Should You Buy That Business?: If You See Any Of These 5 Red Flags, Proceed With Caution
Updated on October 11, 2023
Buying an online business is an exciting venture and you don’t want anything to get in the way of your success.
You might be looking at a business you think could be a good purchase. If on the surface it ticks all of the boxes for qualities you want a business to have, you can start looking at the risks and red flags to avoid as you go through with your acquisition.
There are risks with any business; some are specific to certain business models and some are inherent in all models, and in order for you to have a smooth acquisition you should understand what those risks are and how to mitigate or avoid them.
There are different types of risks; some are related to the seller and their intentions, and others are related to the business and how it has been built and run.
We’re going to cover all of the risk types you could face when acquiring an online business in this article, starting with the red flags you should watch out for.
5 Red Flags to Watch Out For When Buying An Online Business
The following can be found in any business, regardless of its size or model, so be sure to check through each one as you’re acquiring a business.
1. Lack of Financial Transparency
There’s a certain level of trust that needs to be established when a business sale is taking place.
The seller needs to trust that you’re not going to misuse their business’ sensitive information and you need to trust that the seller is providing accurate information.
This is where a non-disclosure agreement (NDA) can help protect both parties and alleviate these fears. If, after signing a document like an NDA, the seller is still unwilling to share financial information about the business, then you shouldn’t go any further.
If they initially share the information in unofficial forms like screenshots, then make sure you get into the dashboards and financial documents to confirm the accuracy of the figures.
2. Unsustainable Business Model
Some businesses can be poorly built but are still highly profitable. They can look like attractive investment assets, but when you dig into the business operations, legal setup, and financial structure you could find points of weakness that could fold the business instantly if exposed.
For example, if the business is an agency that’s heavily reliant on the owner for its success and doesn’t have a strong employee base to support the business, then that’s an unsustainable business because once you take the owner out of the equation, the business can’t run.
Make sure the business has strong enough foundations that you can work with.
3. Untrustworthy Seller
For the transaction to go through well, the seller needs to be trustworthy. No matter how attractive the business asset is, if the seller is difficult, uncooperative, or untrustworthy, it’s probably not worth the hassle of acquiring the business.
Some signs to look out for are a lack of clear communication, high staff turnover in the business, and poor reviews about how the business operates and interacts with its customers.
4. Lack of Proper Legal Licences and Certifications
To operate in any industry, a business must have some licenses or certifications to meet industry regulations.
Before you look into the business, research what certifications and licenses are required to operate in the industry the business is in. If it doesn’t have these documents, seriously consider pulling out of the deal as they could have already breached regulations and the legal repercussions could come after you’ve acquired the business.
Licenses and certifications are especially important in industries with a lot of red tape like health supplements and finance.
5. Unresolved Legal Issues
Businesses are inherently vulnerable to many legal regulations, so it’s not uncommon for a business to have faced a legal impeachment or breach in its lifetime.
Resolved legal issues aren’t so much of a concern as in most situations, once the case is closed there are no more repercussions. However, if there’s an ongoing legal dispute or altercation, then that’s a red flag.
You should learn about the issue and decide whether it will impede your ability or willingness to buy the business.
Any of these red flags could be a reason to retract from the deal, but depending on your risk tolerance, resources you have available to deal with these risks, and the specific situation, you may want to continue pursuing the deal.
The risks could be good bargaining leverage to get a better price for the business.
If you do decide to go forward, you should first understand the risks and how they can impact the business and deal.
Legal Risks
There are numerous legal risks that businesses are subject to, one of the main ones being around intellectual property (IP).
Ownership of brand names and associated materials causes big issues in business. It’s surprisingly easy to accidentally make a copyright infringement by using a brand name that’s too similar to one already registered.
Another area for common legal issues is customer data. If a business is collecting, storing, and using customer data including personal and financial information, it is subject to the laws surrounding the protection of that data. This is why it’s vital to be compliant with laws and regulations set by regulators like the general data protection regulation (GDPR) and the California consumer protection act (CCPA).
Check to see if the business owner is aware of the obligations set by these regulators. If they’re not, there’s a chance they’ve unknowingly breached some of the regulations and the business could be liable to legal action, even if the seller doesn’t know it.
Highly-regulated markets like health and wellness require considerable legal diligence. For example, an ecommerce store selling medical supplements needs to comply with regulations such as the dietary supplement health and education act (DSHEA), which requires stores to label and market products properly and be able to verify claims made about the products.
To mitigate any legal risk that surrounds a business, there are some actions you can take.
How to Mitigate the Legal Risks of a Business Acquisition
The best way to protect yourself from legal risk when acquiring a business is to work with a legal professional. Revision Legal is a firm that specializes in online business acquisitions and they can support you through the entire acquisition process.
Many business buyers try to avoid seeking legal assistance to avoid costs, but some find after trying to handle the legal side of buying a business themselves they end up spending a lot more money and time cleaning up a messy situation that could have been avoided with legal counsel.
A lawyer will be able to tell you all of the legal requirements the business is bound to and they’ll be able to identify whether the business is meeting those requirements with its current practices and documents it has in place.
If you carry out a thorough investigation with a legal professional to identify all of the legal risks hanging over a business, you should prevent any legal problems during the acquisition and any legal repercussions coming back after the purchase.
Financial Risks
We’ve talked about how a business owner can manipulate financial information to paint a false picture of a business’ financial health. However, even if they’re being honest about the finances they think their business is generating, there still could be hidden financial issues with the business they’re unaware of.
Many business owners aren’t tracking their finances properly. They miscalculate profits by failing to account for certain costs, not tracking their advertising costs properly, not seeing hidden production costs they should be tracking, or they aren’t calculating their taxes properly because they’re not using an accountant or a good accounting system.
It’s important to identify financial discrepancies early as they’ll impact the business’ value.
It’s also important to evaluate the strength of the business’ revenue streams.
For example, if the majority of revenue for a content site is coming from one affiliate offer, you should check how long that offer is going to be held in place and if the seller has contracts with the affiliate that’s going to keep that relationship intact.
It’s also not uncommon for business owners to take on debt when growing their business. If they have debts, you want to make sure they’re taken care of before you buy the business so you’re not held liable.
If you spot any of these potential risks, you don’t have to walk away from the deal. There are some precautionary measures you can take to mitigate the risks.
How to Mitigate Financial Risk
The easiest and most-effective way to manage the risk of an online business acquisition and to prevent financial problems from occurring after the sale is to hire professional help as you’re going through the acquisition process.
You can request the seller to go through a financial clear-up with a professional accounting firm specializing in their business model. Having a specialist is key because a general accountant may not have the business-specific knowledge required to analyze and organize a business’ finances.
When we list businesses for sale on our marketplace, we have our vetting team verify the legitimacy of businesses and the accuracy of their financial statements. This allows us to give a highly-accurate valuation that’s based on confirmed and accurate financials.
When you’re acquiring a business, make sure to pull all of its historical financial data to give yourself an accurate picture of how the business has performed over its lifetime. If there are any dips or spikes in revenue or profits at any point, be sure to ask the seller why they happened.
Having a solid understanding of the business’ cost structure, including costs of goods sold, marketing expenses, and other operational costs will allow you to see how profitable the business is and identify where the opportunities to earn more from the business lie.
The more you know about the business’ finances, the less you risk yours.
While you should be aware of all of the risks associated with a business when acquiring one, sourcing potential acquisitions from a good source is the best way to avoid many of the risks.
How to Buy A Business Without Red Flags
At Empire Flippers, we have the only curated online business marketplace. We have an entire department trained and dedicated to qualifying online businesses before we list them on our marketplace.
Our vetting process is so thorough that we reject over 91% of businesses submitted to us. We verify:
- The identity of the seller
- The legitimacy of the business entity
- The accuracy and legitimacy of the business’ financials
- The quality of the business’ operations structure
- The business’ history
Once a business is on our marketplace, our other teams made up of a total of 80+ employees manage the entire business sale and acquisition process, from helping buyers in negotiations to migrating the business to the new owner.
If you’d like a personal concierge service with your own expert business acquisition advisor helping you find a business you can be successful with, then schedule a free, no-obligation call with one of our acquisition advisors.
