Business Valuation For Dummies
If you’re considering buying a business, you will need to investigate the company to make an informed decision about the business's valuation. The valuation process involves research and observation — whether the prospective enterprise is operating successfully or is functioning as a troubled company.
How to Investigate a Business before Buying the Company
Research, observation, and common sense are powerful tools in the business valuation process. Here are some things to consider as you examine and analyze a company you want to buy:
Listen to customers. Assuming that you’re targeting a consumer business where you can legally do some creative loitering, spend some time listening to customers talk about what they think of the business.
If the target business is a restaurant, strike up casual conversations in the waiting area about whether customers have come here before and, if so, why they’ve come back. Don’t be a stalker; just find the right approach. If you find several people on repeat visits who volunteer how great the business is, or what they like and don’t like about it, start recording those comments.
Watch the foot traffic. Pretend that you’re a plainclothes detective for a few weeks. At different times during your target company’s business hours, park the car or sit in a coffee shop across the street, and set up a chart that notes the time, date, and segment of time you’re watching. Note when the business gets busy; note when it’s dead. Note what kinds of customers are going in, and try to find out why.
If the business is a clothing store, are shoppers showing up only when a sale or promotion is going on, or are their visits tied to crucial shipments of merchandise that they can’t wait to see? Professionals get paid a lot of money to do this kind of observational research; you can do it yourself for free.
Check out the neighborhood and competing businesses. What’s the character of the street and general area where the business is located? Does the street have a lot of other businesses similar to this one, and where is it on the trendiness and necessity curves?
Does the neighborhood really need this business? Is the area gentrifying (people with money are moving in) or already gentrified (serving the clientele with the most disposable income that would go into your cash register), or could it be slipping, with dollars going elsewhere?
Diagnose the empty-storefront issue. Empty storefronts may not always be bad things. Storefronts may be emptying because the neighborhood has a growing crime problem and residents are fleeing (definitely bad for most businesses, even for non-consumer businesses that want to attract a workforce).
Alternatively, storefronts may be emptying because a quiet real estate boom is going on in the area, and landlords feel that they can charge rents that more upscale tenants are willing to pay to attract a rising clientele.
Study the local power base. Identify the politicians who are lowest to the ground where your target business is. Study what they’re doing — and not doing — for their business constituents. See whether the area has any nonprofit groups that aid local businesses, and find out as quietly as you can what data and intelligence they can provide you in your research.
Do a news search. You know those boring columns in the business section with the dopey headshots, talking about how Joe Jones just got a big promotion? These columns can get pretty interesting when you’re thinking about buying a business.
Search for any news story that features the name of your target company, and look for good news (expansion, new locations, talented new executives) or bad news (locations closing, top management quitting, lawsuits filed by customers or suppliers).
How to Research Troubled Companies You Want to Purchase
Prospective buyers who are interested in purchasing a troubled company go through a due diligence process that involves gaining permission to see the business's operations.
A company may require a legal confidentiality agreement to allow information gathering about the business. When you’re given the go ahead for due diligence, use this list to request everything you need to make informed decisions.
Don’t be discouraged if a company doesn’t offer up everything you ask for. Some records may be unavailable (or missing).
A summary of the company’s tangible assets so you can physically view them and get a price range on them for potential sale valuation.
A summary of the company’s intangible assets so you can examine records on those items within a company’s computers or physical files.
Recent audited financials and tax returns.
Any verbal or written details on the company’s status with creditors (lenders, suppliers, customers waiting for merchandise, etc.).
Anything resembling a strategic plan in the way of market expansion, product development or other efforts to improve the business.
Projections of future income. (The current owner might .have his or her own data or opinion on this. You definitely want to know what that person thinks about business prospects so you can verify them.)
A summary of all current and possible legal or regulatory complaints against the company (which you should verify through a public documents search).
Account summaries/data for suppliers and customers (accounts payable/receivable data, contracts, invoices, notices of delinquency in payments by the target company or its customers).
Regulatory or tax notices — current or projected. (If a company is expecting major regulatory or tax changes in its business, potential buyers should know about it.)
Any analyses by the target company of its supplier and customer concentration and what losing any of them could mean to the business (compare with your analysis of all supplier and customer data).
Access to all possible correspondence, phone records or e–mails between regulators, suppliers, customers or anyone else in close contact with the target company. (And if you are contacting these constituencies yourself, make sure you ask for their copies of such data as well.)