This is the second in a series of blogs on the information required for a thorough due diligence before going into a substantial business deal. As before I’ll continue with the information as it is presented on the BusinessPortal range of websites, continuing with the information on the Business Information tab. This information is more sensitive and restricted by the business representative until a rapport is built with the prospective buyer/investor.
Where a business is based (designated as the Business Environment on the BusinessPortal range of websites) depends on the type of business. You are unlikely to find a manufacturing business in a mall and almost as unlikely to find a high end restaurant in an area without a view or foot traffic. The mantra, “Location, location, location” holds true in business and if the business you’re interested in investing in is not ideally situated to service its customers and to take delivery from its suppliers (or both – depending on the business), it’s missing a trick. The other important thing to look out for in relation to a business’s location is the property leasing conditions. If the business does not own the property it’s on or the property isn’t part of the deal, transferring a lease is often a large hurdle. Generally landlords need to agree with the transfer to allow the sale of a business to go ahead and since new tenants can often be seen as risky (or an opportunity to raise rents considerably) they can pose a significant stumbling block.
When looking at the Supplier- and Client Types one can start to glean information about some of the risks involved in the market one is considering investment in. For instance, if a business is dependent on specialist suppliers or sells to specialist customers, it could be “held to random” over prices of its inputs or fluctuations in the demand for its end product or service. An example of the strength of suppliers would be in the building industry where concrete and steel prices are a huge determinant in the price of the final product. Alternatively, consider the relative safety in demand in restaurants, because all people need to eat (though competition becomes a bigger risk factor here).
Most businesses need to comply with some legal regulations that govern the industry they function in. Since this applies to all businesses in an industry, confirming it trades while being compliant with all regulations is important. If it’s made its profits while cutting corners there could be repercussions for the next owner. Similarly, it helps to know of pending regulation changes in the industry since they might affect a business’s future profitability. Of course, BEE status of- and pending court cases against a business should come into the risk analysis before investing as well. Though it’s a long shot and shouldn’t effect businesses unless they are sole proprietorship, there are also risks involved in current or pending legal action against other stakeholders in the business (in their personal capacity). Even if the businesses assets cannot be touched directly, getting “into bed” with someone who’s soon-to-be cash strapped or have a serious dent in their reputation, might pose extra risks the business might not be able to carry.
The last two entries on the Business Information page are the Estimate of Business Value and what the estimate is based on. As mentioned in the previous blog this is always a bit of a delicate subject and there’s no right or wrong way to evaluate a business. This information will however, tell you a lot about how the current owner feels about their business and what their level of business skill is. A reasonable starting point for a price is usually the value of assets minus the liabilities plus a reasonable amount to compensate for any free cash the business is generating or potential the business might be forecasting. Alternatively, it might be based on previous offers escalated at relatively high interest rates (to compensate for the risk of being in business). It should always be remembered though that buying a business for cash isn’t the only way of concluding a transaction (though there is generally a cash component). For more information, check out my blog on “Business Valuation: A “How to” guide”.
In the next blog I’m going to consider the SWOT analysis and how much to read into it.