Do your homework before buying an existing small business
BY NANCY DAHLBERG AND SUSAN GUILLORY
Do you dream of owning your own business? There’s more than one way to make this dream come true. Some entrepreneurs launch a business from scratch, while others buy an existing business. There are certainly advantages to buying an established business, but is it the right move for you? Let’s find out.
Pros and Cons of Buying an Established Business
If the idea of starting a new business isn’t your cup of tea, you might consider becoming the new owner of an existing business. Let’s look at the benefits and drawbacks of doing so.
Pros
An established business has done the hard work of setting up, establishing customers and generating revenue, so you will have less work to do. Contrast this to launching a startup, which will require a lot of capital upfront, as well as a lot of strategies and planning to be a success.
Another benefit is that you can have a clear understanding of what sort of revenues you can expect. Smart business buyers ask to see their accounting. Looking at the business’ financial statements for the last three to five years, such as cash flow statements, balance sheets, profit and loss statements, and personal and business tax returns can show how financially healthy the business is and has been.
Cons
On the other hand, you may not be able to find the type of business you are interested in for sale or at a price you can afford.
You may also inherit liabilities like debt from the owner, which can add to the cost of buying a business. In addition, you may not be aware of any issues with staff, suppliers, location or zoning until you take over ownership and see for yourself.
Consider why this person is selling the business. Is it because it’s flailing and they want to get out before the ship sinks? You don’t want to be the one to go down with the ship.
What to Consider Before Buying a Business
If you are considering buying a business, here are some things to consider.
What’s the Real Story?
It’s important to consider why small business owners sell their businesses. If they’re planning to retire, that’s one thing. However, if they have racked up debt and cannot afford to run the business, then that becomes your problem.
Find out as much as you can about the business. Don’t just look at the balance sheet; talk to employees to see how they like the company and how it’s run. Examine equipment to see what kind of shape it’s in.
What Will it Cost?
The purchase price is just one expense you’ll have in buying an existing business. If equipment is outdated, you may soon need to replace it. In addition, consider that some employees might leave when you take ownership, so you may need to invest in hiring new ones.
Also, consider other fees or licenses you may need to transfer or get in your name as a new license. Review the requirements for business licensing in your state so you know those costs ahead of time and can ensure you have the cash flow to cover all these expenses.
Is There Any Debt?
If the business has outstanding loans or other liabilities, what are they, and will you be responsible for paying them off? You may be able to negotiate this as part of the sale agreement so that you’re not saddled with debt, which may start you off on the wrong foot when it comes to building business credit.
What Work Needs to be Done?
You may be able to step into this business as a turnkey operation and do nothing more than put your name on your office door. Or you might have major renovations, hiring, training or purchases to make. Consider your new ownership as an opportunity to make design improvements if the location you’re buying is run down or in need of a coat of paint. A few cosmetic tweaks can communicate to customers that there’s a new owner eager to serve them well.
Do You Need Help?
You certainly can buy a new business but it may be helpful to hire a business broker. They know how to find the kind of business you’re looking for, and can help with due diligence and the negotiation process.
How to Buy an Existing Business
Now let’s look at the steps for how to buy a business.
Step 1: Do Your Due Diligence
It is your responsibility to learn as much as you can about the business. That means carefully analyzing financial records and tax returns or having a CPA or a consultant do it if you are not clear about what the owner discloses about the business’ financial health. You need to look at all the assets including intellectual property and be aware of all liabilities.
Also, check its credit history because you will be inheriting it. If the owner did not pay any outstanding bills, it will be reflected in the business credit scores and may affect your ability to secure future financing.
Step 2: Review the Business Plan
You’ll want to know as much as possible about business operations, so if the company has a business plan, ask to see it. This can give you insight into the previous owner’s vision for the company and you can see how well it is aligned with where the business is.
Step 3: Conduct a Business Valuation
The owner will have given you the sale price, but now it is up to you to do a business valuation to see how accurate that price is with the market value of the business. A business valuation should include both tangible and intangible assets, including real estate, monthly retainers, accounts receivable and debts.
A business broker, accountant or business consultant like Michael Bernard can help with these calculations. Ultimately, you’re trying to determine whether, at the asking price, you would be able to see a solid return on investment within a few years.
Step 4: Give Your Letter of Intent
This letter states your intent to purchase the business, though you can opt out if you decide it is not the right business. Some business owners won’t release tax returns and other financial information until you give them a letter of intent.
Step 5: Get Your Financing Together
We’ll cover this more in-depth in the next section, but before you can buy a business, you need to ensure you have enough cash to cover not only the sale price but also those costs you’ve calculated. If you do not have enough cash you may need to take out a small business loan.
Step 6: Sign on the Dotted Line
Sign the required legal documents to seal the deal. Once both parties have signed, the business is yours.
Financing Options for Buying a Business
Term Loan
Banks and online lenders are willing to finance a business acquisition, if you qualify. You will need good to excellent credit for the low-interest rates.
SBA Loan
Another option is a loan backed by the Small Business Administration. These also offer low rates for those who qualify.
Seller Financing
Some sellers, particularly those who are motivated to sell, may be willing to finance the deal. If you don’t qualify for a low-interest loan, this may be a good option. You may be asked to provide a down payment based on the asking price and then make monthly payments for a predetermined period of time.
Find the Business That’s Right for You
Finding the right business that fits your needs and fulfills your dream will take time, but if you do your due diligence, you have the potential to build on top of a well-established business with your own unique flair.
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