Red Flags You Should Know Before Buying a Business 🚩

May 12, 2021

Buying a business is one of the largest transactions of your lifetime. Making it a nerve-racking process, whether it is your 1st or 100th time.

Our biggest fear is buying a 'lemon'. A business that looks great from the surface but is rotten on the inside. There are always risks to purchasing a business, many of which we can't control (like COVID-19). But we can reduce this risk by keeping an eye out for obvious red flags.

This article will highlight a few red flags you should look out for when buying a business.

1. The owner claims their business 'makes a lot more money than what shows on the books' 🚩

  • It is not uncommon for the owner of a small business to tell you the business makes more money than it looks. If this is the case, simply tell them, "if I can't see your profits on paper, I can't count them."

Screening Question: Can I see your personal tax returns?

2. It sounds like the owner does 12 different jobs 🚩

  • Every business owner wears multiple hats. But if the Seller's day resembles the image below, their involvement in the business is likely more critical than stated. This isn't the Seller being deceptive (usually), but something the Seller actually believes. As many business owners tend to lie to themselves about their business's ability to run itself.
  • Screening Question: Have you taken a vacation longer than 1 month in the past 2 years?

3. The company has no significant long-term staff 🚩

  • In some industries, like food & beverage, high employee turnover is the norm. However, it could also be a red flag if none of the employees have been with the company longer than 1 year.

Screening Question: there are a few different ways to gauge employee satisfaction. You can check Glassdoor reviews or reach out to past employees through LinkedIn. For current employees, most offers include a provision to interview the company's key employees before the sale.

4. A majority of the company's revenue comes from 1 customer 🚩

  • Customer concentration assesses a company's diversity of revenues. It is usually a negative sign if the business's largest customer represents more than 5% of total revenues. It is equally negative if the top 5 customers represent more than 10% of total revenues.
  • It is worth noting that it isn't a deal-breaker if either of the above is true. Some industries (like industrial service companies) tend to have a higher customer concentration. Making it important to benchmark your assessment to the industry the business is in.

Screening Question: Ask for an approximate revenue breakdown of their top 10 customers.

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