The 4 Biggest Red Flags to Look for When Buying a Business

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When buying a company, you cannot afford to get carried away by the emotions of the process and you certainly cannot turn a blind eye to anything. Every single “corner” must be uncovered, analyzed and carefully considered. Failure to do this could result in a bad investment that will eventually haunt you.

As you conduct your analysis and due diligence, there are certain red flags that you should be on high alert. They don’t necessarily mean you can’t buy the deal, but they do raise suspicions. In this article, we explain what they are and why it’s best to avoid them.

Keep an eye out for these warning signs of due diligence

Most businesses fail. That’s just the cold, hard truth. The research shows that 20% of businesses fail within the first year, while about half collapsed by the five-year mark. After a decade, only a third of the companies are still operational. Even though the company you are interested in has gotten through the first few years, you still have some challenging times ahead. Avoid making things more difficult than they need to be by paying attention to the following red flags and warning signs.

See also: 10 questions to ask yourself before buying a business

1. Declining sales figures

Seen in isolation, declining sales figures are not a problem. (Sometimes they will actually give you leverage to acquire the business at a lower price and then make some simple fixes to bring the earnings back to normal levels). However, if there’s a long-term trend, do your research to find out why.

For example, let’s say these are the quarterly sales for the last two years:

  • Year 1, Q1: $1 million

  • Year 1, Q2: $2 million

  • Year 1, Q3: $3 million

  • Year 1, Q4: $1 million

  • 2nd year, 1st quarter: $750,000

  • Year 2, Q2: $600,000

  • Year 2, Q3: $500,000

  • 2nd year, 4th quarter: $350,000

A quick look at these numbers will tell you that something is wrong. This is more than a small problem. There is a fundamental problem with the business model or the market. Even if you can buy the company at a fair valuation, there should be bigger questions about whether or not the deal can be flipped. This may be a situation where there are factors at play that are beyond your control.

2. High pressure sales pitch

A good company reputation and balance sheet speak for themselves. There is no need for a big sales pitch from the seller. If anything, they should be the one with the leverage and soliciting offers from buyers.

If you’re on the receiving end of a high-pressure sales pitch, ask yourself why that might be the case. Chances are the seller wants to unload the deal quickly. There may be valid reasons for this, but also some concerns.

See also: 4 things to consider when buying a business

3. Back on taxes

Don’t just take a company’s internal financials at face value. Obtain tax records for the last three years (at least) and make sure they match the information in the company’s financial statements. If the numbers are wrong or something smells funny, examine it carefully.

4. Questionable past

Look beyond the balance sheet and finances. You also need to consider the company’s brand and industry presence.

The easiest way is to do a Google search for the company’s name and study the first few pages of the results. Read everything you can get your hands on. This includes blog posts, social media posts, news, images, videos, reviews, testimonials, independent review sites, founder interviews, etc.

As you research, make notes of anything negative. This can be as simple as a one-star review on a product, or as serious as a legal matter. Because here’s the thing: once you’ve bought the company, any problems the previous owner had immediately become yours. It doesn’t matter if you weren’t affiliated with the company when someone wrote a scathing review or article, it will follow you. This is not necessarily a reason for not Buying a business, but it should pause you to make an even more careful evaluation.

See also: The benefits of buying a business versus starting your own

Never underestimate the importance of rigorous due diligence when acquiring a business. While this review process can feel exhausting and overwhelming, it is an important part of the process. Not only will you dig up the proverbial skeletons in the closet, you may find hidden benefits and bright spots that you weren’t previously aware of.

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