Do You Need To Know & Understand The Business You Buy?

If you’ve already made the decision to buy a business, instead of starting one from scratch, your next decision is to choose the type of business you want to buy.

If you aim to buy a business sooner rather than later, and you’re prepared to take more risk, it’s better to be flexible with your sector choice. But on the flip-side, and if you’re happy to wait longer, and you want a reduced risk, it’s possible to buy a business too, but it may take longer.

It’s a good idea to ask yourself the following question; “do I buy a business I know and understand, or do I buy a business I know nothing about, and I don’t understand“.

When I bought my business, which in my case was a business that designed, manufactured and fitted furniture, I knew nothing about the business.

But why this didn’t matter, is because the business already had employees to design the furniture, employees to make the furniture, and to fit the furniture, plus the employees needed to run the operations too.

This is one of the reasons why I chose to buy a large million-dollar business, which in my case had annual sales of $2 million or £1.6 million.

Why a large business makes a difference, is because the business is big enough, and makes enough money to pay for a good team of people to run it for you, so you don’t have to work in the business, doing the things the business does.

If you’ve not made that decision yet, about the type of business you want to buy, you might want to consider the following reasons why the type of business is important.

Why the type of business you buy is important

Firstly, it’s about risk.

There’s risk involved in buying any type of business, and your “buying risk” can be reduced by doing various things. For example, by doing due diligence on the business, before you buy it.

But, if you buy a business you know nothing about, it’s far easier to miss things, that could be important, during the due diligence process.

For example, something I missed on the due diligence for the business I bought, was a known defect in a type of door that was fitted to the furniture the company sold.

Had I known the industry, it’s more likely I’d have known about this defect, and it’s more likely I would’ve uncovered the problem in the due diligence process.

As it happens, it wasn’t such a problem, and although it cost the business a certain amount of money, the cost wasn’t at a level the business couldn’t afford.

So all was well that ended well in my case.

To protect yourself against these types of problem, when you buy a business, sector knowledge will help you.

But whether your sector knowledge protects you or not, your solicitor should include warranties and indemnities in the sale and purchase agreement, or clawback clauses, which are designed to protect you against this type of thing.

These clauses in the sale and purchase agreement will mean you can recover any losses you suffer, as a result of something that should have been disclosed to you by the seller.

The other way you protect against this type of risk, is by not paying 100% of the purchase price upfront.

It’s far better to use seller financing for as much of the purchase price as you can negotiate, which not only means the seller is effectively telling you they believe in the business, but it also means they’ve “rubber-stamped” it to say the business is doing what they say it does.

On top of that, it’s far easier to withhold money you’ve not already paid to a seller, than it is to recover money back you’ve already paid.

If you know the sector, you are more likely to reduce the due diligence risk, as you know the questions to ask, because you know what you’re looking for. You are also more likely to know if the seller is lying, or if they’re trying to cover something up.

But what if you don’t actually understand what the business sells? This question leads to the second reason why the type of business you buy is important.

It’s far easier to run and grow a business you understand, than a business you don’t. That’s not to say it’s impossible to do it

But to make life easier for yourself, if you choose to buy a business in a sector you don’t know or understand, and therefore reduce your risk, it’s better to buy a simple business than one that’s complicated, so it is easy to learn and understand.

The third reason why the type of business you buy is important, is if you decide to use bank lending to buy the business.

The bank will want to know your background, and to know if you have the necessary experience to run the business. The bank will want reassurance their money is safe in your hands…and that their loan will be repaid.

The easiest way to avoid this problem, if you want to buy a business in a sector you know nothing about, is to not use bank lending in the first place, and instead use owner financing.

But if you are happy to use bank lending, and so long as you buy a business that has the employees to run it for you, the bank is more likely to lend on the strength of the business itself.

The fourth reason why sector choice is important, is in how easy or difficult it will be to find a business to buy.

The more specific you are about the type of business you want to buy, the harder it will be to find what you are looking for.

If you want to buy a business near you, but there are no businesses of the type you want in your area, you will either have to change the sector you buy into, move to an area where you can find a business of this type, or resort to starting your own company instead.

But also, the more specific you are about the type of business, the harder it becomes to tick all of your “business buying boxes”. 

For example, it’s better to find motivated sellers who are selling great businesses, as these sellers are more likely to accept seller financing.

But you may find it takes longer to find a business in the sector you’ve chosen, in the area where you live with a motivated seller as well. So you may need to be willing to compromise.

How to help decide on the type of business you buy

So to help you consider how you may compromise on the type of business you buy, consider the following:

1. Buy a business you know and understand completely. This will make your life as easy as possible, and reduce your risk as far as you can, whilst being prepared for the process to take a bit longer, being willing to move to another area, or perhaps even being happy to compromise on the deal structure, to make it work to get a win-win outcome for you and the seller.
2. Secondly, buy a business in a related or similar sector to the one you know. In this case, your skills should be transferable, and you will still have a reasonable amount of sector knowledge and understanding. It’s not that you should be looking to work in the business, doing the work it does, but it’s about reducing risk where you are more likely to understand what it does. For example, when I was discussing this topic with one of my course students, he currently fits double glazed windows. We discussed other businesses he could buy in this sector, which included window manufacturers, as an example.
3. Thirdly, buy a business you don’t know and you don’t understand, but chose a type of business that’s easy to learn and understand. The more simple and less complex a business is, the easier it will be to learn. So long as you buy a large enough business that has the employees to run it for you. In fact the late Charlie Munger said “buy businesses that even an idiot can run, and the employ a great CEO to run it for you”.
4. Fourth and finally, you could still buy a business you don’t know, and one that’s not so necessarily easy to understand, and buy-in the expertise and experience for someone to run it for you. Unless, the business already has an employee who’s capable of doing this already. For example, a business I very nearly bought, I found a person who was willing to invest in the business with me, and who was happy to run the company, and who understood the sector very well.

What does it mean “knowing” and “understanding” the business or sector.

For you to know and understand a business sector, it means you’ve either worked in it as an employee, or that you already own a company, or you’ve previously owned a company, in the sector.

Another way in which you could know about a business sector, is if it’s a hobby or passion of yours. For example, for me this would include scuba diving and horse riding, but that’s not to say I would buy a business in either one or other of these sectors, but I certainly have the knowledge to do so, if I wanted to.

Ultimately, to buy a business, boils down to how long you want to spend looking for a business to buy, and how much you want to risk in the process.

If your aim is to buy a business sooner rather than later, and/or, if you are prepared to take a bit more risk and buy a business you know nothing about, then it’s far better to be more flexible with your sector choice.

But on the flip-side, and if you are happy to wait a bit longer, and reduce your business buying risk, and if you’re prepared to put in the hard graft, then it’s entirely possible to buy a business you know and have knowledge about, it just may take a bit longer to do.

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.