To help appreciate the volume of information that has to be shared when selling a business and, relatedly, how even evaluating the simplest, small business involves considering various important issues, let’s briefly consider the types of key topics a buyer will want to understand when trying to analyse and value a few different example businesses. These lists of potential buyer questions and issues are not intended to be exhaustive. Rather they simply serve to give a sense of how even for a so-called “simple” business, there will be a lot of questions to answer and a large amount of information that has to be communicated to a potential buyer.
This article is part of our multi-part series - A Basic Primer on Selling a Business. See the other parts of this series here.
A downtown hot dog street vendor
Let’s consider a one-person street vending business, with a mobile hot dog trolley, catering to office workers at lunchtime. In the spectrum of businesses, this should be very simple. But even such a seemingly simple business raises plenty of questions that a buyer will want to explore in order to understand it and value it.
- Permits and location: What determines where you get to set up your stand? Do you need a permit? Who issues it? Is it hard to get? What does it cost? Can a competitor displace you from your preferred location (for example, if he or she gets there first in the morning)? Are there any prospects to increase sales by moving to a better location? Are there restrictions on what kind of things you can sell from your trolley?
- Equipment: What’s the state of the hot dog trolley? What did it cost? Who sells them? What repair and maintenance does it need? What kinds of things can go wrong with it, including the cooking equipment? Where do you store it and how much does that cost? How do you transport it and how much does that cost?
- Sales: What do you sell, who do you buy your supplies from, what prices do you sell at and what margins do you make? Do you have multiple suppliers to choose from? What’s happening to prices? Is there price-cutting and fierce competition among competitors? What about product quality, are some competitors selling inferior hotdogs at “normal” prices? How predictable are your sales volumes and what variables (such as the weather and seasonality) influence them? Are there ways you can pre-plan your purchasing volumes more accurately to avoid getting left with unsold, spoiled inventory?
- Strategy: Do you see any opportunities for growth? Are there any unserved locations that you could target and expand into? Could you offer more than lunchtime food? What would you have to sell and is there enough volume in any such new product lines to make it profitable? Could you improve your margins by focussing on a particular market segment, such as offering premium hot-dogs (at premium prices) to more affluent customers? Or would a volume strategy make more sense, in which you offer basic hot dogs and sell more volumes overall? Is there something totally new, “outside the box” that you could start selling, responding to new trends in fast food tastes?
A pencil manufacturer
Now let’s take the example of a pencil manufacturer that operates from one factory and sells only domestically in its home country. In a generic way, many of the questions listed above for the hot dog vendor example are going to apply here also. And here are some particular additional thoughts about what a buyer might want to investigate closely.
- Sourcing and procurement: What are the trends in availability and pricing for your key inputs (wood, lead, eraser material, metal tubes, paint, packaging)? What are delivery times and are there long lead times for ordering any of these key inputs? How are relationships with these suppliers managed? What are the key terms of your important purchasing contracts?
- Facilities and equipment: There will be heavy manufacturing equipment at the factory: what is its remaining lifetime and current repair and maintenance costs? Is any of it obsolete? Are there opportunities for capital investment to improve production volumes or quality? How long have you operated your current factory and are there any hazardous materials used in your manufacturing processes? Have you had any compliance or safety issues with how you handle these materials? Do you own or lease your factory? If it’s leased, for how long and what are the terms?
- Human resources: Who is your management team and who are your key employees overall? How are compensation and benefits generally structured in the business? How many employees do you have and on what basis are they employed? Are there any unionised workers and, if so, how have union relations been? Are there any industry-wide employment agreements that apply to part of your workforce, even if they are not unionised, just because of the industry you operate in?
- Sales and Marketing: How is your sales team organised and are sales people remunerated in ways that seek to incentivise them to maximise profit for the business overall? What brands do you sell your products under and what is the strategy behind each of them? How do you protect these brands legally? What are the terms of your typical sales contracts? And what line of sight, if any, do you have into future sales volumes with key customers/distributors?
- Finance and legal: How much debt does the business carry? On what terms and at what interest costs? What collateral do you lenders have for these loans? Do you lease any of your equipment or vehicles? Looking at your corporate legal arrangements, has the business been declaring dividends in the past or re-investing net income? How would future dividends be taxed? Does the business need any special permits or licenses, and if so, how are those obtained?
- Strategy: What’s happening to pencil sales generally? Are electronic devices causing a downward trend in sales of pencils and paper? What do you view as your competition (only other makers of similar products, or also including mechanical pencil makers, or other electronic forms of text writing, like with styluses on a tablet)? What is the product segmentation in the world of pencils? Presumably some pencils with higher quality features (more fancily painted surfaces and better erasers) can be sold at higher prices? What’s your distribution channel, entirely through wholesalers? Is there any scope to start a direct-to-consumer sales channel, for example by direct online sales? Do you do any “white-label” sales (supplying others with products bearing their brand, instead of yours)? Do you have any new product ideas or initiatives?
It’s not hard to see that even so-called simple businesses involve lots of enquiries from and communication of information to a potential buyer. And it is not hard to think about other types of non-manufacturing businesses that raise whole other categories of issues. For example, buying a professional services business (like a law, accounting, consulting, design or recruiting firm) will involve close consideration of things like the typical terms of business; how business is won and how projects are analysed, monitored and screened for profitability; employee remuneration, satisfaction and turnover; the evolution of the marketplace and any competitive or technological threats for the advice/analysis being offered; trends in pricing and employee compensation; and office lease terms. Or buying an enterprise software business (that sells a software product to businesses on a subscription basis) will involve close examination of competitor products and the strategic landscape; customer retention/renewal levels; rates of sales growth; the sales channels and strategy; sales force composition, location and remuneration; potential for segmenting the customer base and migrating some segments to higher margin product offerings; and the software development pipeline, including budget and timelines.
There’s one consistent theme here: a buyer will have a lot to learn and a ton of entirely reasonable questions (including buyers that already know the industry), meaning that there will be a huge amount of information that has to be communicated–so that the fluid, dynamic organisation that we call a “business” can first be understood and then valued somehow.
Continue reading our multi-part series:
A Basic Primer on Selling A Business
- Part 1 - Why selling any business is a challenging information-sharing process
- Part 2 - Case studies in selling a business as an information-sharing process
- Part 3 - The role of financial statements and the misguided view that they are all that matters
- Part 4 - What are the key stages in the process of selling a business
- Part 5 - How do people value a business?
- Part 6 - What kinds of information will buyers of a business want to see?
- Part 7 - How to handle the “bad news” about a business being sold
- Part 8 - What legal issues will buyers usually be concerned about when reviewing contracts?
- Part 9 - Summary: An Overview of Business Sale Processes