31 Red Flags When Buying a Business

Potential investors should always be on the lookout for red flags when buying a business. As such a large responsibility to take on, a poor acquisition can cause no end of headaches for those that don’t practice adequate due diligence.

Some warning signs will be more obvious than others, but buyers should ‘trust their gut’ if everything seems fine but doesn’t feel right. If you’ve previously been involved with well-run businesses, you may well have a good feel for if something seems to be off in one that isn’t.

This list provides a handy guide to some of the most common issues you might come across. Not all are instant deal-breakers but will certainly require extra research into at the very least.

 

 

Red flags when buying a business

 

1. Financial inaccuracies

One of the main factors used in measuring a company’s viability is its financial statements. You should be able to see exactly what the business spends on outgoings, and what it receives in revenue. If the seller can’t provide these then you should walk away from any deal.

Without accurate metrics available, you really have no idea of the health of the company. Missing information or dishonest figures are possibly the biggest red flag you can find. Those committed to the idea of buying the company may be tempted to put such inaccuracies down as absent-mindedness on behalf of the seller, but this is a dangerous assumption.

Put yourself in the shoes of the seller. You’d want to generate as much money as possible from the business sale. To do this, any strong financial information would be centrepiece to any sales pitch. If financial performance is obscured or glossed over, it likely makes for poor reading.

 

2. Suspicious reason for sale

A seller is unlikely to tell you plainly that they’re selling their business because it’s in trouble. In these instances, they’ll often give a different reason instead. It can be difficult to know if the reason they give is truthful, but if something seems amiss, then it might be wise to dig a little deeper before committing.

Look into the seller’s history. Do they tend to sell businesses quite regularly? If so, their assertion that they’re retiring or moving abroad may not be the entire truth.

 

3. Has the seller previously sold businesses in the same sector?

If the seller has previously built and sold a company in the same industry, you should seriously reconsider your purchase of the business in question.

While there’s nothing wrong with building and selling businesses, it could point to the seller doing the same again. If they do, then your business could find itself with considerably more competition down the line.

 

 

4. Has the seller previously sold businesses that have since ceased trading?

It can be unfair to level a company’s demise at the person that sold it beforehand, but if there’s more than one example of this in the seller’s history, it could be that they know when to get out of a business before it fails.

Each business could have course been victim of mismanagement of their purchasers, but it’s worth reaching out to ex-owners of these companies to find out what state the businesses they bought were in.

 

5. Lingering legal issues

Verbal assurances that any legal issues are small and “not a problem” should be disregarded. There’s no way to know how a legal case may pan out, and you could end up saddled with a liability that the business is responsible for.

Disputes with employees can see businesses pay significant amounts in damages, while intellectual property cases can be particularly problematic.

 

6. Ownership of IPs

On the subject of IPs, the absence of any documentation certifying ownership should serve as a red flag too. Without these in place, rival companies can quickly replicate your offering and render yours obsolete.

Even if certification is provided, it should still be checked over. Patents may only cover very specific elements of the business, or specific geographical regions. In the case of the latter, this can seriously restrict any growth you might be hoping for.

 

7. Sales trending downwards

Unless you’ve spotted an issue in the business that you believe you can fix, declining sales should be treated as a big red flag.

Blips are to be expected here and there in the short term, but if you can see sales declining over the last three years, say, then you could be looking at a business that’s slowly dying.

 

8. Behind on its taxes

HMRC are quick to add penalties to late tax payments, and as the company’s new owner, it would become your responsibility to make sure they’re paid.

It’s common for HMRC to issue winding-up petitions against companies that don’t pay their taxes. If this is left for too long, you may find that the company has been threatened with liquidation before you can even complete the deal.

Additionally, if the company has filed late tax payments before, HMRC may take a dim view of offering you any help in the future should you need it.

 

9. Over-reliance on one or two clients

Finances may look healthy, but if the majority of that business is coming from just one or two clients, then the company is overexposed. Should one of those clients go bust or simply choose to use another business, your new venture could be at risk.

 

10. Unsellable inventory

A company’s inventory is often included as part of the business sale, but be sure to take a look at what it’s actually made up of. Many inventories have at least some items that they’d struggle to sell. If the inventory is almost exclusively made up of these, however, then it’s useless to you.

In fact, inheriting a large amount of unsellable products can become a huge headache, as you may have to pay to have it disposed of.

 

11. No repeat customers

Some industries struggle to gain repeat custom by virtue of their work, but for those that should, an absence of regular customers can suggest a problem.

For example, repeat custom at a restaurant is a good sign that diners have enjoyed their food and returned for more. The lack of repeat custom in this scenario, suggests that diners have not enjoyed their meal. If that’s the case, there’s only a finite number of new customers that the restaurant can serve before it has none at all.

 

12. Poor credit score

If the business has already run up debts elsewhere or not kept to payment schedules, you may find it difficult to secure future funding. You also have to wonder why it’s needed so much borrowing, and why it couldn’t afford to make its repayments.

 

13. Trouble financing its purchase

If you use a lender to finance the purchase of the business, they’ll often perform a due diligence check on the business you’re looking to buy. They may then decide to decline the funding of this if it fails those checks.

Lenders can refuse finance for businesses that they find have financial issues, structural issues, operate in a restricted industry, or just isn’t viable. When it comes to red flags when buying a business, they don’t come much more obvious than this.

 

14. Large amount of owner financing

Many business owners put money into their company, but you should look out for large amounts or regular financing payments. These can suggest that the business isn’t viable on its own and relies on the seller’s personal money to get by.

Too often, businesses are propped up by external funds in the hope that they’ll eventually turn things around. If you find a business that looks like this may be the case, it’s likely that the seller has finally given up on it and is looking to recoup their money by selling.

 

15. Leases and rental agreements due to be renewed soon

Be wary of expiring contracts. While this isn’t a deal breaker by any means, it certainly requires further investigation.

Developments over the last few years have caused many bills to rise exponentially. The business you’re looking at may have been lucky enough to have had a fixed price in place that precedes such issues. If any of these are due for renewal soon though, there could be a large price hike that puts a serious dent into your profit margin.

Ask for renewal notices from the suppliers and companies in question. If these can’t be obtained, then try to get their phone numbers instead to allow you to speak to them directly. It’s possible that the seller is aware of some upcoming price hikes that could make things difficult for the business.

 

16. High turnover of staff

Employees can smell trouble a mile away, and will often jump before a company folds. In general, most workers are looking for stability in their employer, and if business is a little rocky, it can prompt them to look elsewhere.

Otherwise, it could signify that there’s a problem with the company culture somewhere within. A potential workplace bully within your workforce, for example, can cause no end of problems, not least the potential for legal action later on.

 

17. Issues with the staff

It can be difficult to get an idea of this as a potential buyer looking in, but if you’re able to, it’s worth talking to employees one-on-one. Problems with staff can turn even the easiest business into a monumental headache. As mentioned above, there’s also the threat of legal action if the issues are serious enough. Remember, that the business will still be responsible for issues that happened before your potential tenure.

 

18. High turnover of ownership

Few red flags when buying a business provoke a raised eyebrow such as this.

Be very suspicious of multiple owners that have bought and then sold the company. Then be even more suspicious if each owner only took the reins for a short spell. What has each owner found about the business that’s made them want to get out so quickly? This is one question that it’s best not to find out the answer to. Walk away from businesses like these.

 

19. Bad mystery shopping experience

Some businesses lend themselves better to a mystery shop than others, but if you (or a friend) can visit the company as a customer, you’ll receive a brilliant perspective of how its doing.

You may be able to discern problems within the staff, infrastructure, equipment, and more by going undercover. If you have a terrible experience too, you can bet that others have had the same too, which affects the reputation of the business.

 

20. Bad reputation

A bad reputation can be hard to shift. This is especially true now that reviews on sites such as Google and Trustpilot are so visible. For many, their website’s search engine results acts as their company’s shop front. Bad reviews are the equivalent of having placards in your physical shop window with disparaging one-star reviews on.

Even outside of the internet, word of mouth spreads quickly. Particularly when it’s negative. Taking on a business with an established poor reputation poses new owners with an uphill battle from the start.

 

21. The industry is struggling as a whole

Unless you have a fantastic new idea of how to market a flagging product line, or for a similar but new offering, it’s best to steer clear of a dying market.

Unfortunately, some businesses have a finite shelf life. Anything dealing in current trends are particularly susceptible to this. Others may become obsolete over time. Imagine if your whole business was centred around manufacturing plastic VHS cases or even portable sat nav devices to affix to your car, both are near-obsolete now.

Take a look at the industry as a whole, and ensure that you understand the threats to it on the horizon. The last thing you want is to invest in a sector that’s sliding into insignificance.

 

22. Movement amongst competitors

This can throw up red flags when buying a business for a number of different reasons. Take a careful look at what the company’s rivals are doing at the moment. Are they all struggling? If so, this could suggest the start of a wider industry decline.

On the other hand, if its competitors are expanding and pursuing growth strategies, this could spell a decrease in market share for the business you’re looking at.

 

23. No potential for growth

On the subject of growth, how much potential does the business have?

Buyers may not be too concerned with growth if they’re purchasing a low-risk, low-reward venture such as a corner shop or laundrette. For most though, potential for growth is a key factor in their decision to buy.

Bricks and mortar businesses set within an area with limited potential clients can only go so far before they would have to set up extra branches elsewhere in order to grow. However, if the company doesn’t make enough money to make such plans feasible, then such plans are unlikely to materialise.

 

24. Zoning legal restrictions

Any business with legal restrictions on where it can trade will make growth plans difficult from the off. You may find that other areas become available, but these may need to be paid for. Check for any such restrictions before committing any further.

 

25. Pressure to complete the deal

Has the seller been actively chasing you up for developments since you showed an interest?

Pressure from an owner to close the deal can make them seem desperate. In these scenarios, buyers should wonder why they’re so keen to wrap things up quickly.

Of course, everybody likes a quick and simple transaction. If the selling party seem more agitated to complete than you’d expect, then it could mean that trouble is on the horizon for the business.

 

26. Owner unsure about selling

On the flipside to the above, if the seller is dragging their heels, it suggests that the company may be in decent health but may throw up some different issues entirely.

If the owner keeps changing their mind about whether to sell, you might be best to pull out early on. There are a number of expenses involved in the acquisition process, and you’ll need to devote plenty of time to it too. Should the seller pull out last minute with a change of heart, you could find yourself out of pocket.

 

27. Equipment issues

Try to get a handle on what equipment the business relies on, and how much it costs to replace.

If a key piece of machinery needs replacing soon, it could saddle you with a bill that could potentially cripple the business. Check on servicing records and ask to see key equipment in action.

It could also be difficult to source replacement parts for older or less common machines. Bear this in mind when thinking about potential costs.

 

28. Suspicious seller

We’re often taught not to judge a book by its cover, but equally, you should also know when to trust a ‘hunch’.

If the owner seems like a ‘shady’ type of character that you’re uncomfortable dealing with, it’s often best to walk away from any deal. Even if everything is above board, you may find that they have run their business in a way that doesn’t sit comfortably with you as a potential owner.

 

29. Artificially inflated valuation

It’s worth having an independent valuation conducted on any potential acquisition. Our own free valuation calculator is a great place to start.

Some sellers may be tempted to inflate the value of their business by adjusting factors such as its SDE (Sellers Discretionary Earnings). Such factors should be carefully examined by an expert to ensure that there are no erroneous components propping up the valuation.

 

 

30. Seller understates their importance

Some businesses rely on its owner to function. Take that person away, and there’s no real business to buy. In such instances, the owner may talk down how much they do. If you sense a disconnect between what you see and what the seller tells you, don’t just put it down to modesty. They could be concealing their importance to the running of the company.

 

31. Seller tells you there are no problems with the business

As any business owner will attest, there’s always something within a business that requires attention. In a similar way to buying a car, you’d find the seller that mentions a car’s issues more trustworthy than one that tells you everything is perfect.

The business may still be worth buying, but do your research before believing any such claims from sellers.

 

How to deal with red flags when buying a business

It’s always worth explaining any concerns you have with the seller. They may be able to amend the issue or put your mind at rest. With some of the more minor problems, it could even serve as a bargaining tool if you’re still tempted to go ahead.

A business acquisition is a large undertaking and responsibility to take on. You shouldn’t feel any pressure to close a deal that doesn’t feel right. Other opportunities will present themselves in the future, and each failed purchase only serves to make your acquisition skills sharper in the future. While you may fear that you’re missing out on a means to make more money, remember that money saved is often as good as money earned in certain circumstances.

 

Let us ease the stress of buying a business

We specialise in helping potential buyers to avoid the myriad pitfalls that can turn a business purchase sour. Acquisitions take a lot of time and effort to do right, and we know that our clients don’t always have enough hours in the day to do everything they’d like.

As business sales specialists, we navigate the complexities of company purchases for our clients to ensure that they acquire the right business for them. Call us on 0800 975 0380, or email [email protected] for a free consultation.