Don Forrer: Know about a company before you purchase it

Deciding whether or not to buy a company is a big decision. Therefore, several steps must be taken to ensure an adequate analysis.

It is extremely important that potential business purchases are analyzed against similar companies and not bigger organizations. Comparing apples to apples is the only way to obtain an accurate comparison.

When analyzing small businesses, investors should look for problem indicators such as weak management, poor capitalization, inefficient controls and independent goals. A small business may be limited in management depth, leaving the organization short on skills necessary to advance the company beyond the profit point it currently occupies.

Capitalization should be examined closely for the amount of debt. A weak debt-to-equity ratio will cause problems in the future. Both issues — weak management and poor capitalization — could indicate insufficient operational controls.

Additionally, a small business may have internal strife due to conflicting goals between managers and investors. All of these issues must be examined thoroughly prior to purchasing a business.

The following checklist will help small business owners analyze potential purchases:

• Business history: A complete history should be obtained, including license history, name, date of origin, original management, product history and any pertinent data that could affect the status of the company. Additionally, a review of corporation documents such as bylaws, officers and structure would be beneficial.

• Market and competition: This is an area that must be analyzed thoroughly. Issues such as market strategy, growth potential, sales patterns, market niche, major products and other product information is critical. Additionally, data on the competition such as comparative product pricing and sales — plus competitive strengths and weaknesses — will support the analysis. Basic information such as industry averages, brand, trade and product names are also important.

• Sales and distribution: Information on how the company does business, including sales force compensation, sales terms, inventory, and distribution, will tell you a lot about company potential. It is critical that you review customers, credit ratings, bad debt history, maintenance agreements and warranty information.

• Facilities: The most expensive issue in any purchase is the physical assets of the company. Facilities should be examined for value, owned or lease, capacity and ability to expand. Remember that the three most important aspects of business are location, location and location. Ensure the facility is located in a place that supports the business.

• Employees: A complete analysis of employee history, unionization, work stoppages, wages, benefits and number of personnel is critical. Additionally, one should review training records, education levels and employee skills.

• Financials: A review of the past three years of financial data, including all ratios, is paramount to a good analysis. The financial analysis must be inclusive of every aspect of the company. Issues such as inventory, market appraisals, accounts receivable, assets and the balance sheet are among the many items that should be reviewed, compared and critically analyzed prior to purchase. Included should be previous tax returns.

• Management: A complete history on all management is imperative to a quality analysis. Other issues such as structure, compensation, training, skills and reputation are key areas to analyze.

• The list of analysis is not inclusive and it is imperative that all aspects of the company be thoroughly reviewed and compared prior to purchase. The only way to ensure that the business is cost effective is to understand as much about the company as possible. The only way to do this is through analysis prior to purchase.

Don Forrer, D.B.A., is a professor of management and director of International College's MBA program. The Naples SCORE chapter provides free-of-charge small business counseling to firms located in Collier County. For an appointment or the schedule of inexpensive workshops, call 430-0081, or contact SCORE through its Web site at www.scorenaples.org. SCORE is sponsored by the U.S. Small Business Administration.