Items to Investigate

Capital Equipment, furniture, buildings. Two things need to be determined. First, what is the market value of these items. Here, the market value means the price others would pay for these items, not what it would cost you to replace them. There may be large difference in these two prices. The second thing to be determined is whether these items are in good repair, capable of being fixed, or in need of replacement. Always get an independent appraisal of these goods. Never take the owner’s word when it comes to the value, even if you personally know the owner to be an honest person. The owner could be wrong. Moreover all machinery and other equipment should be carefully checked by a mechanic or other skilled tradesman to make sure that it is in good operating order.

Accounts Receivable . The most important thing to look for is how old are the accounts. A business with a large amount of its sales in accounts that are past due is a business that is not being paid by its customers. Obviously, this is not a good thing. If the business does have a large number of accounts receivable that are over thirty days past due, you need to dig into its financial records to see what the collection rate is on those past due accounts. You might be able to implement better credit/collection practices or choose better customers and improve those numbers, but you need to find out why the owner is not able to avoid these problems. Ask the customers with past due accounts and other businesses with similar operations for their views on why the business may have so many accounts receivable; meaning, money that is owed.

Contracts. Every contract that the business has entered into must be closely examined for a number of things. First, are the material terms of the contract being fulfilled? Second, can the contract be assigned (transferred) to a purchaser of the business? Third, is the contract a profitable one for the business? Fourth, can the contract be renewed, and if so, by whom, either party or only one? Remember that leases, rental agreements, and service contracts all fall into this category, not just supplier and customer contracts.

Customer Lists. These lists are more important in some businesses than they are in others, but you should have a customer list for any business where you count on or expect any sort of repeat business. Look into the records used to develop these lists. Topics of interest include the activity level of customers, length of relationship with the business, size of orders, attrition rates (the percentage rate the business lost its customers over a year), etc. Customer lists are important for three reasons. First, this will help you carve out an area that the former owner must not intrude into by resuming his business after he sells it, thus ending the threat of the owner immediately resuming business as a competitor against you. Second, it provides you with an instant customer base. Third, finding out who the customers are tells you something about the future of the business. (If the business depends on an expanding customer base, the business is worth more than it would be if the particular customer base is shrinking!) Specify in any agreement to buy a business that you (the purchaser) will get ownership of the records relating to the customers.

Employees. More than just meeting the people who work there, you need to find out something about the employees you may inherit. Do they intend to stay? Are they long-term employees with a history or does the business have a revolving door? (Note that some industries, like food service, rarely have long-term employees.) If possible, before negotiations concerning the business are concluded, take the employees out to lunch and talk to them away from the owner. Assure them that nothing will get back to the owner and ask them what they think about operations at the business. You may get some interesting information about the business. Try to find out how easy it is to replace workers who leave, and how expensive.

Economic Forecasts. Although economists and local government officials who predict economic trends are hardly the best source for business information, you should pay close attention to what they say. Sometimes they do provide useful information about trends and occurrences that impact a business negatively or positively.

Intellectual Property. Copyrights, patents, trademarks, tradenames, trade secrets all fall into this category. For most small businesses being purchased, the only real intellectual property will be the business’s name, but this may be quite important if it is a well-established name. (E.g., Pizza Hut.) If you are considering another type of business, however, there may be significant intellectual property involved, requiring significant investigation and documentation of the transfer. Anything essential to the business clearly needs a great deal of legal attention before the business is purchased to insure that the intellectual property rights are transferable.

Liabilities. Every single liability must be uncovered when investigating a business. Lawsuits, unpaid creditors, back taxes, possible claims not yet pursued against the business, etc. all must be found before a proper valuation can be done. Get help from an accountant and your lawyer for this. (Looking ahead a little bit, if you do end up buying the business, make sure that a list of all known liabilities and possible liabilities are listed and attached to the purchase contract. Then include a clause stating that any liability which was incurred prior to the sale and not on that list is a liability that the SELLER will pay off. This gives the owner an incentive to help you uncover all possible liabilities.)

Licensing. Find out what permits are required by the local, state and federal authorities for the business. There may be onerous regulation of the business involving a great deal of expense, and this needs to be taken into account as an expense when valuing the business.

History. Both the history of the particular business (bankruptcies? relocations?) as well as the history of businesses generally in the same industry should to be well known by the buyer before the purchase.

For your convenience we have also included a checklist commonly used by attorneys when they are hired to investigate a business that may be acquired by their client.