5 Mistakes to Avoid When Buying a Business

Common mistakes when buying a business

Having unrealistic expectations 

One critical mistake some investors make is thinking that business ownership is an easy route to a healthy income. However, that’s rarely how it works. 

Even when buying an established business, you still have to work hard for every penny of revenue and slice of market share. With competitors fighting you every step of the way and constant shifts in everything from customer demand and technology to cost inflation and economic conditions, it’s no easy ride.  

How to avoid it: 

You need to be realistic about what you can achieve and how much work it’s going to take to get there. Owning and growing a business takes time, energy and discipline, and an opportunity that sounds too good to be true usually is. 

For example, an opportunity promising outsized returns with minimal effort is likely to be high-risk or based on short-term market conditions that are difficult to sustain. Instead, you should prioritise businesses that generate sustainable income and have resilient cash flows to support growth and reinvestment and withstand unexpected challenges. 

Not understanding the industry

One of the most common financial risks when purchasing a business is falling in love with the idea of an industry without having a solid understanding of its market dynamics, competitive pressures and operational challenges. In this case, even an established and profitable business can become a risky investment.   

Some industries sound attractive but often come with hidden challenges. For example, lifestyle businesses like cafes and small restaurants sound appealing to many, but the reality is long hours, tight margins and high failure rates. The same applies to online stores and health and fitness businesses, which can be susceptible to seasonal fluctuations and shifting trends.

How to avoid it: 

Before buying a business, you must understand what it takes to run an operation in that industry. That includes everything from your target customers and how to reach them to cost structures, licensing requirements, staffing challenges and the key operational processes required to be profitable and sustainable.  

It’s always beneficial to have firsthand industry experience. However, if you don’t, talk to the current owners, read trade publications, attend industry events and ensure there is plenty of relevant experience within the existing team. Hiring an industry advisor can also help you assess the opportunity and identify the potential pitfalls. 

Making due diligence errors

Making due diligence errors in a business acquisition can be a very costly mistake. The primary role of due diligence is to mitigate risk. However, it’s also crucial in negotiating a fair purchase price, ensuring the business complies with all relevant regulations and equipping you with the detailed commercial and operational knowledge to make an informed decision. 

Some buyers rely solely on the information provided by the seller. However, while most sellers act in good faith, information can be selectively presented or overly optimistic. Some buyers also rush the due diligence process to get the deal over the line, while others do not act on the prospective red flags they uncover.

How to avoid it:

When investing such a large amount of money, you need to know precisely what you’re buying and whether any issues could affect the business’s value, operations or legal standing.

The first step is to create a detailed due diligence checklist that you do not compromise on. If the responses you receive aren’t clear, pause the deal until they are. And if something doesn’t make sense, ask questions until it does. 

Your accountant, solicitor and business transfer agent will be able to help you conduct these key checks: 

• Financial due diligence - Scrutinise the company’s financial statements, projections and management accounts to establish a clear picture of its revenue streams, liabilities, performance and profitability.

• Legal due diligence - Examine the company’s contracts, property leases, licences, intellectual property rights and any potential litigation to confirm its legal position.  

• Operational due diligence - Assess the business’s processes, technology, infrastructure, supply chain and customer base to ensure it can operate efficiently after the acquisition. You should also consider the impact of key employees leaving and whether retention incentives are in place to keep critical staff on board. 

• Commercial due diligence - Evaluate the business’s market position and competitive landscape to get a clear picture of the opportunities, risks and growth potential.

Overpaying based on optimistic projections

A key financial risk when purchasing a business is paying over the odds. Valuing a business is not straightforward, and some of the most commonly used valuation methods can produce very different results. That’s because some are based purely on the value of a company’s assets, while others take into account its future earning potential.

One mistake we see is buyers placing more emphasis on future potential than past and current performance. Understandably, sellers and their agents often highlight expansion ideas, growth opportunities or ‘easy wins’ to make the business seem more attractive. However, these future unknowns rarely justify an inflated price. 

How to avoid it:  

To avoid overpaying, base your offer on what the business has actually achieved, not what it might do in the future. Get a professional valuation and check that any growth forecasts are realistic and supported by past performance.

Whatever valuation method you use, whether it’s asset-based or an EBITDA multiple that takes into account future earnings potential, it’s crucial to stress-test your assumptions and account for risks, such as market volatility, operational inefficiencies and unexpected liabilities. 

And if the seller is confident about future growth, consider tying part of the price to post-sale results through deferred consideration or performance-linked payments, rather than paying more upfront.

Underestimating your working capital requirements

Another common mistake when buying an existing business is to pour your money into the acquisition without considering the ongoing capital you’ll need to run it. The expectation is that day-to-day costs will eventually be covered by cash flow. However, when you first buy the business, you’ll need to fund inventory, payroll, marketing and repairs yourself until it has enough money in the bank cover these expenses. 

Failing to plan for this working capital gap can strain finances, force you into short-term borrowing on poor terms and lead to difficult cost-cutting decisions early on.

How to avoid it:

To reduce the financial risks when buying a business, build working capital requirements into your purchase plan. You should ensure you have the money in the bank to operate the business for several months without relying on immediate profits.  

Having this financial cushion will enable the business to continue running smoothly while you settle in and start implementing your growth plans. It will also help you fund the additional costs that early ownership often brings, such as addressing deferred maintenance, investing in marketing and tightening operations.

Avoid costly mistakes when buying a business

Buying a business for the first time can be daunting, particularly when the costs of making a mistake are so high. That’s why, at Eddisons Business Sales, our experienced brokers guide you through the process. From initial research and valuations to due diligence and negotiations, we help you find the right opportunity and protect your investment. 

Find out more about buying a business, including mergers and acquisitions as a route to growth, browse our businesses for sale and register as a buyer.