While buying a business always carries an element of risk, if as a potential purchaser, you perform a forensic investigation on any prospective business, you should quickly gather an impression of its current performance and prospects. You’ll certainly pay close interest to the balance of assets and liabilities to determine whether or not it’s solvent – but what if your investigations discover that the business is already in debt? Should you automatically walk away from the deal?
Not necessarily. One of the main aims of due diligence is to understand the level of risk associated with your prospective business. Securing the perfect acquisition isn’t always about buying a business that’s still on an upward trajectory; for some, a business that is experiencing financial problems may provide an opportunity to buy an enterprise with enormous potential at a significantly reduced price. It’s not for the faint-hearted, though. You’ll need to understand what would be required to turn the business’s fortunes around and how it would fit into your broader plans.
If historic profits are steady and the company’s financial problems are down to cash-flow issues, inefficient practices or underinvestment, you could be looking at an opportunity to fix these issues and get it back into the black. It’s also likely that you’ll face less competition from other buyers and be able to factor a budget for improvement and development into your offer.
Understand the risk profile
There’s a difference between financial risk and business risk. Financial risk relates solely to the company’s approach to debt management, while business risk is connected to the company’s overall performance. It’s important to determine whether the business has the capacity to earn the income necessary to cover operational expenses. If you feel that projected revenues could comfortably cover costs, you may feel that the financial risk is manageable.
Consider the deal structure
Not every transaction involves transferring existing debts to the new buyer. For instance, while a stock sale would automatically transfer all assets and liabilities, an asset sale would allow the purchaser to pick and choose the assets and liabilities they want to own. You may be able to acquire the parts of the business that are important to you – premises, technology, customers or brand, for example – while dodging the debt.
Secure your funding
Make sure your finances are in place before you make any firm plans: if you don’t have essential funds secured, you could end up losing your stake before you’ve managed to turn a profit. The business may have racked up debts because of restricted cash flow and lenders are likely to be nervous about the prospect of throwing good money after bad by investing in a business that’s already hit the buffers.
Give yourself the third degree
Ask yourself some tough questions before you progress negotiations: Why does the business have debt? Can you fix what’s wrong? Why do you want to buy it? Is the price right and is the fix affordable? How long before it turns a profit? Is the level of risk acceptable to you?
Risks can pay off
Although many people see debt as a negative, in business it’s not such a black and white issue. In fact, it’s common practice to take on debt to fund capital acquisitions like buildings and equipment. Understanding the nature of a company’s debt and how it fits into the bigger picture will give you an indication of how viable the purchase is and whether the financial and business risks can be offset. If you’re armed with the right information, there’s no reason why you can’t profit from a business in debt.
Posted on February 26, 2019 | buying, buyers, buying a business, Buying a cafe, running a business, debt