For those considering buying a business, here are some lesser-known pitfalls to watch for, from your friendly neighbourhood accountant.
Buying a business is a significant leap towards entrepreneurial success in Canada. Accounting issues can significantly impact the viability and future profitability of your investment. Here’s a comprehensive guide to navigating these potential pitfalls, ensuring you’re well-equipped to make an informed decision.
1. Debt vs. Equity: Financing by Issuing Shares
When acquiring a business, understanding the structure of the deal is paramount. Financing the purchase through debt or equity can have vastly different implications for your future financials. Issuing shares may dilute ownership but can also be a strategic move to preserve cash flow. Conversely, taking on debt increases your financial leverage but comes with the obligation of regular repayments. Scrutinize the terms of any financing agreements to ensure they align with your long-term business strategy.
2. Earnouts: Bridging the Valuation Gap
Earnouts are a common tool to bridge the gap between the buyer’s and seller’s valuation of the business. They involve future payments to the seller, contingent on the business meeting specific financial targets. While earnouts can facilitate negotiations and make the purchase more affordable upfront, they also carry risks. Misalignment of expectations or business performance can lead to disputes. Ensure any earnout agreement is clear, achievable, and aligned with your business plan.
3. Intangible Assets: The Hidden Value
Intangible assets, such as brand reputation, customer loyalty, or intellectual property, often constitute a significant portion of a business’s value but may not be recorded on the balance sheet. Understanding the true worth of these assets is crucial. They can be the key drivers of future growth and profitability but are also vulnerable to depreciation. Ensure a thorough valuation of intangible assets is conducted to avoid overpaying.
4. Assets Acquired That Rise in Fair Value
Assets that have the potential to increase in value over time, like real estate or proprietary technology, can offer long-term benefits beyond the initial purchase price. However, the initial valuation and subsequent revaluation of these assets can significantly affect your balance sheet and tax obligations. A strategic approach to managing these assets can optimize their contribution to your business’s financial health.
5. Agreements Surprisingly Falling Outside the Acquisition
Sometimes, critical agreements essential to the business’s operation are not automatically transferred to the new owner upon purchase. This can include leases, supplier contracts, or customer agreements. Ensure a thorough review of all contracts is conducted to identify any that require separate negotiations or renewals to maintain business continuity.
6. Contingent Liabilities: The Hidden Dangers
Contingent liabilities, such as pending lawsuits or under-assessed tax obligations, can emerge as unwelcome surprises after the purchase. These liabilities can have a substantial impact on your financials. Conducting a detailed due diligence process, including a review of all legal and tax aspects of the business, is essential to uncover and quantify these risks.
Final Tip: Partner with a Fractional CFO Service
Navigating the complexities of buying a business can be daunting, particularly when it comes to the financial intricacies. Partnering with a fractional CFO service can provide you with the expertise necessary to address cash flow problems, improve profits, scale your business, and offer insights on how to finance, buy, or sell a business. At IDM, we specialize in delivering the numbers that matter, saving our clients an average of $20 to $40K. Let us help you make informed decisions and focus on what you love doing, knowing your financials are in expert hands.
