Should your clients be buying and what are the risks?
Between the Baby Boomers pending retirement, those who have had enough following COVID, rising interest rates and changes in the economy, many people are looking to sell their businesses. So, should your clients be buying and what should they consider?
Whether your client is buying their first business or an additional one to augment an existing business, it’s a great way to generate income and wealth. And an established business can provide immediate cash flow and reduces the risk of failure that is more likely to happen in the startup phase.
But, as advisors, you’ll firstly want to ensure your client knows what they are buying.
When clients can’t see past the physical assets they’re buying or how much profit the vendor tells them they will make, it’s important to understand what they are actually acquiring.
Future profit stream
Your client is buying the future business profits. That’s a combination of what the physical and intangible assets can produce in the future—not how they’ve performed in the past.
Your client is also acquiring risk. These can be:
The profit stream might not occur.
The market changes.
Competitors entering the market.
Liability for any harm or damage the business creates.
Responsibility for employee actions etc.
Confirming the assets and understanding risk of the business through both accounting and legal due diligence is essential. Some critical areas to consider are as follows.
Cash, cash, and more Cash
Four key cash-related issues to check are:
Cash does not exist. When your client is told the actual profit is higher because they get a lot of cash that’s not declared. It does not exist, and your client should not pay for it. Offer to have the Australian Taxation Office (ATO) verify it.
Cash paid to the ATO. Verifying what cash is paid to the ATO for BAS and income tax payments is one of the best ways to verify turnover, expenses, and profit. Given many people dislike paying tax, it’s normally a pretty good guide of the real situation. If a vendor refuses to provide access due to confidentiality, this is a reason to walk away.
Cash taken by vendors. See if the business paid the vendor a real return in cash. See how the cash taken was financed: did it come from the cash flow the business generated (i.e. what we want to see) or was it funded by increasing creditors, e.g. ATO debt, or other financing.
Cash-flow forecast. Can the business pay for itself. Does it generate enough cash to pay back any interest and debt taken on to acquire the business. Can it still provide your client with an income while paying off the debt?
Who’s going to run the business?
Many businesses being sold have family members in all the key positions. Are any of those people staying on with the business sale or does your client have a recruitment challenge ahead? And if some family members will continue with the business, will they be committed to your client’s standard of work?
Goodwill that lives as intellectual property in the vendor’s head is not goodwill. Are the procedures, process, and critical information such as customer details and methods of operation, documented? If not, they will leave with the vendor.
Is the vendor a good corporate citizen?
Ensure they have all the appropriate registrations and licenses. Check to make sure they have a good ATO track record. Do a credit check. Choose your favourite search engine and do searches on the business, the vendor, and its directors. Your client doesn’t want to inherit a bad reputation.
Sudden business improvement
If the business profits suddenly improve before the proposed sale, additional investigations are required to verify the true financial position. It may be an indication of poor compliance in the past or greater risk.
Will further investments be required?
When inspecting the business premises and assets, it’s important to assess what further investment is required for the business to maintain its earnings. Is equipment nearing replacement; are the premises big enough or do they need upgrading? Will your client need to move to and fit out new premises?
If it’s an additional business for your client
What is the integration process? Are there additional costs to integrate? Do the systems used by both businesses integrate? How will staff work across both businesses?
Do a PPSR search to make sure your client will get clear title to any business property they are buying.
Review the lease and speak with the landlord to ensure your client will have tenure. Look to renegotiate to extend the lease if necessary. If there are any unusual clauses make sure your client understands what they are committing to.
Finally, getting both the structure of your client’s entities and the deal right are going to greatly influence the client’s financial and tax position, the level of risk they are taking on, and their asset protection. We see many situations where poor or ineffective structuring of the client’s entities and purchases lead to poor financial outcomes, greater tax, and place their assets at risk.
For assistance with your clients’ business purchase, please connect with your Worrells contact to discuss how we can assist you and your client. We can help to put your client in the best position for maximising their returns from their new business while keeping risk to a minimum.