Starting a business from scratch and building it up can be costly, risky and time consuming. Instead, it can often pay to enter or expand into a market by acquiring a business or franchise. However, there are still difficulties in buying an existing operation, not least knowing whether you are paying the right price. Here is our short guide to how you can avoid overpaying.

Problems of business valuation

While it can be easier to get finance to buy a business with a proven record than to fund a complete start up, it is important to understand the valuation risks: debts can be understated, debtors and stock overstated and equipment and property overvalued. Above all, the premium (known as goodwill) for the whole business, rather than just the business assets, can easily be priced too high.

How to value goodwill

Goodwill can often be based on multiples of income. However past performance is not an indication of future performance. The goodwill may be attached to the previous owner, so that customers are loyal to the owner rather than the business. The brand and reputation may have been damaged. Staff may leave with the old owner or not approve of you as the new owner, but you will still have legal obligations with regard to their employment. It is therefore vital that you conduct thorough research to decide whether the market potential justifies the profitability forecasts given.

Deciding on whether to purchase

You will need to have the right aptitude for managing the business that you acquire. Before making a purchase you should:

• Be ready to start running the business.
• Conduct proper due diligence to verify the value given to the business.
• Ensure that you have the ability to run the business.
• Ensure that the business demands do not conflict with your future plans.
• Ensure you understand the vendor's reason for selling.
• Obtain a proper contract for the deal.

Proceeding with caution

Before you agree a purchase, the vendor will normally draft a heads of agreement. This document will state when the business is to be sold, the assets to be transferred, guarantees, warranties, indemnities, covenants, representations and obligations. Before you agree to the terms in the heads of agreement, you must carry out due diligence. This will normally require the services of specialist valuers such as surveyors, patent lawyers and accountants to review the financial statements.

We can advise on the suitability of starting or growing your business through an acquisition and help with the due diligence process.

Please contact us to discuss your requirements.