When searching for businesses there are a number of classic warning signs that should alert you to potential problems. Buying the wrong business could result in a financial disaster for you. The following is a partial list of common warning signs that you should be aware of.
Unfamiliar business
It would be a serious mistake for any buyer to invest in a business that the buyer knows nothing about. The dangers in running the enterprise are accentuated by inexperience and unfamiliarity. If you are the potential buyer, you could be buying a business totally unsuited to your personality, talents, or interest. You would be at a considerable disadvantage in trying to survive and compete with your competitors.
Partner-wanted business
Some business partnerships that are based on sound economic data can work out well and may be worthy of your consideration. On the other hand, many business partnerships do not survive in the long run. This could be because of conflicts of personality, philosophy, policy, priorities, or contribution of money, time, or skill into the business. Some unstable and undesirable business operations attempt to defraud the unwary investor by obtaining an injection of funds into the business and then using those funds in an inappropriate fashion without any controls. For example, investment funds could be used for paying past creditors’ debts rather than for working capital for future need and growth. Be cautious of any business partnerships that promise a disproportionate return based on the investment of money or time.
Business which use up all investment capital
If you are considering a business which would require all of your financial resources to pay the purchase price, you could be in a situation that you are starting off undercapitalized, without working capital or reserve for future needs. For example, if you take over a business and there is a decline in sales and profit during the transition phase, you would not have any resources to be able to buffer the financial crunch. Never buy a business without taking into account your working capital and contingency fund.
Personal service business
There are special concerns you should be aware of if you are considering buying a personal service business (for example, an architectural, engineering, law, dental, or legal practice). The main concern relates to the bonding and goodwill that has occurred on a one-to-one relationship between client and the professional. Once the business is purchased, a substantial portion or possibly most of the clientele could leave and go to other professionals because of a difference in style and operation. If you do buy a personal service business, you should build in protections because of the high risk that the goodwill may not necessarily stay when the other party leaves.
Failing or distressed business
Don’t proceed any further if you are considering a business which is going through serious financial problems. The exception would be if you are an expert in that type of business, have clearly identified the reasons for the financial difficulties, and know that you have the expertise and management resources to turn it around. There are people who buy businesses with a turnaround strategy in mind, and skillfully negotiate a purchase package which is very attractive. This can be done effectively, of course, only if the buyer knows what he/she is doing and is sophisticated in this type of distress purchase.
