Don’t buy a ‘pig in a poke’

2008-04-22 00:00

The expression “a pig in a poke” means to buy something that has yet to be examined. Last week I looked at some considerations of buying a business from the perspective of determining a value or realistic buying price.

One of the most important considerations with regard to this is to ensure that, indeed, you don’t buy a pig in a poke.

This means, once you have set a tentative buying price, you need to establish whether the business is truly worth that price.

The term used to describe this process is called “due diligence”.

If the seller is serious about selling his/her business, they should be willing and supportive of your investigation.

In respect of due diligence, if you are not an accountant, lawyer or highly competent at interpreting financial statements yourself, spend the money and employ a professional to carry out this task — you could save yourself a lot of money.

The size of the investigation will depend on the nature and complexity of the business. At the least, it requires evaluation of the business’s funding, analysis of future prospects and, most importantly, establishing ownership and value of the company’s assets, both fixed and current, and the extent of its liabilities.

Don’t assume that the business owns the assets you see within its framework. It may not. Ownership could rest with a completely separate company.

Equally, the business may possess a very large level of stock. The questions to answer are, how valuable is this stock, and is it paid for? It is of no value if the stock is outdated or inappropriate to future sales’ needs.

Everything needs to be in writing. At the meetings to discuss each of the stages of the possible purchase, the buyer should take notes (minutes) of all the discussion and decisions. These should be signed and dated by both parties at the meeting’s conclusion — it is amazing how quickly people forget what they have said or agreed to.

Buying a SME can bring with it some problems unique to such small businesses. You may find there are no formal accounting records at all. It is almost a case of what you see, you buy.

The truth is, you don’t buy under such conditions. These circumstances suggest you have to become a bit of a Sherlock Holmes. This demands you ask yourself: “Why do I want to buy this business? Why not just start-up my own business?”. If the answer is, “I need to buy this business”, then the homework needs to be done and done thoroughly.

The best place to start is with the company’s bank statements. These will give information, not just in respect of revenues, but also in respect of liabilities; for instance, VAT and PAYE payments, personal drawings and cash-flow in general.

The conclusion that such an investigation could lead you to, is: “I won’t buy the company, but perhaps I will buy the right to manufacture/sell the products owned by the company”.

I have witnessed too many businesses failing because the nature, form, structure and price of the original acquisition were blatantly flawed and the new owners truly bought a pig in a poke.

They paid for what they thought they were buying, not what was really being sold to them. They acquired liabilities they had no idea they were becoming responsible for. The business was doomed to fail from the very beginning.

The conclusion: let your preliminary investigations agree on a ballpark acquisition price, then conduct a thorough analysis of all the operating circumstances to confirm or otherwise value the price.

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