What is the wisdom in buying a failing business?

QUESTION: I am considering buying a local business that is losing money. Other than acquiring it at a bargain price, what other factors should I consider?

ANSWER: The major factor to consider is why is the business losing money? Unless you possess the management skills to turn the business around, such a purchase is ill-advised.

To begin, you should develop a written business plan that addresses the key factors that determine the success or failure of any business. The following is a list of factors to consider:

• Are the products or services provided obsolete, out of favor, or being replaced by new and better competing products?
• Who is the competition?
• Is the business in an area that is in decline? Is the building in disrepair? Is lighted and safe parking available to customers?
• Is customer service an issue? Are the employees friendly and helpful? If not, why not?
• Is the business taking advantage of the latest innovations in technology? Do they have a viable marketing plan and a budget for advertising?
• Is the current management complacent and slow to embrace change? This is a problem with many older principals who are tired of the daily grind and reluctant to invest more money in the business.
• Is cash flow a problem? The business may have increasing sales but is lax in the collection of accounts receivables (money owed from customers). Customers should understand and agree to prompt payment terms. Creditors want to be paid in a timely fashion, and failure to do so can result in an unfavorable credit rating.

Any of the above factors can be resolved with a proactive business plan. They are all good reasons you should place a discounted value on the business being considered.

If an all-cash sale is requested from the seller, a sum equal to the depreciated value of current inventory, building, furniture, fixtures and equipment might be reasonable. 

However, in the case of a failing business, an earn-out method of payment is desirable. In this instance, the buyer agrees to pay a set percentage of income generated on a monthly or quarterly basis for a specified time.

Do all due diligence before signing any contract for purchase and have the terms and conditions reviewed by both a qualified accountant and attorney, specializing in the purchase and sale of businesses.

Gray Poehler is a volunteer with the Naples Chapter of SCORE.

A SCORE counselor since 2005, Gray Poehler owned and operated an independent insurance agency with 20 employees and two locations. He has earned the Certified Insurance Counselor designation and is familiar with both personal and commercial property and casualty insurance. Areas of expertise include: Business Finance and Accounting; Business Strategy and Planning; Business Operations; Human Resources and Internal Communications; Sales, Marketing and Public Relations.

To learn more about management issues of small businesses, contact the SCORE office nearest you.

Tags: Florida Small Business