Top 10 Important Factors to Consider When Buying a Business

February 2023

Buying a business for sale can be an exciting and rewarding venture, but it can also be risky. If you're considering purchasing a business, it's essential to do your due diligence to make a smart investment decision. 

There are many factors to consider when buying a business, such as financial performance, assets and liabilities, customers, employees, intellectual property, legal issues, growth potential, and the reason for the sale. 

In this blog, we'll dive into the top 10 important factors to consider when buying a business for sale. Whether you're a first-time buyer or a seasoned investor, understanding these key factors will help you make an informed decision and increase your chances of success in your new business venture. So, let's get started!

Understanding Industry and Market Conditions

Consider the industry and market conditions when buying a business for sale. Is the industry growing, stable, or declining? Is there growth potential? What are the current and future market trends? 

Knowing the industry and market trends can help you make an informed decision about the business's future prospects. 

In 2022, Arizona was experiencing a growing economy with a strong job market, fueled partly by an influx of new businesses and population growth. The city's diverse economy includes a mix of manufacturing, technology, healthcare, and finance industries. 

In recent years, the city has seen significant growth in the technology sector, with several high-profile companies expanding their presence. 

The real estate market has also been strong, with rising property values and a growing number of new commercial and residential developments.

 Additionally, the city has made significant infrastructure and transportation investments, including expanding Phoenix Sky Harbor International Airport and developing a new light rail system.

The investment sales market has experienced a decline in volume due to the rise in interest rates, marking the lowest volume in two years.

However, the leasing side of the industrial market has not been affected and has shown no signs of slowing down. In 2022, the industrial market in Phoenix recorded a net absorption of 27 million square feet, surpassing 2021 by 12 percent. 

The completion of new products in the fourth quarter was the largest in the Phoenix market's history, with 8.1 million square feet delivered, bringing the total to 26.2 million for the year. 

Rental rates also experienced a significant increase, with a 33.4 percent year-over-year rise, ending at $0.94 per square foot. The industrial labor market in Phoenix has improved, with a 4.0 percent increase in employment from November 2021 to November 2022. 

Despite the looming threat of a recession, the Phoenix Industrial market has maintained positive momentum, with the fourth quarter outperforming the previous quarter in every aspect except investment sales.

Financial Performance 

Assess the financial performance when buying a business for sale. Review financial statements and tax returns for at least the past three years. Look for consistent revenue growth, positive cash flow, and profitability. Make sure to verify that the financials are accurate and not inflated.

Here is an example of a successful business financial performance over three years: 

ABC Company, a technology startup, has been in business for three years. The company generated $500,000 in revenue in the first year and had a net loss of $100,000 due to high startup costs. 

However, the company's revenue increased to $2 million in the second year. They turned a profit of $500,000 after cutting expenses and improving operational efficiency. 

In the third year, the company's revenue grew, reaching $5 million, with a profit of $1.5 million. 

The company's return on investment (ROI) also increased each year, with 15 percent ROI in the second and 25 percent in the third year. 

ABC Company's financial performance is an example of a successful business that grew its revenue and profitability while maintaining a healthy ROI.


Assets and Liabilities

Examine the assets and liabilities of the business. Determine the value of the assets and any outstanding debts or liabilities. Ensure that the assets are in good condition and have not depreciated too much.

Here's an example of assets and liabilities for a hypothetical company:

Assets:

Cash: $50,000
Accounts receivable: $100,000
Inventory: $200,000
Equipment: $150,000
Real estate: $500,000
Total Assets: $1,000,000

Liabilities:

Accounts payable: $75,000
Salaries and wages payable: $10,000
Bank loan: $150,000
Mortgage: $300,000
Total Liabilities: $535,000

In this example, the company has total assets of $1,000,000, which includes cash, accounts receivable, inventory, equipment, and real estate. 

On the other hand, the company has total liabilities of $535,000, which include accounts payable, salaries and wages payable, bank loan, and mortgage. 

The company's assets are used to generate revenue and grow the business. At the same time, the liabilities are the company's debts and financial obligations that must be repaid over time. 

A healthy balance between assets and liabilities is essential for a company's financial stability and growth.

Customers and Market Share 

Understand the customer base and market share of the business. Find out who the customers are and whether they are loyal to the company. Determine how the business is positioned in the market and how it compares to its competitors.

General factors to consider when assessing a business's position in the market:

● Unique Value Proposition: A unique value proposition (UVP) sets a business apart from its competitors. Consider whether the company offers a unique product or service, and if so, how it differs from what competitors offer.

● Target Market: Assess the business's target market and how well it aligns with its offerings. Is the market large enough to support the company, and is there growth potential?

● Market Share: Look at the business's market share and how it compares to its competitors. Consider the business's growth trajectory and whether it is gaining or losing market share.

● Pricing: Evaluate the business's pricing strategy and how it compares to its competitors. Is the company charging more or less than its competitors, and how does this impact sales?

● Marketing and Branding: Consider the business's marketing and branding efforts and how they compare to its competitors. Is the company effectively reaching its target market, and is its branding and messaging compelling?

● Reputation and Customer Service: Look at the business's reputation and customer service and how it compares to its competitors. Consider factors such as online reviews, customer loyalty, and customer satisfaction.

By considering these factors, you can better understand how the business is positioned in the market and how it compares to its competitors.

Employees 

Consider the employees of the business. Look at the number of employees, skill sets, and experience. Determine if they are well-trained and whether they are committed to the company. Understand the labor costs associated with the business.

To determine the labor costs of a business, you'll need to gather information about the number of employees, their compensation, and any related expenses. Here are some steps you can take:

● Review Financial Statements: Look at the business's financial statements, including the income and balance sheets. These statements may provide information about the wages and salaries paid to employees.

● Identify Employee Types: Determine the employees in the business, such as full-time, part-time, and temporary workers. Categorize employees by their roles and responsibilities, such as sales, marketing, operations, or administration.

● Calculate Wages and Salaries: Determine the hourly or annual wages and salaries paid to each employee, including any overtime pay or bonuses.

● Add Related Expenses: Consider any additional expenses associated with the employees, such as payroll taxes, benefits (such as health insurance and retirement plans), training, and recruiting costs.

● Calculate Labor Costs: Once you have gathered all the relevant information, add the wages, salaries, and related expenses to determine the total labor costs for the business.

● Compare to Industry Standards: Compare the labor costs to industry standards to determine if the business is paying a competitive wage and has the appropriate number of employees.

By following these steps, you can determine the labor costs of a business and gain a better understanding of its workforce and related expenses.

Intellectual Property 

Identify any intellectual property associated with the business. This may include trademarks, patents, and copyrights. Ensure that the company has the necessary licenses and permits to operate.

Here is a list of examples of intellectual property:

Patents: Exclusive rights granted by the government to an inventor for a specific time to prevent others from using, making, or selling the invention without permission.

Trademarks: Distinctive marks, logos, or symbols are used to identify and distinguish a company's goods and services from its competitors.

Copyrights: Exclusive rights granted by the government to the creator of original works of authorship, such as books, music, and artwork, to prevent others from reproducing, distributing, or displaying the work without permission.

Trade Secrets: Confidential information, such as business plans, manufacturing processes, and customer lists, that provide a competitive advantage and are kept secret to maintain a competitive edge.

Industrial Designs: A type of intellectual property that protects a product's ornamental or aesthetic aspects, such as the design of a car or a piece of furniture.

Plant Varieties: A type of intellectual property that protects new varieties of plants bred or genetically modified to have specific characteristics, such as disease resistance or higher yields.

Geographic Indications: A type of intellectual property that identifies a product originating from a particular region, such as Champagne or Parmigiano-Reggiano cheese.

Domain Names: Internet addresses used to identify websites and other online resources.

Software: Code, scripts, or programs used to operate and control computers, mobile devices, and other electronic devices.

Databases: Collections of data, such as customer lists, product catalogs, and financial records, that are organized and stored for easy access and analysis.

Legal and Regulatory Issues

Review any legal and regulatory issues associated with the business. This may include lawsuits, zoning issues, or environmental regulations. Ensure that the company complies with all legal and regulatory requirements.

Growth Potential

Evaluate the growth potential of the business. Determine if there are opportunities to expand the business or enter new markets. Consider any barriers to growth, such as competition or regulation.

Reason for Sale 

Understand the reason for the sale of the business. This may provide insights into the business's strengths and weaknesses. Ensure that the reason for the sale is not related to significant problems with the company.

Price and Negotiations: 

Determine a fair price for the business. Consider the business's financial performance, assets, liabilities, and growth potential. Negotiate the terms of the sale, including the price, payment terms, and any contingencies. Ensure that the final agreement is documented in writing. Seek the assistance of professionals, such as accountants, lawyers, and business brokers, to help at each stage of the sales process. 

In conclusion, understanding the factors to consider when buying a business for sale is crucial for making an informed investment decision. The top 10 factors, including industry and market conditions, financial performance, assets and liabilities, customers and market share, employees, intellectual property, legal and regulatory issues, growth potential, reason for sale, and price and negotiations, provide a comprehensive framework for evaluating a potential purchase. By analyzing these factors, a buyer can determine the value and potential of the business and make an informed decision. A successful acquisition can lead to growth and prosperity for the business, while an unsuccessful one can result in financial losses and other challenges. Therefore, it is important to conduct thorough due diligence, seek expert advice, and negotiate effectively to ensure a successful purchase.