Whether you’re a first-time small business buyer or experienced entrepreneur, buying a business is a complex process fraught with risk.
No matter which type of M&A deal you’re considering, there’s lot to consider before making an offer…not to mention things to watch out for after the sale is finalized.
In this article, we’re going to cover 17 of the most common mistakes I see small business buyers make. Take the time to avoid these pitfalls and you’ll be well on your way to a smooth acquisition.
Small Business Buyers: 17 Common Mistakes
- Hiring Professional Advisors with Inadequate Expertise
- Getting Emotionally Attached to the Business
- Buying Yourself a Job
- Not Accounting for Pandemic Fluctuations
- Unreasonable Sellers
- Not Owning the Race Course
- Significant Working Capital Requirements
- Dependency Risk on Key Customers or Suppliers
- Failing to Perform Adequate Due Diligence
- Heavy Regulatory Burden
- Not Fully Understanding the Business Model
- Real Estate Risk
- Buying a Business In Decline
- Limited Room for Error
- Unable to Finance Business
- Not Knowing What You Want
- Not Planning the Transition Period
1. Hiring Professional Advisors with Inadequate Expertise
When buying a business, there are a lot of moving parts and potential risks. From financial and legal due diligence to negotiating the purchase price, it’s important to have experienced professionals on your side. Working with strong M&A advisors is one of the best investments you can make when buying a business.
It’s common for business buyers to try and save money by using inexpensive advisors. This can be a major mistake if those advisors don’t have the expertise necessary to properly guide you through the purchase process.
Make sure your accountant, lawyer, and other professional advisors have extensive experience with business purchases so they can help you avoid common traps, such as inadequate due diligence or overpaying for the business.
This is not an area you want to skimp on, as spending more up front can save you headaches and thousands of dollars later on.
2. Getting Emotionally Attached to the Business
Getting too emotionally attached to the business can cloud your judgment and cause you to make poor decisions through the process.
It’s important to remember that you’re buying a business, not a personal project. Don’t get so attached that you’re willing to overlook serious problems or pay more than the business is worth.
This is a major financial transaction and you need to approach it with a clear head.
If you find yourself getting attached to the business, take a step back and ask yourself if you’re making decisions based on logic or emotion. If it’s the latter, it might be time to walk away.
3. Buying Yourself a Job
One of the biggest mistakes I see small business buyers make is buying a business that essentially turns them into an employee.
This can happen when you’re too involved in the day-to-day operations of the business or you don’t have a clear plan to transition away from the tactical activities.
Will you be trapped working ‘in the business’ rather than ‘on the business’?
Before buying a business, ask yourself if it’s something you can eventually hand off to someone else. If not, you might want to reconsider the purchase.
In this scenario, you might not be getting the lifestyle you’re looking for. You might soon find out that you’re working even harder than you did before, with long hours and little free time.
4. Not Accounting for Pandemic Fluctuations
We use past performance to try and make reasonable predictions around future profits to establish what a business is worth.
The challenge is that future profits can be a complete shot in the dark for many companies. The COVID pandemic has flipped everything on its head.
The billions of dollars in economic relief from the US Government have helped many businesses stay alive, but have also clouded their true profitability (the last few years are likely not a reasonable proxy for the future).
I recommend really digging into the long term viability and profit prospects of any company you’re considering. Do your best to understand how the pandemic has affected the business and what the future may hold.
5. Unreasonable Sellers
You’ll find a fair share of sellers out there who have an unrealistic view of what their business is worth.
They may have poured their heart and soul into the business, or maybe they just need to get a certain price to retire.
Whatever the reason, don’t get caught up in their emotions. It’s important to stay focused on the facts and base your offer on the business’s true value. Otherwise, you may find yourself overpaying or getting into a situation where the seller is unwilling to negotiate on price.
This is another reason why working with high quality M&A advisors can be helpful – they can help you stay steady and establish a fair price for the business.
6. Not Owning the Race Course
Make sure the business you’re looking at isn’t single source dependent. A lot of businesses rely on someone else’s “race course” – such as exclusively using Google’s platform for their marketing.
This scenario is incredibly dangerous: Google could change their algorithm overnight and you could lose everything.
You should have a diversified marketing mix that includes various channels and platforms (i.e. content marketing, email marketing, and social media).
Amazon FBA businesses have the same risk: you don’t own the relationship with the customer, Amazon does. The last thing you want is the entire business depending on a third party platform or single source of paid traffic.
The takeaway: make sure the business is an asset that you own and control.
7. Significant Working Capital Requirements
This is a common issue with businesses that have a lot of inventory, such as retail businesses. They may need hundreds of thousands of dollars just to keep the doors open and maintain operations.
You might be in a situation where the cost of necessary inventory far outweighs the business purchase price.
This also applies to future growth – it’s worth getting a good handle on all necessary resources associated with growth. Is this something the business can handle?
If you’re not prepared for this, it can quickly become a financial burden and drown your business. Make sure you understand the working capital requirements before you buy the business and factor it into your offer price.
8. Dependency Risk on Key Customers or Suppliers
What would happen if your largest customer left tomorrow?
A business that’s overly dependent on one or two customers is a big risk. A good rule of thumb is to ensure no single client makes up more than 15 percent of your revenue.
The same goes for suppliers – the business could be massively disrupted if that supplier were to suddenly go out of business or raise prices significantly.
Make sure you understand the customer and supplier landscape before you buy the business.
A large percentage of revenue from just a few customers or suppliers is a red flag. Both of these items are critical value drivers worth paying attention to when you eventually look to exit the business.
9. Failing to Perform Adequate Due Diligence
This is perhaps the biggest mistake you can make when buying a business and often goes hand in hand with being emotionally attached.
Due diligence is the process of investigating a potential business acquisition to ensure that all material information and risks are known. This includes everything from financials and tax returns to employee contracts and supplier agreements.
If you don’t perform adequate due diligence, you could be in for some nasty surprises down the road. The last thing you want is to buy a business only to find out that it’s in debt or has major legal issues.
Make sure you understand what’s involved in the due diligence process and give yourself (and your team) enough time to do it properly.
10. Heavy Regulatory Burden
Some businesses are subject to heavy regulation from the government (i.e. healthcare). This can make it difficult (and expensive) to operate, comply with regulations, and make changes to the business.
Part of the challenge is trying to anticipate the future around areas of emerging technology. As an example, businesses related to bitcoin and cryptocurrency will likely be highly regulated, which creates risk.
Before you buy a regulated business, make sure you understand the regulatory landscape and the compliance costs. Otherwise, you may find yourself in a situation where the cost of compliance is too high.
11. Not Fully Understanding the Business Model
You might be looking at a business that seems like a great opportunity on the surface. Sometimes vanity metrics can blur the true picture.
If you don’t fully understand the business model, you could be in for a rude awakening.
For example, let’s say you’re looking at an ecommerce business that’s generating $100,000 in monthly revenue. But upon further investigation, you might that the business is losing money on every sale.
Or maybe you’re looking at a subscription-based business, but you don’t realize that the vast majority of customers cancel after the first month.
Make sure you thoroughly understand how the business makes money and whether or not their model is sustainable in the long run. Does the business truly have a competitive advantage?
12. Real Estate Risk
If you’re buying a business that leases or owns real estate, there’s an additional layer of risk to consider.
- What would happen if the business had to relocate? Would you be able to sell the property for enough to cover the mortgage and other associated costs?
- What happens if rent skyrockets when the current lease expires? This could be a likely scenario if the real estate is currently below market rates and in a growing area.
Take some time to think through implications with a couple scenarios. How much wiggle room do you have with current profit picture? Could you deal with tightening cash flow and still be successful?
13. Buying a Business In Decline
Just because a business is in decline doesn’t mean it can’t be turned around – but it’s going to take a lot of work (and money). This applies both to the specific business but also broader industry trends. As an example, I’d steer clear of the declining newspaper industry these days.
If you’re not prepared for this, you could find yourself in a situation where you’re constantly throwing good money after bad.
Before you buy a declining business, make sure you have a plan in place for turning things around. This should include an analysis of why the business is declining and a detailed strategy for how you’re going to turn it around.
You also need to make sure you have the financial resources in place to sustain the business during the turnaround process. Otherwise, you might find yourself having to close up shop.
14. Limited Room for Error
When you’re first coming into a business, you want to be able to make minor mistakes and learn from them without it having a catastrophic impact on your business.
I’d recommend staying away from any existing business that has limited room for error. Do you have the flexibility to create contingency plans when something goes wrong?
If not, even a minor mistake could be severe – and potentially put you out of business.
This is another reason why diligence is so critical before buying a business. Make sure you understand the risks involved and have a plan in place to mitigate them.
15. Unable to Finance Business
One of the most common mistakes that business buyers make is assuming that just because a business is for sale, it must be able to be financed. In reality, financing can be difficult to obtain, especially for small businesses.
Certain businesses can be considered unfinanceable by banks – B2B service businesses with no hard assets being one example.
All too often, buyers will find themselves unable to obtain the necessary financing and are forced to back out of the deal.
16. Not Knowing What You Want
Many buyers go into the process without a clear idea of what they want in a business. This can lead to wasted time looking at businesses that aren’t a good fit.
Before you start looking for businesses for sale using a haphazard approach, take the time to sit down and think about what you really want.
- What type of business do you want to own?
- What size company do you want to purchase?
- What industry does it need to be in?
- Do you have restrictions on location, or are you geographically agnostic?
- How much involvement do you want to have?
Once you have a good idea of the type of business you’re looking for, you can start your search with a clear focus.
One of the most common mistakes buyers make is purchasing a business that isn’t a good fit for them. There are a number of reasons why this can happen, but it usually boils down to one thing: the buyer didn’t take the time to do their homework.
Before you buy a business, make sure you understand what you’re getting yourself into. Do your research and make sure the business is a good fit for your skillset, interests, and goals.
17. Not Planning the Transition Period
Once you officially purchase a business, there will be a transitional phase where you’re taking over from the previous owner. This is a critical time for the business, and if not planned properly, can lead to big problems.
You need to make sure you have a plan in place for the transition period. This should include training on how to run the business, transferring key relationships, and learning about the company’s history and culture.
- How will you handle getting up to speed?
- What needs to happen in order for the transition to be successful?
- How long will the previous owner stay on? Do you have an earn-out or other terms in place?
- What’s the plan for training you on the business?
- How do you minimize disruption to your new customer base?
These are all important questions that need to be answered before you buy a business.
If possible, it’s also a good idea to have an agreement with the previous owner in place so they can help out during the transition if needed.
Not having a plan can often lead to confusion and chaos, which can be very damaging for a business. Make sure you take the time to plan out the transition period before you purchase the business.
Conclusion
Buying a small business (or expanding via acquisition) can be a great way to achieve autonomy and financial independence – but only if you go about it the right way.
One of the hardest things to do when buying a business is knowing when to walk away, but I hope the 17 common mistakes we covered can help you avoid potential red flags.
Remember, the goal is to find a business that’s a good fit for you and that you’re comfortable with. Don’t let yourself get caught up in the excitement of the purchase and forget what you’re really looking for.
If you take the time to do your homework and plan the purchase carefully, you’ll be in a much better position to find a business that’s right for you.
