3 non-negotiable red flags during due diligence

In business acquisitions, knowing how to spot a bad deal is even more important than knowing how to spot a good one.

If your goal is to:

• Become a passive (or semi-passive) owner

• Take over the business with minimum hassle

• Start scaling the business quickly and smoothly

Then there are three major red flags you need to keep an eye out for.

You should view these all as dealbreakers no matter what industry or niche you’re in:

1. Owner is the primary service provider

You might see deals where the business is bringing in incredibly high profit margins. Say, 60% to 70%.

But watch out!

It’s probably high because:

• The owner is working 60+ hours per week

• They’re in the weeds with every minor detail of the business

• They don’t hire anyone, therefore their labor costs are almost zero, and they keep all the extra margin for themselves

As soon as they step away, that profit is going to plummet.

There are some business models where you can have high profit margins without the above scenario. But this isn’t standard.

For most other businesses that sell a physical good or service (not based online), and where the owner isn’t doing all the work...

A healthy profit margin will be somewhere between 20% to 35%.

2. No management layer

If you see there’s no clear hierarchy consisting of the owner → a general manager → the rest of the employees...

And instead, it’s just the owner handling everything directly...

It’s going to be pure chaos when you take over.

You’re going to be working all day, every day because you have to:

• Micromanage every employee

• Do the scheduling

• Do the hiring

• Do the firing

• Do quality checks

These are tasks for a manager, not for you!

Your job should be to manage the manager, scale the business and focus on high-level strategy.

If you are not able to install a general manager, then cut your losses and move on.

3. The business needs specialized knowledge

Every business requires specific industry knowledge.

I'm specifically referring to businesses that require highly specialized credentials or technical expertise. Think medical practices, engineering firms, or scientific laboratories.

Most people who are interested in these deals are from private equity groups who have a ton of money and institutional backing, and know the niche well.

As regular people, we want to buy a business that sells a product or service that basically everyone understands.

This way it’ll be straightforward to hire people, bring in more customers, and keep on scaling.

Interested in buying a small, boring, cash flowing business?

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Onward,

— Ben Kelly