Whether or not you should buy a business with problems is tough to answer in general terms, but plenty of people do either intentionally or unintentionally. In short, the answer is yes if you know what you’re doing. Obviously there is no perfect business. See this article What are the Inescapable truths of Buying or Selling a Business?
Let’s start on one end of the spectrum where you have seasoned turnaround artists. These are professional business buyers who have deep expertise in an industry or in a specific function like operations, sales, marketing, growth or finance. They have the experience and the systems to turn around failing businesses.
One Owner’s Problems is Another Owner’s Opportunity
On the other end of the spectrum you have new business shoppers, most of whom never operated, let alone purchased, their own business. Luckily, most of these would-be buyers never cross the finish line to be able to call themselves buyers. This is a good thing in many cases. Many shoppers who give up are smart enough to realize they don’t know enough or are better off with a job. They’re instincts protect them from disaster and they move on with life, never experiencing the promise of becoming a business owner.
Should I Find a Business with No Problems?
I often receive emails from professional buyers introducing themselves and outlining their goals and investment criteria. Some of them take the extra initiative to call me and then send a follow-up email. The criteria might look like this.
- EBITDA over $800,000
- At least 80% commercial
- Recurring revenue of at least $500,00
- In operation at least 10 years or more
- Increasing revenue and profit trends
To be perfectly transparent, these interactions do very little for either of us. The buyer has not done anything to separate themselves from everyone else who wants the perfect business. If and when I have a listing that fits these criteria, my duty is to get the most for the seller, forcing these types of financial buyers to compete with other qualified buyers. See many samples of emails I have received from financial buyers.
No business is perfect. While some businesses have too many problems for most sane buyers, other businesses have problems that are addressable. Even these businesses often have little interest from shoppers. So if you have the experience and skills to get past some of these addressable problems, you might find a good opportunity.
Should I Buy a Business with Declining Profit?
Businesses that are declining in profit are less attractive and should be priced accordingly. If you find a business aggressively priced because of declining profits, you may have an opportunity on your hands as long as the problem is addressable. You may bring resources that can address the problem in a way the owner cannot or will not, such as capital investment, digital marketing, sourcing, or business development. Or you may value aspects of the business such as employees, intellectual property, specialized equipment or some other strategic value. See How Do You Find the True Profit in a Business?
Should I Buy a Business with Declining Revenue?
Just as with declining profit, there may be opportunities, in fact more opportunities. There are a lot of moving parts between revenue and profit, so there may be some key opportunities to keep profit strong despite declining revenue and eventually address the revenue issues. Furthermore, you may have the skills to turn around revenue in ways the current owner is not capable of or motivated to do because of their stage in life. See Is it Better to Focus on Revenue or Expenses?
Should I Buy a Business with Only a Few Significant Customers?
A business with a small number of customers, or sales derived mostly from a few key customers, is said to have a customer concentration problem. While the owner may be comfortable with their customer mix, customer concentration poses a significant risk for a buyer who knows nothing about the customer relationships, whether the customers will remain loyal through a change in ownership, whether the customers are open to long term contracts, or whether new customers can be developed to spread the risk.
Many buyers will pass on a business with high customer concentration. This is certainly the prudent thing to do. However, this can present opportunities for buyers who ask deeper questions and can structure a deal to minimize risk. See How Do I Buy a Business and Retain Employees and Customers?
The most extreme case of customer concentration is a customer base of one. I successfully sold two such businesses early in my career and it is quite possible I had the opportunity to do so because more seasoned brokers would not take these listings. Those experiences were invaluable in opening my eyes to low probability businesses.
Example 1: Logistics company with one large customer – Amazon. The business had an adjusted EBITDA of over $1M and was sold at just over a one multiple, or $1.25 million. Typically, a business with $1M profit would sell for a 3-4 multiple, but this business was an Amazon partner and derived all their revenue from Amazon. Buyers were excited about Amazon, but leary of Amazon’s potential to pivot and leave delivery partners stranded. In the end, there were two buyers willing to pay cash, with roughly 50% at closing and the balance in payments for 12 months after closing to minimize the window of risk of Amazon ending or significantly altering the program.
Example 2: Small manufacturing operation with one customer – a Tier 1 automotive supplier. The husband and wife owners consistently pocketed a quarter million in profits and had been doing similar numbers for 30 years. At some point in their 30 year career, they shed their other customers to focus on this Tier 1 supplier, their largest and easiest customer. They felt comfortable enough in their experience with that customer to take the risk. The business had many attractive qualities, primarily the simplicity of the operation and the consistency of orders over decades from this sole customer. Three larger manufacturing businesses were interested in acquiring this small company. In the end, the best match was a 3-person team that paid a 1.5 multiple with less than 20 percent down and the rest paid over a few years as earnouts.
Should I Buy a Business with Legal Issues?
No surprise here – you should not buy a business with legal issues. In most cases, there are critical steps to acquiring a business that significantly minimize the risk of inheriting the seller’s legal problems.
A business is typically purchased one of two ways: a stock purchase agreement or an asset purchase agreement. The majority of small businesses are acquired via an asset purchase agreement. A significant characteristic of this method of acquisition is the buyer does not assume the liabilities of the seller. While you may purchase Acme Corporation and continue to run it under the Acme Corporation brand, your Acme Corporation is under an entirely different corporate entity than the Acme Corporation run by the seller. For example, let’s say the seller ran Acme Corporation under his corporate entity SellerJoe LLC, and you are running Acme Corporation under your corporate entity BuyerChris Inc. In an asset purchase agreement, BuyerChris Inc. does not assume the liabilities of SellerJoe LLC. With respect to liability, the one caveat is successor liability defined by the state which does not consider how the business was purchased.
In certain cases, it is more advantageous for a buyer to acquire a business via a stock purchase agreement. Read this article to learn more about the pros and cons of a stock purchase versus an asset purchase. In this case, the buyer takes over SellerJoe LLC as the new officer and assumes all the liabilities of this corporate entity since its inception. A stock purchase requires a skilled attorney to create a stock purchase agreement with all the necessary language to shift the liabilities of SellerJoe LLC back to the seller even after the seller is no longer an officer of SellerJoe LLC.
It is highly recommended that you engage an appropriate business transaction attorney to protect you from the liabilities of the seller. Sophisticated buyers in the M&A world often take 90 days or so to conduct due diligence on acquisitions that are usually in the $millions. The buyer and management team conduct due diligence in the first 30 days. Then the CPA or accounting team will conduct a deep financial due diligence in the second thirty days. This is followed by the attorney or legal team conducting legal due diligence in the final 30 days.
Are there any exceptions to the rule? As with anything, I suppose there could be an exception if all of the pros and cons are well considered and line up in your favor. For example, 1) you are working with an appropriate attorney for the transaction. 2) the opportunity is significantly large or strategic, 3) the legal risk has a high probability of being resolved through negotiation or settlement, or contained to a financial limit set by law.
Should I Buy a Business with Debt?
Much of the discussion in the last paragraph not only applies to legal liabilities, but also assumption of debt and other liabilities. The buyer’s attorney can run a lien search and ensure the proper clauses are utilized to protect the buyer. If the buyer is utilizing a third party loan, the lender will also do their best to uncover any existing loans, liens, or liabilities that they require to be settled by the seller prior to closing.
If a seller has considerable debt, the seller may need an all cash offer to settle those debts at closing. The seller of a highly debt-leveraged business is unlikely to be able to seller finance any portion of the sale price.
Should I Buy a Business that has Closed?
In an asset liquidation sale, the business has stopped and its assets are being sold. Such an acquisition can make sense for a business owner who understands the market value of the equipment, vehicles and other assets. Even better if a buyer can cherry pick only the assets they need, but sometimes these sales are done as a package deal. In some cases, the buyer intends to take over the assets and the lease and restart the business in some fashion. Buying a stopped business falls somewhere in between starting a business from scratch and buying an ongoing business and its cash flows.
Should I Buy a Business with No Assets?
Sometimes buyers will ask me, what am I getting with the business? This question sometimes comes when there are little or few tangible physical assets. The answer is cash flow. The reason to buy a business is for the cash that can flow back into your pocket to quickly pay for your investment and continue to provide a reasonable stream of profit in the future. When you buy an ongoing business, you are not buying it for the assets, but what the assets can do for you. In fact, many investors prefer “asset light” businesses that require less capital for equipment and maintenance. This enables them to maximize the return for each dollar they deploy.
Should I Buy a Business with A Lot of Assets?
Conversely, there is no problem buying a business with a lot of assets. Some businesses require a lot of physical assets and others require very little, yet both can be profitable. If the best business for you is one that requires a lot of assets, just be sure the assets are effective at generating profit. You will add the financial ratio “return on assets” as a key metric to running such a business.
Asset-intensive businesses may require more capital to acquire and to maintain. Lenders like collateral, so if the business comes with furniture, fixtures, equipment, vehicles, real estate, as well as positive profits, then the business is well-suited for a loan. Just remember that one day down the road when you exit the business, you will need to find a buyer who is financially capable of acquiring and running an asset-heavy business.
Should I Buy a Business with Bad Reviews or No reviews?
Businesses with little to no reviews may be young, not actively focused on customer feedback, or exist in industries where reviews are not common or not important. Many business customers of B2B businesses do not leave reviews in the way that consumers do. Little to no reviews does not necessarily mean a business is not worth considering for an acquisition.
If a business has bad reviews, read the reviews and ask the owner for insights. There may be some remedies that a new owner can implement easier than the current owner. A buyer can also take an extra step to rename the business and start fresh with reviews.
Should I Buy a Business with Bad Bookkeeping and Financial Records?
There are very few scenarios where buying a business with poor records or messy financials is a good idea. Inexperienced business buyers should avoid the risk. It will require the experience of a serial business acquirer, or at least a seasoned business owner, to properly evaluate a business with poor financials and records. Here are a couple of examples where it might work:
- You’re already in the same industry, the industry has enough standardization or uniformity that you have a handle on a general cost structure that applies across the industry. Examples of such industries are tax preparation, dry cleaning, and many franchise operations. Being in the industry, you are a strategic buyer and you may be able to save on certain costs by combining businesses. With a great handle on the cost structure of businesses in your industry, you still need the top line revenue. This should not be difficult since even unorganized business owners can produce tax returns or sales reports.
- Businesses for sale with bad financial recordkeeping will not attract many buyers if any. This can present an opportunity for an experienced business acquirer patient enough to sift through the business in a series of conversations with the owner. Many owners can verbalize their business, provide some documentation to support their claims, and enable a seasoned buyer to piece together a comprehensive picture. Owners who cannot elaborate, or expect buyers to take their word for it, won’t get very far.
Should I Buy a Business in a Recession or Economic Downturn?
Do not rule out buying a business in a downturn. Opportunities lie in businesses that are unaffected or even thrive when the rest of the economy is suffering. Pickup and delivery pizza restaurants did well during COVID while eat-in restaurants suffered.
COVID also disrupted employment in many ways. Aside from the obvious layoffs due to business shutdowns, government incentives like the Payroll Protection Plan (PPP) helped keep businesses with employees going in 2020 and 2021. Many employees collected unemployment, re-evaluated work-life balance and the meaning of work. While some things have returned to the way they use to be, COVID has had some lasting effects on small businesses and small business employment. See How Do I Buy a Business and Retain Employees and Customers? and The Best Ways to Teach and Manage People.
There are other opportunities to identify the strong from the weak and capitalize on a new landscape caused by the downturn. While a rising tide floats all boats, a sinking tide exposes the weak. For example, the work-from-home trend during COVID devastated many dry cleaning businesses. Most business buyers wrote off the entire industry during this period. But the stronger cleaners weathered the storm and picked up customers stranded by dry cleaners that closed their doors. The surviving dry cleaners leveraged their pickup and delivery routes that brought higher margins. They also upgraded older equipment with the excess used equipment that became available due to the industry downturn.
Many owners of these strong dry cleaning businesses were interested in selling to pursue retirement and retire in peace without worrying about the next economic downturn. In business acquisition, as in real estate, you make your money when you buy and buying opportunities exist in downturns. The question that remains is, “how long will it take for a recovery?”