Before you buy, be careful - buying a business

Nation's Business, March, 1996 by Steven B. Kaufman

Acquiring a business requires a lot more work than simply finding one for sale.

Grant Beck, the president of BaseLine Inc., a Kent, Wash., manufacturer of products used in the lithographic printing process, knew he had to move fast. He wanted to buy a similar business in Connecticut to gain a foothold in the Northeast, but creditors were threatening its survival.

So two years ago, in a span of only two weeks, Beck bought the company's assets for $150,000--without the help of a business-acquisition specialist or a thorough

examination of the company. Soon thereafter, he paid a fat premium: enormous headaches and $250,000 in red ink.

Beck had relied on financial statements that dramatically inflated the company's sales volume, he says. "I learned that if the time line is that tight, you walk away."

Beck's episode illustrates the downside of what business brokers nationwide say is a hot trend in the '90s--purchases of small companies by entrepreneurs and would-be entrepreneurs who are determined to shape and improve their economic destiny. The movement is powered in part by the wave of corporate downsizings, which have led many displaced executives to decide they want to own their own businesses rather than work for someone else.

But those seeking to buy a small business need a healthy dose of professional help and skepticism--and some luck. As much information as possible must be unearthed before a prospective buyer can reasonably gauge the likelihood of success.

"Part of the problem is that entrepreneurs are risk-takers to begin with," says Ole Carlson, a suburban Seattle manager for The Executive Committee, a San Diego-based company that creates teams of small-business owners who consult with one another. Such entrepreneurs, he continues, "run more on their gut than their intellect. They tend to fall in love with deals rather than analyze them."

A way to avoid that problem, say those familiar with buying and selling companies, is to assemble a team of experts, including an acquisition specialist or a business broker, a lawyer, an accountant, and an insurance broker. Such a team usually costs an entrepreneur $3,000 to $20,000, depending on the size of the business and the complexity of the deal. But experts know what to analyze in order to minimize the chances of a bad purchase.

Key considerations are whether a firm is financially solid--generally meaning it has been profitable for at least three years and has a solid balance sheet--and whether it has a history of stable employment.

The most important checkpoint, others say, is to distinguish between cash flow and profit. Buyers who look strictly at the bottom line may not realize that a business may have to pay its vendors within 30 days yet offers 60- or even 90-day terms on its receivables. The difference can be fatal.

Entrepreneurs should avoid any business whose owner says he or she doesn't report all of its profits to the Internal Revenue Service. Such underreporting is surprisingly common, says Steven Maynard, president of Business Acquisition Systems, a Sunnyvale, Calif., consulting firm. He says the IRS could ultimately hold you, not the former owner, responsible. "And if he's lying to the IRS, he may be lying to entrepreneurs about plenty of other things," Maynard says.

Where do you find businesses for sale? About 85 percent of opportunities are tucked within the unadvertised "hidden market," says Michael Sipe, president of Private Equities, a San Jose, Calif., consulting firm for small-business acquisitions. Such businesses have a low profile--often because their owners have been involved in a recent divorce or there's been a death in the family--and have not yet been listed for sale. They offer buyers the best opportunities, experts say, because there is minimal competition among prospective purchasers.

The hidden market is accessible by networking with lawyers, accountants, bankers, and insurance brokers who specialize in serving small business.

Though most business brokers focus on the nonhidden market and represent sellers, not buyers, they obtain good listings and are useful resources, say experts in the field. Good brokers show buyers the true earnings of a business, qualify buyers, and help close the deal. They typically advertise in the Yellow Pages; small-business lawyers and accountants can steer entrepreneurs to the best of the lot.

In the end, the best that an entrepreneur can do is assemble a top-notch team of professional advisers, do extensive due diligence (a thorough investigation of the business, similar to one an investment banker might perform), and hope for the best. There are no guarantees.

Take Ed Blanchard, for example. He took all the right steps in August 1994 when he bought AET Thermal Inc., a Milpitas, Calif., maker of rapid-thermal-heating systems for the semiconductor industry. Due diligence unearthed that the former owner had given some customers a guarantee of up to three years on equipment without specifying what the warranty covered. So Blanchard worked out a pact allowing him to relinquish responsibility for contracts that made him uncomfortable.