DESKTOP REVIEWS AND SCREENING

Your research to this point may have generated you a sizeable list of potential target companies in the right industry and location. Based on some other databases available you should also have an idea of the businesses’ size in terms of either turnover or number of employees.

You will then need to reduce this to a manageable number to approach or at least to prioritise them in order of attractiveness so you can concentrate your efforts on those that appear to best suit your needs.

You also need to be as well prepared as possible before you make that initial approach so as to have an idea what questions you want to ask, and be considering your strategy for persuading the owner to sell the business to you.

So the next stage of the process is to:

• find out as much as you can about each business, which means identifying both financial and non-financial information
• refine your research as you go, moving from desktop reviews to more detailed examination as you focus down on the businesses that are really of interest
• undertake a desktop review of the available financial information on the business to obtain a picture of the business’s performance.

Since many people lack confidence in their ability to understand or extract useful financial information from accounts, this chapter will set out some basic things to look for that will apply to most sets of accounts. If, however, the business has reached the stage where the accounts contain significant numbers of pages of notes to the accounts you may need to take professional advice.

SOURCES OF NON-FINANCIAL INFORMATION

Many sources of non-financial information have already been touched on, such as the company’s website, trade associations and public or government websites about the industry. But don’t forget the step of contacting the company.

• Ring for a brochure. See how professional both it and the service you receive is. Sometimes it is interesting to see whether you get a subsequent telephone call to follow up your interest as a potential customer who has contacted the business. I am always amazed when this doesn’t happen.
• Try emailing for a brochure from the company’s website or use their contact point to ask a question. Do you get a response? The number of businesses who operate a website that appears to be connected to a black hole for customer inquiries is another constant source of surprise to me.

If you come across either of these situations you may find there are some very easy steps you can take to improve the business’ sales performance following your purchase.

As you narrow your search down, there are many practical things that you can do to check out the business before you approach. In fact for individuals looking at buying some of the smaller types of businesses such as shops and restaurants, these activities can form a central part of your due diligence:

Observe the business

By spending some time both during the week and at weekends watching the numbers and types of people that are visiting the business you can get some idea of:

• The customer base – is it all old people or is it a good mix of old and young that suggests a long lifetime of customers?
• What type of people are they? Do they look wealthy, with money to spend or not?
• The variability of trade – is it busy all the time or are there definite highs and lows?

Check the local media

• How effectively is the business promoting itself? How does this compare to its competitors’ promotional activities?

Check the locality

• Are there large numbers of competitors? Dependent upon the nature of the trade, this can be a good thing. A ‘cluster’ say of antiques businesses or art galleries may bring many more potential customers to an area so that all the businesses benefit. Of course it can also be a disadvantage as an oversupply of, say, care home places, may push down the rates that can be obtained.
• Do any of the competing businesses seem to be doing significantly better than the one you’re looking at? If so, what appears to be the cause?
• Do customers specifically come to the business or does it rely on passing trade? Is one side of the street busier than the other?
• Is there a good local transport system to bring customers from the surrounding area?
• What are the neighbouring businesses like? Is the business surrounded by complementary ones, residential areas or industrial units?
• Are there any particular location issues in respect of the particular type of business you are looking at?

Make inquiries

• Talk to the competition. Try using their shop, restaurant or bar as a customer and get into conversation about how business is. Most business owners are happy to talk about their business as part of promoting it to customers so long as you choose the appropriate moment. So ensure you pick a quiet time of day when they’re not likely to be busy.

Be a mystery shopper

• If possible use the business as a customer, and/or ask your friends and relatives to use it. Try to observe how good the service is, how content the customers appear to be, whether there seems to be a strong regular clientele.

When the property is important

Many of the smaller businesses that an individual might typically be looking to buy (such as shops and sub post offices, pubs, hotels, guesthouses and holiday cottages, restaurants, nurseries and care homes) are in many ways as much about buying the premises as about buying the business. When looking at these type of businesses you should focus initially on the property:

• From looking at a map or visiting the area, is it in the right location to attract the customers that the business needs? What are the local conditions like in terms of competitors, property trends and trading conditions?
• From walking past, what condition is the building in? Will it need significant refurbishment or alterations to meet future trading or regulatory requirements?
• From undertaking a Land Registry search (www.landregisteronline.gov.uk), what tenure would you expect to be getting? Is the property a freehold or are you buying a lease? (If so you will need to find out the terms early in your discussions with the owner.)

As with any property matter, the old rule – location, location, location – applies. You can always make alterations to the physical structure of the building (obviously with the landlord’s consent if it’s a leasehold). But you can’t move it.

So if the business needs a car park but hasn’t got room for one, or if the place is difficult to find, or in a location that is not appropriate for this type of business then you need to think seriously about whether this is right for you.

This whole issue of the property becomes even more important in the case of businesses which include the owner’s accommodation, as you are not only buying the business and the property from which it operates, but a home as well.

Only if you’re satisfied with the position in respect of these property elements should you be going on to look at the financial aspects of these types of business and their trading performance.

FINANCIAL INFORMATION

If you are looking at a business that is actively for sale you should expect to receive copies of audited and/or management accounts in the sales pack. If not, you will need to rely on what you can obtain from public sources.

Sole traders and partnerships

If the business you are looking at is currently operated either as a sole trader or a partnership you are unlikely to be able to find any significant financial information in the public domain. This is because since sole traders and partnerships are in effect people trading in their own right, they do not have to file public accounts and simply account to the Inland Revenue for the tax on profits as part of the individual’s or partners’ personal tax returns.

The principal exception to this will be any information that you may be able to obtain on such businesses through various credit referencing agencies.

Limited companies and partnerships

If the business is currently operated through a limited liability partnership or a company it will, however, have to file accounts at Companies House and as a minimum you should undertake a search (www.companieshouse.gov.uk). The principal documents that this can provide you with are the company’s:

• memorandum and articles of association – in effect the company’s objectives and its constitution. For the purpose of most business sales these days, these tend to be of little relevance but every so often a situation comes along in which these are vital, as they can, for example, set out that different classes of share exist with different voting and ownership rights
• annual return – a form completed every year by the company secretary which sets out details of the directors and shareholders (although since this is always only a snapshot you also need to check the register of shareholders for the current position)
• register of charges, which records the security given to third parties such as a mortgage over the company’s property or a fixed and floating charge to the bank to secure its overdraft
• copies of any forms notifying Companies House of changes in the company’s registered office or directors
• annual accounts in the standard statutory and UK Generally Accepted Accounting Practice (GAAP) format, which should provide you with information on the business’s financial position and performance.

HAVING FAITH IN NUMBERS

If you are not familiar with reading accounts there are some general rules that you should bear in mind throughout this chapter:

• The numbers don’t tell you what you need to know. As will hopefully be made clear below, they are guides to help you work out the questions to ask and consider what plans to put in place; and they can help you to test whether information you may be given later is right.
• The numbers are produced as a result of how the business is being run, they are symptoms and evidence of what is happening, not the cause.
• The trends in the numbers (over time, such as growth, or in comparison to other similar businesses, known as benchmarking) tend to be more important than any individual absolute figure.
• Publicly filed numbers will always be significantly out of date.
• Do not be fooled into thinking that the numbers are ever absolutely ‘true’, as any set of accounts will always be a matter of judgement. For example, a company should provide for bad debts, which means recognising the cost of the bad debts in its profit and loss account and reducing the value of debtors on the balance sheet. But how much it should provide is a matter for the directors’ (reasonable) judgement.
• The degree of analysis that you will be able to undertake will be completely dependent upon the extent and quality of the data that you are able to obtain. You may need to revisit your financial analysis as more information becomes available during your discussions with a target.
• The numbers should be used to plan your actions for the future if you acquire the business by setting quantified and measurable financial targets for the business (e.g. reducing average debtor payment time to 45 days by the end of the first quarter) as part of your plan. You can then use the financial information to monitor your progress.
• But the actions you will have to take to make these financial results appear will be real actions in the real world, such as setting tight credit terms for the customers, issuing statements, picking up the telephone to chase in the money when it is due, and putting customers on stop if they don’t pay.