12 Things To Know Before You Buy a Loss-Making Business
You may be thinking it’s a good idea to buy a loss-making business, but before you embark on a risky entrepreneurial journey of this nature, make sure you first know and understand the risks and challenges involved.
Before you buy a loss-making business you must understand why it’s making losses, and how you fix the problem. But you also must know how long it will take to fix the loss-making problem, quantify the losses it will make until it’s profitable and have the necessary money to fund those losses.
One of my businesses became loss-making, which unfortunately coincided with being diagnosed with cancer, and being given months to live (don’t worry, that was in 2014, so I survived).
I will admit that I struggled with what I faced. I had to ask myself some serious questions. One of which was; “what’s more important, money or life?“
As a result, I lost hundreds of thousands of Pounds (or dollars) in the process, whilst trying to keep the business afloat, at the same time as fighting for my life in hospital.
It’s strange that it affected me in this way, because I had previously taken a business from barely breaking even, to being very profitable. I put it down to being given months to live.
I think my priorities had changed in that moment, and whilst I tried, my heart was no longer in it.
This was the catalyst that led to me ultimately sell this business.
The point I want to stress to you, and for you to learn from my experience, is that by me having gone through these challenges in business (twice), is that it takes a lot of energy, effort and entrepreneurial knowhow to turn a business around.
So, please don’t underestimate what it will take. Otherwise you could find yourself in deep water! You could lose all your money.
12 things to consider BEFORE you buy a loss-making business
With that said, let me take you through the 12 things that are key if you are considering buying a loss-making business, which are as follows:
1. Understand why the business is making losses
You need to understand why the business is making losses, because if you don’t know why the business is losing money, how can you possibly know how to fix it.
On this first point, you should ask yourself the question; “what makes you think you have what it takes to change the company’s fortunes, when the current owner hasn’t been able to fix the problem?“
After all, they may have owned the business for many years, and they probably understand the business more than most.
It may be as simple as they’ve run out of money, and the banks are not willing to support a loss-making business, not necessarily because it can’t be done, but due to a lack of collateral for the loan.
2. Understand how to fix the reason why the business is losing money
After you’ve established why the business is making losses, you now need to work out how to fix the problem. You need a plan of how you will achieve the turnaround, because it doesn’t always follow that just because you know why the business is making losses, you know how to fix the problem.
It’s important you understand why the business is making losses, and you must have your well thought-through plan of action to fix the problem, before you buy the business, as this is definitely not something to work out as you go along, after you’ve bought the business.
Also be aware that just because a business is making losses, it doesn’t necessarily mean it can’t be over-valued.
During my search to find a business to buy, I came across a food wholesaler and an ice cream manufacturer that were both loss-making businesses.
Both businesses in my opinion had been way over-valued by brokers. For example, the food wholesalers was valued at £500,000, no less, which is even after it hadn’t made profits for a number of years. The owner tried to convince me that this was the value of its goodwill.
That made no sense to me!
I did look at both opportunities, as they had come across my desk. But when I looked at each business, I couldn’t immediately see how I could fix the problem in either one and make them profitable. But ultimately, what I really wanted was to buy a profitable business with immediate cash flow.
3. Know how long it will take to fix the loss-making problem
You need to have an idea, or an estimate of how long it’s going to take you to fix the problem, and to turn the company into a profitable and cash flowing business, which leads onto point four.
4. Quantify the losses
Once you’ve established the timescales necessary to fix the loss-making problem, you’ll then need to quantify the total losses (and hence the total loss of money) the business will incur over this estimated timeframe, and therefore the amount of cash that’s needed to turnaround the business.
The best way to quantify the cash injection needed is to use cash flow forecasting software.
Plus, the added benefit of using cash flow forecasting software, is the ability to run various scenarios of the business’s working capital cycle.
This will include changing customer payment terms, changing supplier payment terms and adjusting stock (or inventory) levels and stock ordering cycles, which will affect the levels of working capital requirements for the business.
Changing the working capital cycle will ultimately affect the amount of cash required to fund the business’s turnaround.
You can also use the cash flow software to review alternative funding solutions, such as invoice financing.
When you’re doing your calculations, always build-in an extra time buffer and an additional money buffer, because these things always take longer than expected, and take more money than you think.
5. Make sure you have the necessary money to fund the losses
After you’ve estimated the timescales, quantified the losses over this timeframe, and you’ve calculated the required cash injection needed to fund the business’s losses during this period, you need to make sure you have available the necessary funds, be it your own cash or cash funded from elsewhere.
At least if you’ve prepared cash flow forecasts, you’ll have something to present to investors, if you are seeking outside investment for your turnaround project.
6. You must be able to afford to lose the money you invest to buy a loss-making business
You must be able to afford to lose the money needed to turn the company from a loss-making business into a profitable one.
If you can’t afford to lose the money, don’t do it.
You don’t want to invest the only money you have, or even a large proportion of your personal wealth, or an amount you really can’t afford to lose. Or if you plan on using other people’s money, make sure they understand the risks involved in the transaction.
And be very careful, because you could end up losing more than just the money you invest in the business to turn it around, which leads to the next point.
7. Use the right corporate structure to protect yourself
You need to use the right corporate structure for buying any business to protect yourself, which is even more important when you buy a loss-making business.
Having the right structure in place will avoid you losing more money than the amount you invest in the transaction.
With this in mind, if you borrow part or all of the money needed for the turnaround, don’t offer personal guarantees on any money that’s borrowed, because if it all goes terribly wrong, the lender will come after you for the amount unpaid and guaranteed.
8. Avoid trading whilst insolvent
Make sure you consider the ramifications and consequences of trading whilst insolvent, which might be the case with a loss-making business, as this can have all sorts of knock-on effects on you personally.
If you’re found to be trading whilst insolent, you may be held personally liable for the debts incurred by the business, even if the business is a limited liability company, so be careful and seek professional advice on this point.
9. Do you have the nerve to turnaround a loss-making business?
Understand that it’s not going to be an easy task to turn around a business. You need to ask yourself whether you’ve got the nerve to take on this type of challenge.
Never underestimate what it takes to turn a loss-making business around.
Also understand that this may involve problems with employees leaving the “sinking ship”, suppliers may not be supportive of what’s happening, and if customers get wind of what’s going on, they may also take their business elsewhere too.
Banks are often unlikely to support this type of situation. This is unless they can see a well constructed business plan with supporting profit and cash flow forecasts, and that any lending is to be secured on a suitable asset, or assets.
Be aware that it takes a very determined and experienced entrepreneur to turn a business from making losses to making profits.
10. Do you have the business experience to turnaround a loss-making business?
Do you have the necessary business experience needed for a business turnaround, and do you have what it takes to be an entrepreneur in the first place?
Make sure this isn’t your first venture into the business world, as it could all end in tears very quickly.
Your job may involve business turn-arounds, but just because you’ve worked for someone else doing business turnarounds, this doesn’t necessarily mean you can do it for yourself with a business you buy.
Be aware that it becomes a very different transaction to pull off when it’s your own money at stake, vs knowing that whatever happens with the transaction, you’ll still get paid your salary at the end of the month, regardless.
11. You should have sector knowledge and experience
To improve your chances of success, you should ideally have sector knowledge and experience, as this will help you to understanding why the business is making losses, and it will give you the necessary experience to know how to fix the problem. Plus it may also mean you have the right contacts in the sector to help in the turnaround.
12. Be prepared to lose your entire investment if you buy a loss-making business
Finally, you must be prepared to lose all the money you invest in the transaction, on the basis that it doesn’t go to plan and the business ultimately fails.
Your reason for you to consider the purchase of a loss-making business might be because you don’t have the money to buy a profitable one.
But you may not have considered the fact that you’ll need money to fund the business losses, and will need to inject cash to bridge its negative cash flow gap, until it becomes profitable.
But if this is your reason for wanting to buy a loss-making business, you may want to consider the alternative ways you can finance the purchase of a profitable business instead, like using seller financing.
I hope this helps you on your journey to finding a business to buy, and if you have any questions on this topic about buying a business, or on any other aspect about the process involved in buying a business, please drop a comment below.
And always remember that no question is a stupid question, if you don’t know it, you don’t know it, and by having the answer to a question you have, might be all it takes to move to the very next step in your journey to buy a business.