a Google alert to notify you when any new information about your competitors shows up online. This way, you can multitask while still receiving the most up-to-date and relevant information about potential threats to profitability. 

You want to avoid acquiring a pile of bills, unpaid vendors, past due rent and other outstanding debt along with your new business. Solid due diligence will help you avoid buying someone else's problems and mistakes. 

5. Not understanding goodwill 

Goodwill is an intangible asset that represents the value of the customer base and the future earning potential of a business. Goodwill represents the excess of the purchase price over the fair market value of the tangible assets. If the business' reputation or goodwill has been recently tarnished, the business' future value will most likely be less than it was in the past. By failing to properly account for goodwill when you purchase a business, you can end up overpaying for the business or overestimating the future earning potential. 

Operational Mistakes 

1. Ignoring the culture: Client, customer and community relationships

Before buying a business, you should look into its general business culture. Business culture is not only an expression of a company's values but also the way the employees work, leadership style and management structure. Before buying a business, look at everything from leadership and employee behavior to business processes and compensation structures.

Equally as important as business culture are the relationships the business and its employees have with clients, customers and the communities surrounding or affiliated with the business. These relationships extend to the online world and call for careful checking of the business' social media interactions presence and other online presences. 

Owners and upper management have often cultivated relationships with customers and vendors who are critical to the business' success. Depending on several factors, those relationships may not continue under new ownership, or, as the new owner, you will be responsible for providing the same level of care and interaction. There may also be different expectations from loyal online consumers regarding posting, interaction and type of content shared on various professional and social media platforms. 

Misguided assumptions about external relationships or uninformed decisions regarding internal structures and routines can quickly result in declining revenue, decreased word-of-mouth marketing, disrupted supply chains or disgruntled employees. 

2. Market and marketing 

When you perform your due diligence and look at market-related issues, profits and potential, you should go a step further and research the business' current marketing and untapped marketing opportunities. Determine what marketing avenues are open to the particular business in question (for example, an e-commerce marketing plan wouldn't be appropriate for a small-town diner) and then determine if the business is lacking a strategic marketing plan or is struggling to position itself despite having an actionable plan. 

If it's the latter, you will want to proceed with caution. The inability of a business to gain a foothold somewhere in the vast array of modern marketing methods might signify that, while the industry market looks good overall, that particular company is lacking something crucial to the brand story, customer awareness, retention, or general interest. If it's the former (a lack of a strategic marketing plan), it will benefit you to draft out a few marketing ideas and avenues to pursue after acquisition and ensure you have the funds, ability and skills to implement a new, long-term marketing plan. 

Legal Mistakes

1. Signing documents in your own name 

A common mistake new business owners make is to use their own name when signing loan agreements, the lease and other legal documents required in an acquisition. If you sign documents in your own name, you take on liability and responsibility you don't want or need. Because you don't want to subject your personal assets to the risks of the business, you need to make sure it’s your business, not you, that is buying another business. 

To do this, establish a corporate entity such as a C corporation, an S corporation or an LLC, to buy the business with a business name that will be used when signing all documents. To be legal, the corporate entity's creation must occur before closing and appear as the acquirer in all closing documents.

2. Failing to obtain intellectual property and digital rights

During the due diligence phase, make sure the seller provides for review a complete list of all of the Intellectual Property (IP) that is related to the seller's business as well as all of the digital rights that are linked to or crucial for the operation and marketing of the business. Digital and IP rights can include: 

• Trademarks and service marks
• Proprietary information 
• Patents and patent applications (including patent numbers, jurisdictions covered, filing, registration and issue dates)
• Technology licenses 
• Software and databases
• Open-source software pertinent to the seller's products and services
• Domain names
• Social media accounts (LinkedIn, Twitter, Facebook, etc.)

Failing to review these items and secure rights to them in the acquisition can severely limit or negate your ability to use websites, names, advertising, specialty products, software management tools and other intellectual property crucial to the success and profitability of the business. 

To Avoid These Mistakes, Hire a Team of Professionals 

You might be tempted to search for, perform due diligence, and complete an acquisition yourself to save money. The reality is that, by doing so, you will be at risk of incurring much higher costs later or having the whole deal fall apart if you miss something.

Professional brokers, accountants and attorneys have built their careers on handling business sales and acquisitions. They know what to look for and are skilled with financing, valuation and negotiation. They understand tax structures, real estate and business law, and the nuances of various business-related local, state and federal laws that are impossible for just one person to truly master. Buying a business should not be a DIY venture — if you're serious about buying a business, you should budget for their services. 

The Takeaway 

Buying a business will always involve a series of complexities and moving parts, but it should also be an exciting and hopeful venture. Don't let your excitement lead you to impulsivity or carelessness. You are embarking on a new adventure filled with possibilities and increased profit potential! Visit the numerous other informative articles on the DealStream blog designed to impart knowledge and make sales and acquisitions smooth, seamless, and professionally enjoyable. And when you’re ready to start the acquisition process, let DealStream’s listings help you find the perfect business!