Buying a failing business might seem counterintuitive, but it can be a smart move for savvy entrepreneurs. At Unbroker, we’ve seen firsthand how struggling companies can be transformed into thriving enterprises with the right strategy and execution.
This guide will walk you through the process of identifying, evaluating, and acquiring a failing business with potential. We’ll cover everything from spotting opportunities to negotiating the deal, helping you turn a struggling company into a success story.
Spotting Hidden Gems in Failing Businesses
Red Flags of a Struggling Business
To identify a failing business with turnaround potential, you must recognize the signs of trouble. These include declining sales, shrinking profit margins, and increasing debt. Businesses with outdated technology, poor online presence, or negative customer reviews often struggle. The U.S. Bureau of Labor Statistics reports that about 20% of new businesses fail within their first year, often due to these issues.
Root Causes of Failure
Understanding why a business fails is essential. Poor management, outdated products, or ineffective marketing can all contribute to a company’s downfall. A CB Insights report reveals that 42% of startups fail because there’s no market need for their products or services. This insight can help you determine if the problems are fixable.
Turnaround Potential Assessment
Not all failing businesses deserve saving. Look for companies with strong fundamentals like a loyal customer base, valuable intellectual property, or prime locations. These assets can provide a solid foundation for a turnaround. Decisive action in turnarounds can lead to successful results, as demonstrated by case studies of successful mergers, acquisitions, and turnarounds.
Market Research Importance
Understanding the broader market context is vital. Ask yourself: Is the industry growing or shrinking? Are there emerging technologies or trends that could impact the business? Tools like Google Trends, industry reports, and competitor analysis can provide valuable insights. For example, the International Data Corporation (IDC) predicts that by 2025, the global datasphere will grow to 175 zettabytes. This kind of trend data can help you identify potential growth areas for a struggling business.
Risk and Reward Balance
Buying a failing business involves risks, but it can also offer significant rewards. With thorough research and a solid turnaround plan, you can potentially acquire valuable assets at a fraction of their true worth. Many entrepreneurs have successfully navigated this process, transforming struggling businesses into success stories.
As you move forward in your quest to buy a failing business, the next step is to conduct thorough due diligence. This process will help you uncover hidden issues and confirm the potential you’ve identified in your initial assessment.
Digging Deep: The Due Diligence Process
When you buy a failing business, thorough due diligence protects you from unforeseen issues. This critical phase requires a comprehensive investigation of various aspects of the business. Here’s what you need to examine:
Financial Health Check
Start with a comprehensive review of financial records. This process aims to determine whether a company’s financial information is true and accurate, which is crucial for the buy-side in M&A transactions. Examine profit and loss statements, balance sheets, and cash flow reports for the past 3-5 years. Look for trends in revenue, expenses, and profitability. Pay close attention to accounts receivable and payable.
Don’t just rely on the provided financial statements. Request tax returns and compare them with the financial reports to ensure consistency. If possible, have a certified public accountant review the books. They might spot red flags that you could miss.
Legal and Regulatory Landscape
Investigate any pending lawsuits, regulatory violations, or compliance issues. These can be costly and time-consuming to resolve. Check with local authorities about zoning laws, permits, and licenses. Ensure all are current and transferable.
Review all contracts, including leases, supplier agreements, and customer contracts. Look for any change-of-ownership clauses that could affect the business post-purchase. The American Bar Association recommends having a lawyer (specializing in business acquisitions) review these documents.
Human Resources Deep Dive
Assess the current management and employee structure. High turnover rates or a lack of key personnel can be significant red flags. Other warning signs include waning employee engagement, restricted feedback channels, and lack of career development opportunities. Review employment contracts, especially for key employees. Understanding the company culture and employee satisfaction is essential for a smooth transition.
If employee engagement is low, factor in the cost and effort of improving it into your turnaround plan.
Customer Relationships
Analyze the customer base. Is it diverse or dependent on a few key clients? Review customer contracts, satisfaction rates, and complaint history. Conduct surveys or interviews with key customers to gauge their loyalty and potential for continued business post-acquisition.
Intellectual Property and Assets
Identify all tangible and intangible assets. This includes equipment, inventory, trademarks, patents, and proprietary technology. Verify ownership and transferability of all intellectual property. According to a study by Ocean Tomo, 90% of the market capital of the S&P 500 Index is driven by intangible assets, up from 32% in 1985, highlighting the growing importance of intellectual property valuations.
Assess the condition and value of physical assets. Outdated equipment might require significant investment to upgrade, impacting your turnaround budget.
With a thorough understanding of the business’s true value and potential, you can now move on to the next critical step: negotiating the purchase. This process will require all the insights you’ve gained from your due diligence to secure the best possible deal.
Mastering the Art of Deal Negotiation
Setting the Right Price
Determining a fair price for a failing business requires complex considerations. You must account for the company’s assets, liabilities, and turnaround potential. The discounted cash flow (DCF) analysis finds the present value of expected future cash flows using a discount rate. For struggling businesses, focus on asset value or a multiple of current earnings.
The asking price often exceeds the final sale price. For example, For Sale By Owner (FSBO) homes typically sell for less than agent-assisted sales. According to the National Association of Realtors, in 2024, FSBO homes sold for $380,000 compared to $435,000 for agent-assisted home sales.
Understanding Seller Psychology
Sellers of failing businesses often have motivations beyond price. Personal issues, burnout, or lack of turnaround skills can drive their decision to sell. Understanding these motivations provides leverage in negotiations.
If a seller worries about their employees’ future, offer to retain key staff as part of the deal. For those concerned about their legacy, propose keeping the company name or involving them as a consultant during the transition.
Structuring the Deal
Deal structure can match price in importance. Consider an earn-out agreement, which ties part of the purchase price to future business performance. This aligns the seller’s interests with yours and potentially lowers upfront costs.
An asset purchase (rather than a stock purchase) allows you to select desired assets and leave behind liabilities. A recent survey of 255 M&A professionals found that 67% predicted a rise in deal volume over the next 6 months.
The allocation of the purchase price across different asset classes significantly impacts your tax burden. Consult a tax professional to optimize the structure for your situation.
Protecting Your Interests
Include key terms and conditions in your purchase agreement for protection:
- Representations and warranties about the business’s condition
- Indemnification clauses for undisclosed issues post-purchase
- Non-compete agreements to prevent competing businesses
- Transition services agreements for handover assistance
Don’t hesitate to include these protections.
Leveraging Professional Expertise
While platforms like Unbroker simplify business transactions, involving legal and financial professionals remains essential (especially for failing businesses). M&A attorneys spot potential contract pitfalls and negotiate better terms. Financial advisors help structure deals to maximize tax benefits and minimize risk.
Professional help often costs a fraction of potential losses from negotiation mistakes. An Axial survey revealed that 54% of business owners who sold without a broker later regretted their decision.
Final Thoughts
Buying a failing business presents both significant risks and potential rewards. This complex venture demands meticulous research, careful planning, and strategic execution to transform a struggling enterprise into a thriving success story. The process involves identifying promising opportunities, conducting thorough due diligence, and negotiating favorable terms.
Entrepreneurs who buy a failing business must reevaluate every aspect of the company, from core offerings to operational processes. This approach requires innovative thinking, strong leadership, and the ability to make tough decisions. The rewards can include acquiring valuable assets at discounted prices, tapping into established customer bases, and leveraging existing infrastructure.
Platforms like Unbroker offer valuable resources and support for those considering this path. Unbroker’s modern approach to business transactions can simplify the process of acquiring a struggling company. It provides access to a vast network of opportunities and expert guidance throughout the acquisition journey, helping entrepreneurs navigate the complexities of buying and revitalizing a failing business.
