When evaluating a potential investment or purchase of an operating business, you should carefully evaluate the business to learn as much as you can. Where do you begin? What records and documents should you review? Below is a list of some of the information you will want to review. (You should also share this information with your other business advisors such as your attorney, banker, accountant and financial advisor).
Financial information to review
- Five years of financial statements – filed, reviewed or audited (be sure to request supporting schedules of expenses)
- Interim financial statements / trial balances (minimum current year and previous year)
- Copies of prior valuations
- Latest tax returns (1-year minimum – but three to five years is best) for business income tax, sales tax, and payroll tax; as well as filings associated with the sale of alcohol, lottery or cigarettes
- Website address and social media accounts
- Marketing material / product brochures / menus
- Depending on type of entity – articles of incorporation, minutes book, operating or partnership agreements; classes of equity ownership and their applicable rights
- Shareholder, voting, buy/sell, management agreements
- For Intellectual Property – License / Royalty agreements, franchise agreements, trademark and copyright registrations, trade secret protection program documents (recipes, operating procedures, customer lists, etc.)
The most important part of a business is its financial performance, but it is important to dig deeper and learn about the business and what is behind the numbers. You should also look at:
Non-financial Information to review
- Nature, background, and history of the business
- Facilities of the entity (what is owned and what is leased?)
- Organizational structure
- Management team (officers, directors, and key employees)
- Products and/or services
- Economic environment
- Geographic markets served
- Industry / market served (is it a niche business?)
- Competition Climate
- Business risks
- Business strategy and future plans
- Governmental or regulatory environment
Information to help you analyze the numbers
- Lists and sales to top (5-10) customers/clients (ex. catering contracts, festivals, charity events)
- List and purchases from top 3-5 suppliers/subcontractors
- Owner(s) compensation, including benefits and personal expenses
- Contingent or off-balance sheet assets or liabilities need to quantify
- Quantification of financial impact of new products, locations, divisions
- Prospective financial information – next year’s budget / multi-year projections
- Non-recurring income & expenses items
- Segregate income & expenses for non-operating
- Discretionary expenses
- Depreciation/amortization schedules and identify Section 179 deductions (legal tax write-offs for equipment that can skew annual financial performance)
This is not an exhaustive list, it is just some basic ideas to get started. I usually recommend that my clients observe the business for a few shifts. As they say, a picture is worth 1,000 words. Many brokers, accountants and restaurateurs are likely to have suggestions of what to look at to “kick the tires”. What telltale things would you add to the list?