3 Warning Signs for Business Buyers

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3 Warning Signs for Business Buyers

Feelings aren’t facts… but they have a basis.

There are no absolutes when it comes to “warning signs.” Just because a warning sign exists doesn’t mean there is a substantive problem with a business deal.

Warning signs are what I call “notifications for specific due diligence.”

You may see warning signs in the initial financial reports, the shared business plan, or other documentation. It is equally valid to explore warning signs that you sense. If something feels off to you, explore that feeling enough to find verifiable ways to either confirm or disprove the concern.

Let’s talk about these three warning signs.

  • Reason for Selling
  • Price vs. Value Proposition
  • 3rd Party Anxiety

1 | Reason for Selling

In my last article, I wrote about putting some thought into why you might be selling a business and articulating that reasoning authentically and positively.

I tell seller clients to prepare to answer this question. When you’re on the buying side, you can come out and ask, “Why are you selling?” but as I mentioned in that article, the word ‘why’ often puts people on the defensive.

Here are some alternative ways to ask the question.

“What makes this a great time for you to sell ‘INSERT BUSINESS NAME HERE’?”

“How will you be spending your free time after the sale?”

“What’s next for you?”

By asking disarmingly curious questions, you can begin and guide a conversation without putting your counterpart on the defensive.

Remember, you’re not trying to trick or manipulate them. The goal here is to provide a safe environment to share what the seller can about a business you intend to buy.

There are spins on why someone might be selling, but there are only a few actual reasons.

  1. They want to retire.
  2. They’ve had a change in their lives or want one.
  3. The business isn’t performing.

When speaking with the seller, you will need to figure out which category they fall into and what impact their reason will have on your valuation and buying decisions.

It’s important to note that none of these are, by definition, ‘bad’ or ‘non-starters.’ You need to know where you’re starting to develop a plan to move the business forward.

2 | Price vs. Value Proposition

If the price is inconsistent with the value proposition, either you’re dealing with an inexperienced seller, or there are additional factors you will need to uncover.

The base valuation for a company is a surprisingly simple calculation based on the valuation formula you think is appropriate. Using the Seller’s Discretionary Earnings method, for example, a business that generates $100,000 of profit every year (including the owner receiving a salary) when the industry norm is 4x profit, you might expect a price tag near $400,000, excluding all other factors.

If the asking price is $250,000, it’s time to see how the ‘other factors’ impact the selling price. Alternatively, the asking price may be $1.2 million, and, again, it’s time to dig deeper.

When you’re ready to complete a deal, you will be clear on what makes the company you’re buying worth the price you’re paying.

3 | 3rd Party Anxiety

I did a preliminary meeting with a buyer a few months ago. We talked about the opportunity, including the valuation from the seller and the most recent financial information. I explained that the financial reports didn’t support the company’s valuation and that we would need to incorporate that into our due diligence.

The buyer understood and submitted a few questions to the seller but mentioned that she had engaged a 3rd party to help her.

Upon hearing that my client had engaged outside help, the seller immediately ceased the process, and the deal stopped.

While I’m sorry that my client was disappointed, I know that it was a better result for her than pouring time and energy into that deal.

I won’t say that a seller with this response has something to hide. At the same time, it is a defensive reaction that indicates that if they aren’t actively trying to cover something up, they don’t feel prepared to answer the questions they anticipate from a subject matter expert. 

In this case, “business,” but when you purchase, you will engage lawyers, accountants, and other experts to ensure that the deal is beneficial to both parties and that there is a complete and fair representation of the facts.

The Bottom Line

It’s important to restate that a warning sign does not, in itself, represent a no-go condition.

A warning sign or even a gut feeling may lead you to due diligence that puts a stop to a deal. Still, it can lead you to an understanding of the business that modifies your offering price or, even, to a way of leveraging the value of the business in a way you hadn’t considered.

The three topics I shared provide opportunities to be curious. 

  • Reason for Selling
  • Price vs. Value Proposition
  • 3rd Party Anxiety

Curiosity uncovers possibilities in addition to liabilities.

Remember that doing it yourself doesn’t have to mean going it alone.