Buying a business can be a complicated process, especially for first-time buyers. There are many considerations to take, and just as many red flags that signal a business should be avoided. While consultation with an experienced local business attorney is always the preferred course of action, this article aims to provide some baseline information on red flags to be aware of when looking to purchase a business.

Dishonest Owners

Although it may seem obvious to avoid engaging in a business transaction with a dishonest owner, it can be hard to assess this character trait given that no business owner will openly admit that they are dishonest. Therefore, as any experienced business attorney will attest, determining the honesty of a business owner requires some due diligence.

One way to assess honesty is to take a look at the business owner’s discretionary income, which is the amount of money the owner takes home after business expenses. A business owner may upsell a business that has consistent revenue, but if discretionary income is declining then this signals a red flag for prospective buyers.

Dishonest owners can also pose a risk of setting up a competing business and taking existing customers with them, leaving the new buyer with the current debt. Drafting a non-compete clause in the purchase agreement can help mitigate this risk. Including a disclosure agreement may also be advisable, but consulting with your business attorney is always the best course of action.

Recent or Current Developments

For any prospective buyer of a business, it is important to be aware of any recent or future developments associated with the business they are looking to buy. For example, new competition may have recently entered the market, and the current owner is attempting to sell before their business loses value.

Key employees may be planning to leave or have recently left the business, creating a need for new hires which may or may not lead to the same output and value the business had previously produced. Also, new technology may enter the industry which may render a currently attractive business less valuable or even obsolete.

Condition of Equipment

The condition of any important equipment used in a business is important to consider when looking to purchase the organization. If it appears that pieces of expensive equipment are reaching the end of their useful lifespan and will need replacement in the near future, it can mean a significant financial investment above and beyond the actual purchase of the company. Working with an experienced local business attorney and business appraiser can help prospective buyers assess the current state of important capital associated with the company.

Suspicious Financial Records

The internal financial records of a company should match with that company’s tax files. If there is a mismatch or something does not add up, this is a red flag for a prospective buyer. It is not sufficient for a business to conduct a self-review of its financial records; an independent accounting agency should conduct the audit. If a business puts up any resistance to furnishing their financial records, this is also a major red flag for buyers.

Getting Professional Legal Counsel

For years, the attorneys at Coepio Legal have been helping business owners in the Bay Area as they navigate the sale and acquisition of a company.