What are Good, and Bad, Questions to Ask When Buying a Business?
Thinking of good, and bad, questions to ask when buying a business is useful in many ways. And it’s not just for buying a physical business with staff, a premises, physical products etc. It can be a digital business or website where perhaps there aren’t any employees or premises or all the other concerns such as rent, insurance to think of.
Plus we can also use these questions to evaluate the purchases or mergers that happen in public companies that we may want to invest in.
At the time of writing this article in February 2023, Elon Musks’ purchase of Twitter is still in the public consciousness, so you can use these questions to make up your own mind about whether this or other mergers/acquisitions were good deals.
Then you can invest accordingly, let’s say buy shares or calls if you think it was a good decision, and perhaps buy puts if you think they made a bad decision based on the questions below.
Let’s take a look at some good, intelligent questions to ask when buying a business:
Perhaps the most obvious one, and the one that can be open to interpretation. Warren Buffet has the reputation for finding undervalued companies, Carl Icahn the same.
They surely ask themselves these questions before they invest, so it is good to try and replicate their mindset. Then on the opposite side of this there are probably many examples where these questions, or their answers, were ignored and people bought very bad or overpriced businesses.
- What are the financial statements for the last 3-5 years?
For public companies, this information is available on the SEC website, you can read more about how to find out how much a business sold for here, we use Elon Musks’ Twitter purchase as an example and examine the SEC filings to calculate the valuation ourselves.
- How does the business generate revenue and what are the costs associated with running the business?
- How does the business perform compared to the industry averages?
An important metric here when comparing public companies is their p/e ratio which is their price earnings ratio.
Public companies will report their EPS Earnings Per Share every quarter, let’s say it is a $1.30 EPS, and their share price is $17.50, then their p/e ratio is :
$17.50 / $1.30 which is around 13.5
and you can now compare this to other companies in the same sector. The lower p/e ratio the better, but of course the market can be irrational longer than you can stay solvent.
So those companies with a very high p/e ratio can continue to rise in price which may seem inexplicable. Unfortunately there are no hard and fast rules in the stock market, if there were then we could all get rich.
Market and Industry:
It can be quite easy to research competitors for digital businesses, many great tools are available for free, for example Mozbar is a browser extension from Moz, it allows you quickly and easily see how "strong" a website is, and they have other similar free tools.
There are some extremely powerful online tools that are available at a reasonable price such as Ahrefs, Semrush. There is also Similarweb which compares key metrics of competing websites and many more.
For regular businesses we need to put in the work to get the data we want. However, the internet is still the best place to start your research but a lot of information may not be made public.
- What is the size of the target market and how has it evolved over time?
- Who are the business’ competitors and how is the target business different to them?
- How will the industry grow in the future and how could this affect the business?
Probably more of a concern for bricks and mortar businesses with in-person customers but these factors all need to be considered when buying a business
- How does the business operate on a day-to-day basis?
- What are the processes for managing inventory, production, and distribution?
- How does the business handle customer service and support?
Staff and Management:
Again Warren Buffet placed huge emphasis on staff and management of companies he bought, you can read through his thoughts on this in the Berkshire Hathaway Letters to Shareholders which goes right back to the 1960s.
Here are some questions worth considering:
- Who currently runs the business and what is their experience and expertise?
- What is the current staff structure and how is it managed?
- What is the current management structure and how is it likely to change in the future?
Legal and Regulatory Issues:
Some of the answers to these questions can be found out from government agencies. If you can hire a lawyer then they can check into these areas so that you don’t have any nasty surprises after completing the purchase of the business.
- Are there any pending legal actions against the business?
- What permits and licenses does the business hold and are they up to date?
- Are there any potential regulatory changes that could impact the business in the future?
Future Plans and Strategies:
Sometimes the purchaser can be so focused on completing the purchase that they haven’t put a strong plan in place on how to run the business in the future. Ideally you should even be looking ahead to the point of when you sell the business in the future.
At the very least you should have plans on how to grow business, if you don’t then perhaps purchasing the business is not the best idea.
- What are the plans for future growth and expansion?
- How does the business plan to handle any potential challenges in the future?
- What is the exit strategy for the current owners and how does this impact the future of the business?
These questions can be a starting point and you should have more questions prepared that are specific to the business you are looking at buying.
As we mentioned having a lawyer to ask specific legal questions is a good idea, you can’t be expected to know everything. Likewise there are other professionals that can help guide you through the process that you can consider working with such as a business broker, accountant, or consultant.
What are Bad Questions to Ask When Buying a Business?
Just as important as good questions to ask here, are some ba questions to ask when buying a business:
- How much can the seller lower the price?
If you ask this question too early in the purchasing process then it could lead to bad faith with the seller. By trying to get a discount it could backfire and make them less open to negotiation in the future, instead try and create a rapport with the seller which can benefit you in the long run.
- Can you give me a complete list of all the current problems and issues?
In many cases the seller is not legally obligated to give you this information, your lawyer should know what they must reveal to you. Caveat Emptor or “buyer beware” is very important, so you should be doing your own due diligence. If the seller really wants to sell then they will probably do their best to not reveal problems and issues.
If a seller is revealing many problems and issues then you might want to reconsider purchasing it. Or perhaps they could be bluffing you by trying to put you off a really good deal as they want to hold onto their business! Who knows.
- How much will I make if I buy this business?
If only life, and business, was so simple. We would all love to know how much a business will make in the future. Sure, we can make our forecasts, and certainly in public companies this is a very important part of earnings as companies give guidance for the future and it can affect their share price positive or negatively.
However this question also doesn’t reflect well on your as a buyer and again my show bad faith on your part.
- Can I get a discount if I pay cash?
This question is valid in many transactions, it is even common in large transactions such as buying a house or car, but it can make you look cheap and unprofessional when buying a business. It simply may not be possible for the seller to offer a cash discount.
- What is the return on investment (ROI)?
The return on investment ROI of a business can be a complex calculation that depends on many factors. Again caveat emptor, ideally you know should know a lot about the business and industry so you can arrive at this figure yourself. The seller almost certainly will not want to spoon feed you.
Overall it's important to approach buying a business in a professional and respectful manner, and to avoid asking questions that might undermine the seller's confidence in your ability to run the business successfully.
You might also be interested in what does it mean when a company's corporate spread tightens and what is an EBITDA bridge.