The most common mistakes we see with those buying a restaurant is failure to understand the due diligence process. Due diligence is undertaken to confirm the items learned during the initial discovery phase of the business. For those buying a restaurant, the issues fit under three major headings:
- Too Soon
- Too Much
- Wrong Focus
Let’s look at these one at a time.
Too Soon -
When buying a restaurant, some take the approach that they want to see everything, and they want to see it before any form of an offer is made. As Restaurant Brokers, we’ll receive a laundry list of items before a deal even goes into contract. Taking this approach, however, can hinder your ability to purchase. Here’s why.
Sellers are cautious by nature. They want to avoid revealing too much about their business until the buyer feels more “certain” to them. They trust the broker but aren’t sure, (YET) whether they have faith in the buyer to keep this information confidential. Even though a confidentiality agreement may be in place, they are thinking of the people who work in the store, their customers and their current livelihood. All of these are put at risk if someone doesn’t honor the terms of the confidentiality agreement.
It’s too soon if you start pushing for items like tax returns and 941 filings before a deal is even accepted. There hasn’t been enough time in the transaction to develop the trust needed between the parties. It will happen; just not at the outset.
To avoid the problem of “too soon,” it’s better to go into an agreement to purchase, with a due diligence period and a fully refundable escrow if you are not satisfied. If the books don’t bear out in the due diligence period, you have the option to terminate or renegotiate the pricing or terms.
Asking for sensitive data like tax returns and 941 filings before a deal is even accepted is often a path to seller resistance, buyer stubbornness and ultimately, failure in buying a restaurant.
There is a checklist for buying a business floating around on the Internet that is ten pages long and has about 100 items on it. I know this because I’ve been presented with the exact same checklist dozens of times.
This list asks for items that have very little to do with buying a restaurant. I’ve received it on franchise transactions multiple times. This list asks for terms of the intellectual property owned and all trademarks and patents. HINT: The franchise brand owns the intellectual property and the rights to all trademarks and patents. It also asks for the minutes from every shareholder meeting. HINT: The average small business being transferred has one meeting on the books – the one that established the legal entity. There’s nothing else. It also asks for contracts with every vendor. AGAIN – the average main street business doesn’t have vendor contracts. If they are a franchise, they typically have one, their franchise agreement.
If I receive this checklist after I’m in contract, it tells me that as a business broker, I need to do a better job to setting expectations and providing good stewardship over the deal. I need to make sure my buyers seek my guidance about what they should be looking at in buying a restaurant. If I receive this checklist before a deal is even made, I know I have a buyer who doesn’t really understand what he is buying and probably needs some more education about the industry and small businesses in general.
If your interpretation of due diligence is to Google - - “Buying a business Due Diligence Checklist” and present your broker with a ten page document that isn’t relevant, it’s TOO MUCH, the second mistake made by most buyers.
Along with too soon and too much, the third mistake is “wrong focus.” Some of the items cited above are examples of items that are not relevant to the transaction. Another area where buyers spend too much time and money are in areas they can’t change. One example is the franchise agreement review. It is rare to never that a franchisor will change the terms of their franchise agreement. It simply doesn’t happen. All 1,000 units operate on a similar plane and they simply will not exempt any one party from certain element.
When a buyer spends time hiring an attorney to review the franchise agreement, knowing that it cannot be changed, it’s the wrong focus. The restaurant buyer should be looking at whether a franchise model is the right fit for him or her. If he wants to change the menu; a franchise is not a good fit. If he or she wants to reduce the royalties to earn more money, it won’t happen. Don’t waste precious dollars focusing on the items you cannot change. Instead, focus on the items in due diligence open to negotiation or change.
These three mistakes in due diligence can cost you the restaurant you want to buy. Avoid pursuing due diligence too soon. Be careful of requesting too much and lastly, watch your focus.