Reducing Risk when Purchasing a Business

With over 10 years of experience in business sales, we have witnessed many buyers who have successfully mitigated risks and now run successful businesses. So here are a few key points to help business buyers mitigate risk when buying a business.

1. Choose the Right Type of Business

To minimise risk, it's essential to choose a business that not only has good financial potential but also aligns with your interests. You’ll be investing significant time and effort, so it’s important that you find it rewarding on more than just a financial level. Too often, prospective buyers are motivated solely by profit, which can lead to disengagement and failure over time when they lose interest in the business.

Financially speaking, in today’s dynamic environment, two categories stand out for their resilience: businesses with subscription or recurring revenue, and asset-light businesses that don't require large investments in equipment or machinery. These types of businesses tend to have lower overheads and more stable revenue streams, which helps mitigate financial risks.

2. Understand What the Seller Knows

The knowledge gap that exists between the buyer and the seller creates a potential risk when purchasing a business. It is common for sellers to concentrate on increasing sales since they are conscious of impending exit; but, quick and irregular growth can be a warning sign. 

In the long run, you should look for businesses that have consistent revenue and earnings. A business that has demonstrated continuous performance is typically a safer option than one that has experienced wild fluctuations in its financial earnings. When there is a rapid spike or fall in sales, it is important to be vigilant because these variations may indicate more serious hidden problems.

3. Identify Key Person Risks

Another critical risk in a business is the reliance on key individuals, whose sudden departure could disrupt operations. Key people include CEOs, managers, employees with niche skills, or long-standing founders. Their departure can leave a business vulnerable, from losing market knowledge to damaging client relationships.

For example, if your top salesperson leaves unexpectedly or a skilled employee departs to start a competing business, it can create a significant issue. 

4. Is the Business Resilient in Tough Economy 

The resilience of a business in an economic downturn is another crucial factor in risk mitigation. Some industries are naturally more resilient, such as those dealing with essential services like healthcare, insurance, or food. Businesses that produce essential goods or services are typically better positioned to weather economic uncertainty, making them attractive to investors and buyers.

When assessing a business’s defensive qualities, ask yourself:

• Does it operate in an essential industry?
• How resistant is it to economic slowdowns?
• How stable are its long-term financial returns?
• How volatile is the industry in which it operates?

These factors can help determine how well the business might perform during a recession or other financial downturns, providing valuable insight into its potential risks. 

5. Clarify the Seller's Intentions

Often sellers are not looking to exit completely; they may be interested in scaling back or retaining a stake in the business. In these cases, selling only a portion of the business can benefit both parties. The seller continues to benefit financially from the business, while the buyer gains the advantage of the seller’s ongoing involvement, which can provide stability and reassurance during the transition.

In some cases, sellers may choose to stay on as minority stakeholders, retaining a 20% or 30% share in the business. This not only reduces the buyer’s risk but also demonstrates the seller’s confidence in the business’s future success. Full sellouts are still common, but phased buyouts with the seller remaining in a reduced capacity are becoming more popular.

Final Thoughts on Risk Mitigation

Buying a business is a significant decision, and understanding how to mitigate risks is critical to ensuring long-term success. By choosing the right type of business, carefully evaluating its financial history, and understanding key person risks, you can make a more informed decision. 

Risk is inevitable, but with proper strategies in place, you can navigate the process with greater confidence and security. The key lies in thorough research, understanding the business landscape, and identifying areas of potential vulnerability before making your investment.