Buying a business is one of the biggest financial decisions you can make. And here’s the first thing I tell buyers:
Don’t buy the business. Buy the cash flow, the systems and the opportunity.
I’ve watched buyers get excited about a restaurant because they love the food, a contractor because they like construction, or a business because they think the industry is “hot.”
That’s backwards.
Here are 10 things I look for when evaluating a small business.
1. Cash Flow
Revenue is nice. Cash flow pays you.
Look at Seller’s Discretionary Earnings, EBITDA where appropriate, margins and the consistency of earnings. A $2 million company that doesn’t generate cash can be a worse acquisition than a $750,000 company producing dependable SDE.
2. Recurring Customers
A business with customers who come back is fundamentally different from one that has to find new customers every morning.
Recurring revenue, maintenance contracts, memberships and repeat customers reduce acquisition risk.
3. Transferable Employees
If the seller leaves Friday and the business falls apart Monday, you aren’t buying a business.
You’re buying a job.
Look for employees who understand the operation and can continue serving customers after the transition.
4. A Good Lease
For restaurants, retail and many service businesses, the lease can be one of the most valuable—or dangerous—assets.
Review rent, term, options, increases, assignment provisions and landlord requirements.
5. Clean Financial Information
The books don’t have to be perfect.
But you need enough information to understand how the business actually makes money.
Tax returns, P&Ls, bank statements, POS records and merchant processing can all tell part of the story.
6. Multiple Customers
If one customer represents 40% of revenue, that’s a risk.
If that customer leaves, your cash flow could fall off a cliff.
Customer concentration deserves serious attention during due diligence.
7. Equipment in Good Condition
A business can look profitable until you discover that the $100,000 piece of equipment needs replacing.
Understand deferred maintenance and future capital expenditures.
8. A Transferable Reputation
Does the customer relationship belong to the company—or the owner?
That’s an important distinction.
9. Growth Opportunities
Don’t pay the seller today for growth you intend to create tomorrow.
Instead, identify where growth can come from and determine whether you have the skills to capture it.
10. A Business That Fits You
This may be the most important.
A great business for someone else may be a terrible business for you.
Your skills, capital, lifestyle and risk tolerance all matter.
For more on my philosophy of buying businesses, start with my [10 Commandments of Buying a Business]. 10 Commandments of Buying a Business