You've been looking for a business to buy for a while now, and you have noticed - since the pandemic - that more business owners are eager to sell. Perhaps you are getting a sense that this economic turmoil is ripe with opportunities for the Strategic Buyer.
Let's say a couple of business opportunities have presented themselves - and it's time to talk to your Accountant.
But when is it the right time to engage an Accountant - and what can you expect? And should you talk to a financial advisor?
The moment you think you are interested in buying a business, talk to your Accountant. If you are nervous about paying accounting fees for a purchase that may never eventuate, ask upfront about fees.
Your Accountant will be keen to help you early on as they will enjoy providing you with services once you have purchased a business. Your Accountant won't want you to make a mistake and should be able to provide you with some useful tips.
An Accountant will help you to make an appropriate financial commitment - that's right for you - and to provide information to a bank if you are looking to borrow. A financial advisor can also be helpful here and perform cashflow modelling of various scenarios to quantify the risk.
When you receive an Information Memorandum, send it to your Accountant for review if you are interested in the business, even if it is still a preliminary consideration. Accountants look at financial statements every day; give them an hour, and they can identify any red flags, key areas to make further enquiries upon and items to negotiate on.
Read as much free information as possible! Start with the banks. They provide helpful guides and can explain their lending criteria. Like accountants, banks and Government organisations don't want you to make a mistake! Check out:
https://business.gov.au/planning/new-businesses/buy-an-existing-business
https://business.vic.gov.au/business-information/buy-a-business/assess-a-business-before-you-buy-it
https://www.nab.com.au/business/small-business/moments/starting-out/buy-business/buy-small-business
Also, read industry-specific information - and see if you can obtain benchmarks for that industry.
You probably think the Accountant can tell you what the business is worth - and sometimes we can!
But often, the factors that drive the value of the business lie outside retrospective financial statements. When looking at a business to buy, you are interested in the profits you can generate in the future - and not a history lesson of profits before COVID.
Rather than a historical Profit & Loss Statement, the Balance Sheet or Statement of Financial Position will provide us with the most relevant and interesting information about the business. Even then, we will most likely struggle with getting a sense of value.
Under accounting standards, most assets are reflected in financial statements at cost less depreciation, not their market value. For most small businesses, assets have been written off under the small business depreciation immediate asset write-off allowance rules / Temporary Full Expensing - so the Balance Sheet may significantly understate the value of the business's assets.
Despite the shortcomings of the Balance Sheet, the Accountant needs to review this, and often, it won't be included in an Information Memorandum.
Where there is Inventory and Equipment, a specialist valuer may be required - but most important will be a detailed stocktake during the due diligence phase, which should be done at a minimum with accountant supervision.
Any cash at bank will generally stay with the original owners, and similarly, Accounts Receivable will also remain with the original owners, but this will depend on the deal.
Nevertheless, the Accountant will be keen to analyse these assets; firstly, it is good to see cash in the bank as opposed to an overdraft. A business in financial stress may still be a viable business proposition, but it should be priced accordingly.
Even if the Accounts Receivable stay with the original owners, the Accountant will review the debtors to see if there are any related parties, old debt, and slow-paying clients. Slow paying clients is a red flag, and it will be worth investigating why clients are slow paying. It is possible that the industry's nature could signal problems with service/sales delivery, or are key clients having financial difficulties?
Whilst the Accountant is looking at Receivables, they will look at sales and ongoing clients. Are any clients responsible for 10% or more of the sales revenue?
When you are purchasing goodwill, generally, you are purchasing the hope that the clients will continue to trade with the business under the new ownership, and key clients may have loyalty to the owners rather than the business.
We must ensure that motor vehicles, owner's private property, obsolete computers and old fit-out are removed or valued correctly.
Once we have looked at the Assets, then we review the Liabilities. Is there any tax debt? Are there Hire Purchase liabilities or loans from banks or related parties? Has annual and long service leave been accrued for employees? Has superannuation guarantee been paid? We also look at the age of suppliers to see if the business has been struggling to pay suppliers on time.
The balance sheet will provide more questions than answers and often lead us to ask about business items off the Balance Sheet.
We will also ask other questions, such as:
Once we are satisfied with the value of the Assets and Liabilities - and off financial statement information - we can go back to the Profit & Loss and assess the asking price.
Generally, we look at the Profit and Loss Statement Before Interest and Taxes with Add Backs for Owner's wages and significant discretionary/extraordinary expenditure (e.g., Legal expenses, business coaching expenditure, private motor vehicles, significant entertainment). We then deduct an appropriate wage for a manager to run the business to arrive at profits to be multiplied.
The right multiple to be used will require some industry research, and various other methodologies may be used to determine an appropriate price.
We also need to ensure the business hasn't been too eager in adding back discretionary expenditure, as a certain amount of discretionary spending is essential for running a business - for example, in a knowledge-based business, staff training is essential.
Once we accept that a fair price has been determined, we must look at your position. At that fair price, can you make a profit? Is the price more than the cost of starting a business from scratch?
Before a firm offer is made, we must look at how the deal will be structured. Will you buy the company's shares or the business's assets? The seller may prefer to sell shares as this will be easier for them to access tax-free capital gains under Small Business concessions. However, this is generally unattractive to purchases due to the risk of lurking unknown liabilities within the company.
Most purchasers prefer to start fresh with a new corporate structure or use their own entities to buy the assets. How the deal is structured may impact the price. Generally, the new owner will take on existing employee liabilities even in a new corporate structure.
A new corporate structure gives you the opportunity to review and set up a more tax effective/efficient structure. For example, just because the business you are purchasing operates out of a family trust doesn't mean it will be the best structure for you.
As little as possible! You can't claim depreciation or a deduction for purchased goodwill. Unfortunately, the seller may want you to pay for goodwill in order to tap into the Small Business CGT concessions. If you agree to maximise the goodwill component, you will be looking for a discount on the purchase price.
Any price offered or accepted will likely still be subject to due diligence or finance.
Due diligence is the most important process, as you should uncover any business weaknesses. There are many a sorry tale of business purchasers skimping on this process and then being surprised by misleading representations. As with a bad property purchase, a bad business purchase can seriously impact the finances of an individual and will deter them from any future property or business purchase.
Even though the due diligence process may identify questionable contracts, staff or supply chain issues, a purchase may still go ahead.
You may be advised to consider an Earn Out Arrangement whereby you pay components of the purchase price on reaching certain sales or gross profit margin targets over a few years.
Perhaps staff need incentives to stay in the business, which could be funded by the original owner.
Explore all these possibilities with your Accountant.
The real work begins once the business is up and running. Your Accountant will want to help you transition or start afresh with the business's bookkeeping.
Your financial advisor will want to help you with personal insurances, utilising superannuation and managing personal cashflows.
If you would like advice or assistance, please contact us.