Buying or selling a business is all about the numbers. They’re one of the most important factors, and if they don’t make sense, the deal doesn’t make sense.
That should be obvious, but buyers sometimes get caught up in the excitement of buying a business or because they are disappointed that they missed out on a previous deal. When emotions start to influence decision-making, buyers can overlook some of the obvious red flags.
It’s a cliché, but if the numbers look too good to be true, they probably are. It’s not always deception on the seller’s part; they may be using a system for accounting that’s inflating the revenue or adding back expenses that skew the numbers. They might not have enough experience to understand what information buyers and lenders need to make financial decisions.
Here are some red flags you shouldn’t ignore if you’re considering a deal.
Profit margins that are much higher than the industry average. An experienced broker will have seen dozens, if not hundreds of listings, and they know that the industry average margin is 10-15%. If you see a seller who is claiming 40% margins, he’s either got a bookkeeping problem, or he’s doing much of the work himself. Most buyers are not looking to purchase a job; they want a business that can be profitable without having to be in the field turning wrenches. Ask the seller how much time he spends in the field and how he pays himself to get a clear picture of how much you can realistically expect to clear.
Margins that change dramatically year over year. If an owner has been clearing $200,000 a year for a couple of years but suddenly reports a 50% increase in profit, something has changed. Either the numbers are being manipulated to attract buyers, or there’s been a one-time event that changed profitability. Look for commercial projects that have been completed and paid or changes in staffing that took tens of thousands of dollars off the books. Numbers on a spreadsheet won’t make sense by themselves; you’ll need the context and story behind them to know whether they can be trusted.
Revenue that happens without marketing and sales efforts. You should always look at a business’s online presence: its website, marketing pages, and customer testimonials. You want to see a system that continually and predictably brings in new business. Keep in mind a company that’s doing mostly new construction or commercial work may not have the marketing structure in place.
If the owner is doing business on just a handshake or because of a personal relationship, that’s a red flag for the buyer.
The best way to know whether the deal you’re looking at is good is to keep emotions out of your discovery stage. Also, ask questions. If you see something that needs more explanation, the seller should give you an honest answer and not try to hide anything or be purposely vague.
Lastly, any deal I have ever done has been based on some level of trust. If you can’t get there with your seller, it’s time to walk away.
