Identifying Seller Red Flags in Acquisitions
Identifying seller red flags is critical to protecting your investment and ensuring a smooth transaction. Below I’ve identified 6 common things to look out for that I see when financing business acquisitions with the SBA 7a loan program:
Inconsistent Financial Records - One of the biggest red flags is when a seller cannot provide consistent or accurate financial records. Financial transparency is essential for SBA loan approval, and any discrepancies or missing documentation can lead to significant challenges. Be wary if tax returns, profit and loss statements, or balance sheets do not match or if the seller is reluctant to provide detailed financials.
Seller Reliance – Can the party go on without them? A red-flag that is sometimes hard to catch in the very beginning of the process of buying a business is how integral the business owner really is to the operation. You may be well suited to take on all responsibilities of the seller, but the only way to know that for sure is to best understand exactly what those responsibilities are. If the broker or seller is telling you that “the place runs itself!” – give pause, and investigate further on what the seller actually does day-to-day, who he delegates to, and what the temperament and situation is with those key individuals.
Declining Revenues - If the business has experienced consistent or unexplained declines in revenue, it could signal deeper issues. While some dips can be explained by external factors, long-term revenue decreases might indicate fundamental problems with the business model, market demand, or customer retention. A seller downplaying these trends should raise concerns, as lenders will scrutinize any downward trajectory when evaluating your SBA loan application. An open and transparent explanation of issues needing correction or improvement may provide you with significant upside potential – but we need to know the true details surrounding the current situation.
Excessive Seller Pressure - If a seller is pushing for an unreasonably quick close or putting pressure on you to bypass due diligence, this is a major red flag. Buying a business is a complex process, and thorough due diligence is necessary to identify any operational, financial, or legal risks. Sellers who seem too eager to rush the process may be hiding issues they don’t want uncovered. All parties naturally want to execute on the transaction as efficiently and quickly as possible – but not allowing you adequate time to collect and analyze pertinent information is a sign that this might not be an opportunity for you.
Unexplained Staff Turnover - If key employees have recently left or if there is a high turnover rate, it may indicate problems with management, work environment, or the company’s future. Lenders will look at the business’s ability to operate smoothly during a transition, and unexplained staffing issues can raise concerns. While this may be a problem that creates opportunity, it is certainly significant and one that there needs to be a clear plan in place to address.
Customer Concentration – Seen in B2B business models, at times, you’ll find that a significant amount of revenue and profitability is actually coming from one or two key customers. That presents a problem because obviously if one of these customers pulls back, or stops doing business altogether after transition the financial performance will certainly suffer. Be advised that even if the key customer is under contract there is likely a “change of control” provision therein which means quite simply – at transition those are not your contracts. There are ways to mitigate this risk such as forgivable, or contingent seller-notes tied to ongoing performance of these key accounts that are SBA compliant but you need a strong knowledgeable lender to make sure these are structured correctly.
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Sebastian H Amieva
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