Small Business

License article

Buying a bargain could be risky business

Many small businesses are going cheap in this soft economy, but potential purchasers shouldn't be seduced by low prices and the chance to be their own boss, experts warn.

They still need to be fully informed about the industry they're entering and the business they're buying.

Small businesses typically sell for about twice their annual profit, known as maintainable earnings, although the precise amount obviously varies from industry to industry and business to business.

The good news is the selling price is down from about three times earnings before the global financial crisis. But this has to be balanced against the risk of buying a business in a weak economy.

John Rickard, a business broker with Barrington Corporate Services and a committee member of the Australian Institute of Business Brokers, says potential buyers should consider why they want a business and whether the one they have in mind fits their needs.

For example, are they looking for an income, an investment or a lifestyle? “If all they're looking to do is buy a job, they want to get as good an income as they can against their investment,” says Rickard. “They're probably not all that concerned about what they're going to do.”


But he cautions against buying a business in an industry the new owner has no interest in.

“Invariably people who buy businesses they do not have any interest in, involvement in or commitment to will have trouble making that business succeed,” he says.

“If they have a genuine interest in the industry they're getting involved in then they will learn from experience".

Rickard says buyers will often receive training and exposure from the vendor.

Business owners should fully research the industry they're thinking about entering, looking at the outlook and challenges for the industry sector. Reports from IBISWorld or can provide a starting point.

Glenn Cosgrave, of professional services firm Bates Cosgrave, advises prospective buyers to check the business has been registered properly and ensure it has an ABN. They also should make sure its tax and GST obligations are up-to-date.

Invariably people who buy businesses they do not have any interest in, involvement in or commitment to will have trouble making that business succeed.

The federal government's Personal Property Securities Register at is worth visiting, to ensure there are no charges over the business' assets. “The existence of multiple charges might ring alarm bells,” says Cosgrave.

Potential owners need to think about the corporate structure of the business they're about to purchase. Cosgrave recommends buying the business itself rather than the company that owns it because it will be easier to structure in a tax-effective way.

Next comes valuing the business. Purchasers need to look at the asking price and calculate the likely return by analysing the business' past performance. Most people will need to call in an accountant to do this.

Marc Peskett, a partner at professional services firm MPR Group, says, when looking at a business' profitability, it's important to ensure the owners are paying themselves a reasonable wage on top of the profit.

As part of this consideration it's worth establishing things such as whether the business owners work 60 hours a week or employ family members at below market wages.

Wages aside, it's also worth finding out whether a vendor is paying full market rent for the business' premises, says Peskett.

Potential purchasers should try to calculate what the return on their investment would be after they have paid themselves a wage. For instance, if they spent $200,000 buying a small business that returns $100,000 per year and paid themselves a wage of $80,000 out of those earnings, the remaining profit would be $20,000 or 10 per cent of the investment.

Numbers reveal only so much, however. Barrington Corporate's John Rickard says potential purchasers should quiz the current owner.

“You'd want to talk to him (or her) a lot about how the business operates and the market it operates in; why he feels the business is successful, its strengths and weaknesses; what he does on a day-to-day basis, his management structure and what the people who work for him are like,” he says.

“He's only going to tell you the good stuff, but you're going to get enough information at that stage to know if you want to go ahead."