A business can look attractive at first glance. Revenue is growing, profits are healthy and the asking price seems reasonable.
But those headline numbers only tell you part of the story.
When assessing a business to buy, the real question is whether its performance is sustainable after the current owner leaves and whether there are risks hidden behind the numbers.
Here are the areas worth looking at before deciding whether an opportunity deserves further investigation.
Financial performance
Start with how the business has performed over the last three to five years.
Look at revenue, gross margin, EBITDA and cash generation, but pay attention to the trend rather than just the latest year.
Is revenue growing consistently or has there been one unusually strong year?
Are margins improving or being squeezed?
Does profit convert into cash?
Try to understand what has driven any significant changes in performance. A business growing steadily through repeat customers is very different from one where the latest year’s growth came from a single large project.
Revenue quality
£10 million of revenue can be very attractive or surprisingly fragile.
Understand where the revenue comes from and how likely it is to continue.
Recurring subscriptions, long-term contracts and high levels of repeat business can provide greater visibility. Project-based or transactional businesses can still be excellent acquisitions, but you need to understand how consistently new work is generated.
Look at how much revenue is already secured for the next 12 months and how much still needs to be won.
Customer concentration
One of the first questions to ask is how much revenue comes from the largest customers.
If the biggest customer represents 5% of sales, losing them would be uncomfortable but potentially manageable.
If they represent 40%, the situation is very different.
High customer concentration isn’t necessarily a reason not to buy a business, but you need to understand the relationship, contract terms, customer history and likelihood of that revenue continuing after a change of ownership.
Reliance on the owner
Ask what the current owner actually does.
Do they manage key customers? Win most new business? Approve every major decision? Hold important technical knowledge? Manage the senior team?
If the answer is yes to most of these, part of what makes the business successful may be walking out of the door after completion.
A strong management team and well-established processes can make a business much easier to transfer to new ownership.
The management team and employees
Look beyond the owner and understand who else is important.
Who runs the business day to day?
Who owns the key customer relationships?
Who would be difficult to replace?
How long have senior employees been with the company?
A good management team can be one of the most valuable parts of an acquisition, particularly if you don’t intend to operate the business yourself.
You should also understand whether any employees are likely to leave following a sale and whether incentive arrangements may be needed to retain key people.
Why customers choose the business
A useful question is:
Why does a customer buy from this company rather than someone else?
The answer might be price, reputation, service, technology, location, expertise, relationships or something genuinely difficult for competitors to replicate.
If there isn’t a clear answer, consider how defensible the company’s market position really is.
A business with strong historic financials but little differentiation may find it difficult to maintain those results if competition increases.
The market
You don’t need to buy into the fastest-growing sector, but you should understand what is happening around the business.
Is the market growing?
Are customer behaviours changing?
Is regulation creating opportunities or risks?
Could technology disrupt the way the company operates?
Are larger competitors entering the market?
A well-run company can still face challenges if the underlying market is moving against it.
Growth opportunities
Most buyers want to see some route to future growth.
This could come from geographic expansion, new services, better marketing, acquisitions, pricing improvements or selling more to existing customers.
But be realistic.
If the investment case only works if you double revenue within three years, make sure there is credible evidence that this can be achieved.
The strongest opportunities often have several possible routes to growth rather than relying on one ambitious assumption.
Working capital and cash requirements
Profitability doesn’t necessarily mean strong cash generation.
Some businesses need significant working capital to fund stock, employees or projects before customers pay.
Others require regular investment in equipment, machinery or technology.
Understand how much cash the business actually needs to operate and grow.
A company generating £1 million of EBITDA but requiring substantial annual capital expenditure may be less cash generative than the headline profit suggests.
What could go wrong?
Before deciding what you like about an acquisition, actively look for reasons not to buy it.
What happens if the largest customer leaves?
What if the owner exits immediately?
What if margins fall by 5%?
What if growth stops?
What if interest costs are higher than expected?
You aren’t trying to convince yourself that the business will fail. You’re testing whether the acquisition still makes sense when things don’t go exactly to plan.
Look at the whole business
No acquisition will be perfect.
There will usually be areas you would change, risks you need to manage and information you want to investigate further.
The important thing is understanding which weaknesses are fixable and which are fundamental to the business.
A good acquisition is one where you understand how the company makes money, why its customers stay, what could threaten its performance and where the opportunity lies after you take ownership.
The more clearly you can answer those questions, the better placed you are to decide whether the business is worth pursuing.
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