You have possibly spent months or maybe even years searching for the perfect small business ideas and now you think you have found it. You are ready to dive right in, quit your present job and dedicate yourself to starting your own business. But, before you make any life-altering changes that cannot easily be undone, it is important that you take some time to first evaluate your business idea to see if it has the legs you hope it does.
Suggested Blog – How To Value A Small Business If You Are Looking To Buy Or Sell One
Buying a business is a big decision. But, when you pull the trigger on buying an existing business, you get the opportunity to become an entrepreneur without starting a business completely from scratch.
Every year, more than 500,000 businesses change hands and that number is expected to skyrocket in the next several years as millions of baby boomers begin retiring and selling their businesses.
Buying an existing business is so popular because it lets you skip past some of the pain points and costs of starting a new business. But the journey from finding a business for sale to closing the deal seems tough and complicated.
So, before you begin the journey of buying a business of your own, find out everything you need to know to avoid buyer’s remorse. Our buying an existing business checklist will give you a step-by-step guide.
We’ll also cover the pros and cons of buying a business when you’re still just thinking about the idea, and end with how to buy a business when you’re ready to close the deal and get the keys. Here’s a rundown of how to buy a business.
If you are set on the idea of buying a business, then it’s crucial to make sure you pick the right business for you. The easiest way to set yourself up for success is by buying a business that you’re passionate about improving and taking to the next level. But passion alone is not enough, experience and knowing which questions to ask when buying a business are also important when making your choice.
Narrow down your passions, interests, skills, and experience. You will be much satisfied if you buy a small business that dovetails with what you already like and have some experience in.
Let’s take an example if you have been a line cook at a restaurant for several years, maybe you have decided you would like to own your own restaurant. Or maybe you have been an employee for a long time at a company that is now on the market.
In that case, who better to buy the business than someone who knows it as intimately as you? Although you might just want to buy a business for the financials alone, say, by its expected return on investment, it is also important to align yourself with the business’ immaterial goals.
After all, the more knowledgeable and familiar you are with the business’s model, products or services, customers, industry and trends, the more innovative and successful your new ideas to achieve your success will be.
There are plenty of ways to find the right business for sale that fits the criteria you have decided on.
Business brokers legally represent the seller, so you should be careful about conveying certain information to them (such as how far you are willing to go into negotiations).
And also, a broker can assist you to understand what kind of business you want, pre-screen businesses to cut out all the failing companies, keep negotiations civil and smart and help you with all the necessary paperwork. Brokers do earn a commission when a sale goes through, but it is typically paid by the seller.
There are plenty of reasons a business owner might put their business up for sale, including something as simple as an innocuous lifestyle choice like retirement. Or, there might be a more worrisome reason, as a fundamental problem with the business.
If you are about to buy a business, then you will want to know exactly why the businesses you are considering are no longer working for their current owners.
You should ask the current owners what challenges they have encountered, what they have done to try solving those problems, and how those attempts fared. During every conversation with the current owner, you should ask yourself, “Do I have what it takes to meet these challenges with different or better solutions?”
Make sure you know as much as it is required to know about the existing business’ successes, failures, challenges, and future opportunities.
In addition to speaking with the owner about these concerns, also talk to existing customers, existing employees, locals in the area, neighboring businesses and so on. They will give you an honest view of how the business is doing, without the bias of the seller trying to convince you to buy.
Next up on our how to buy a business checklist is to zero in on your business of choice. Until now, you might have been considering several different businesses, but now it is time to hone in on the best option. The best option is the business that aligns with your budget, goals, and resources.
Calculating the ideal size, location, sales, staff and so on of your prospective business is an important step in your plan of buying a business since it will give you a scale to keep in mind when you are shopping around.
Just a need to figure out how much you would ideally want to change business and assess how much that will cost you. Money is not the only thing you will be spending.
Look at the time and energy commitments you are planning to invest to make the business your own. Some managers prefer to be “on” at all times, in the weeds with their employees, while others prefer to delegate and, one day, own multiple businesses.
The amount of resources you will have to invest depends in large part on the people and processes already in place and on the experience you have in the industry. For example, if you are buying a tech company but lack technical expertise, you will need to invest time learning the ropes or hiring people who have the experience.
Now, another step to be taken in our guide of how to buy a small business is to do your due diligence. Due diligence is the process of gathering as much information and Intel as you can before buying a business and it is a critical step in your journey to becoming a business owner.
During this period, you should work with an accountant and lawyer to make sure you have all the information you need to move forward. As the buyer, you will want to have a good accountant on your side to review the business’ financials.
It is also beneficial to have a good business attorney to represent you in negotiations and to help you understand how the transaction will be structured.
Prior you can begin your due diligence, the seller will most likely ask for a signed confidentiality agreement or non-disclosure agreement. By signing, you agree not to disclose any confidential information about the business that is uncovered during the due diligence process. This assists the seller in case you decide buying the business is not for you after reviewing all the documents.
There are plenty of business documents, files, agreements and statements that you will want to collect and analyze, ideally with the help of a lawyer and accountant.
Here are some of the must-have documents when doing due diligence in the process of considering whether to buy a business:
First up is to make sure that the business you are looking at has all the business licenses and permits it needs. If you’re buying a business, you want to make sure that the current owner has not run afoul of any local business licensing laws. Businesses in certain industries, particularly highly regulated ones like food services and childcare, need a valid permit to stay open. If you have any confusion, first of all, learn how to get a business license with our ultimate state by state guide.
If the business you are buying is a sole proprietorship or partnership, there may not be official “founding” paperwork. However, a registered business entity, such as an LLC vs corporation, will have organizational documents on file with the state.
For an LLC, this is the articles of organization. For a corporation, this is the article of incorporation. The secretary of state in your state should also be able to produce a certificate of good standing for the business you are interested in buying. This certifies that the business is approved to operate in the state.
Suggested Blog – How To Setup An LLC in NYC In 7 Simple Steps
Check with your area’s local zoning laws to make sure that you’re buying a business that is not violating any restrictions. While some localities allow mixed-use commercial and residential zoning, others have tight restrictions on where businesses can be located. This especially goes for businesses like bars and nightclubs that may not be desirable in a residential area.
Has this business been secretly dumping chemicals into the nearby reservoir or violating other environmental laws? Make sure the answer must be strong and firm no before moving forward with buying the business. Double-check that this business abides by all of the area’s small business environmental regulations.
When you look forward to buying a business, the seller issues a letter of intent (LOI) to the buyer when both sides have agreed on a price point and about which business assets and liabilities will be added and included in the transaction. The price proposal, along with the terms and conditions of the business sale, should all be included in the seller’s LOI.
The LOI is an indication from the seller that they are serious about seeing the deal through to the end. Once you have it in hand, you can feel more comfortable forging ahead with the remainder of due diligence.
Half the fun of the decision to buy a business is all the stuff it comes with. Whether that means a lease for the location, equipment, or something else, you will want to make sure the landlord is alright with transferring over these legal documents to your name. Otherwise, you will need to negotiate a new lease, which can significantly add to your expenses.
You will also want to review any outstanding agreements that the owner has with vendors or customers. This can be very revealing. For example, if your review indicates that 90% of the business’ revenue comes from a single client, you will want to think twice before buying. If that client parts ways with the business, it could put a serious dent in the business’s potential.
Before buying a business, make sure to examine its past few years of financials, which includes the following:
Double-check that the tax returns and financial statements have passed a CPA audit, do not accept those financials from the sellers themselves. Use the business’ financials as an opportunity to analyze its income stream.
The business you purchase does not necessarily have to be profitable yet (particularly if it is a young business), but there should be a clear path to profitability. Be in the know on whether the business’ debts and liabilities will be included in the transaction or not, and be wary of taking these on.
For example, if some of the outstanding receivables the ex-owner was dealing with are too old—90 days or more, for instance, then they will be pretty tough for you to collect on. You might be better off asking the seller to insure them or contact the customers themselves.
If you buy a business with employees, make sure you understand how they rank and relate to one another by asking for a business organizational chart. This should also include compensation data, management practices, and processes, benefit plans, insurance, and vacation policies.
Make sure to critically analyze these aspects of the businesses, since their values will directly impact the business start-up cost.
You will want to check:
Websites like Whayne.com can be used to look up equipment and obtain price estimates.
(x) Other Important Documents
This list of documents will tell you a lot of information about the business, but there is probably more you will want to examine. Your attorney or accountant should be able to identify additional documents specific to the business you are interested in.
For instance, you need to ask the seller for property documents, equipment/asset listing, brand assets for advertising materials, an account of intellectual property assets, insurance coverage, employee policies and contracts, incorporation information and customer lists.
After Due Diligence, You Will Require A Sales Agreement For Your Small Business
Once due diligence comes to a close, you will need to make your final decision about whether buying the business is right for you. If you decide to go ahead, the sales agreement is what ties it all together.
Have a lawyer help you put this document together, or, at the very least, review it carefully before you sign. learn how to find a business attorney in 5 steps.
The next step in our buying an existing business checklist is very important: agree on a price.
This is where many deals fall apart because buyers and sellers often place very different values on the same business and several factors affect a business’s value. Buyers and sellers usually use some kind of pricing model to get a ballpark number and frame negotiations.
During this process, it can be very helpful to call in an independent business valuation professional to make an objective determination of value. Valuation services, which can be found online or through word of mouth, cost around $3,000 to $5,000, but they can save you thousands more in the long run by coming up with a good estimate.
Whether you do this yourself or hire someone, it is helpful to have some knowledge of different business valuation methods. Small businesses should understand three main approaches to valuing an existing company when they are considering how to buy a business
This is best used for buying existing businesses that are already turning a profit or have a positive forecast of earnings. The earnings approach values and consider a business based on its historical, current and projected profits. Specific methods you may come across that fall into this approach include the capitalized earnings method and discounted cash flow method.
For businesses with a history of fairly stable profits, that history can be used to anticipate future earnings and value the business. Even if a business has not generated a profit yet, earnings models can be used to predict how much the business might earn in the future. The disadvantage of the earnings approach is that it relies on a prediction of future earnings, which may not be accurate.
This is best used for buying capital-intensive businesses, such as manufacturing and transportation businesses, and businesses that are not profitable yet. The assets approach measures the value of a business’s tangible and intangible assets minus debts and liabilities.
Tangible assets include things like equipment and real estate and intangible assets include things like patents, trademarks, and software. The assets approach considers the current fair market value of the business’ assets but also the future return on investment that the owner could get from those assets.
This is best used for accounting for local factors or confirming a price that you arrived at based on one of the other two approaches. The market approach measures the value of a business based on how much comparable businesses have sold for. Also, learn how to value a small business if you really search out to buy or sell a business.
It is a good way to get a ballpark range for a business’s value and to account for local factors that the other approaches may miss, such as the business’ location in a particular neighborhood.
It might be confusing to get all these approaches straight in your head, but the point of all of them is to assess the current financial health of the business, as well as its growth potential.
In reality, none of these methods exists in isolation. All three of these approaches can be used to arrive at a fair price for a business and the final price will always be the one that both the buyer and the seller agree on.
Once you and the seller agree on a number, the next step in buying a business is to get the money. There are a few different ways you can gather the capital you will need to purchase a business—some specific to buying an existing business, others pretty standard.
If you are able to cover the costs of buying an existing business, that is always an option. This is more likely if you are buying a small business rather than a chain. Of course, you will want to consult your accountant before ponying up a large lump sum of your own cash. Also, make sure that you are not using all your money buying a business because running a business takes capital, too.
Many businesses are also funded with money borrowed from family. If you go this route, you should understand the tax implications for gifts and family loans. Make sure that you and your family members put the exchange of money in writing and follow IRS rules for family loans.
Some sellers will agree to hold a note or accepting staggered payments—sort of like a lender. This way, they get guaranteed income for the coming months (or years, depending on your plan). There are rules around seller financing, particularly if you plan to use another form of debt financing as well.
For example, sellers have to be on “standby” if you’re also getting an SBA loan, meaning they have to agree that they won’t be paid back until you pay off the SBA loan.
Suggested Blog – What Is The SBA’s Definition of Small Business (And Why)?
Some sellers might also be willing to trade in some assets, like some furniture they really loved or the company car, for a lower price.
By turning to a partnership instead of buying a business solo, you can divide the payments you will be making while still owning that company. Taking on a partner when buying a business is not only useful to cut costs, though: You can also bring someone on board with more specific experience or a different skill set. Do not forget to draw up a partnership agreement, so co-ownership does not cause any problems down the line.
By selling company stock to your employees, you can get a big discount—making up 50% or even 90% of the business price by some measures. You will probably want to sell non-voting stock, if possible, to retain ownership over the business. In order to issue stock, you will have to organize the business (or re-organize it) as an S-corp or C-corp. Also, learn what are the dissimilarities between S-corp vs C-corp are found out.
It might be possible for you to lease the business instead of buying it outright—with the option to make the big purchase down the road once you are able to afford it.
Understandably, not all sellers will be open to this option, since they more likely than not want to wash their hands and walk away from the sale. However, if leasing is something you would be more comfortable with—even though it may cost more money in the long run—you might as well ask.
Buying a business will offer you tons of documents to approach a bank or alternative lender with for financing: financial histories, tax returns, employee records, cash flow analyses, inventory and equipment valuations, and much more. This wealth of data makes business acquisitions a good candidate for loans because lenders are not working with a risky blank slate.
If you are looking for a small business loan, here are a few potential financing options that might help in buying a business:
With a traditional term loan (or a short-term business loan if the purchase price is relatively low), you will borrow a set amount upfront, then pay it back—plus interest—over a predetermined amount of time. This is a pretty ideal format for buying an existing business You will get the cash you need to make your purchase, then pay the lender back over time as the business generates revenue.
Although rates and terms vary depending on your financials—like your personal credit score—as well as on the lender, you can usually expect a term of one to five years and interest rates between 7% to 30%, for amounts ranging from $25,000 to $500,000.
An SBA loan—one of the largest, lowest-cost and most affordable financing products out there—is not actually funded directly by the U.S. Small Business Administration. Instead, the SBA guarantees a big portion of the loans you can take out from a bank or alternative lender.
With up to $5 million in financing, terms of a decade or more and interest rates in the single digits, SBA loans are the dream for most entrepreneurs. For buying an existing business, the 7(a) loan program is the way to go. It works pretty similarly to the above term loans, with a set repayment schedule and a lump sum of cash upfront.
Blog You May Like – What Is The SBA’s Definition of Small Business (And Why)?
For asset-based loans, you will borrow capital against a certain asset, which acts as collateral in case you default on your payments. When buying an existing business, you are taking on all of its assets—which means you have a lot of potential collateral to help finance your purchase.
These loans will be much smaller than the cost of a business purchase, of course, since you are only financing a part of the buyout (based on the value of the collateral), but they can still be very helpful.
You can use three different kinds of assets as collateral for financing:
Choose one, or all three, to help you finance the right amount for your business acquisition.
The last step in our buying a business checklist is to close the deal. When you have finally found the right business, done your due diligence, agreed on a fair price and gathered the capital you need, make sure you (or a broker) have all 10 of these documents, notes, and agreements in place before you officially buy a business
(i) Bill of Sale
When buying an existing business, this document will prove the actual sale of the business, officially transferring ownership of the business’ assets from the seller to you.
(ii) Adjusted Purchase Price
This is the final count of the cost of your purchase, including all prorated expenses, like rent, utilities, and inventory.
If you are taking over the business’ lease, make sure your future landlord is in the know. On the other hand, if you are negotiating a new lease, double-check that everyone understands its terms.
Does the business you are buying come with any vehicles? If so, you might have to transfer ownership with the local DMV, make sure to get the right forms completed by the time of sale.
(v) Patents, Trademarks, and Copyrights
Similarly, when buying an existing business, all patents, trademarks, and copyrights might require certain forms to get transferred to you, the new owner.
Check the SBA’s Consumer Guide to Buying a Franchise to see if you will need to file any franchise documents.
(vii) Non-Compete Agreement
It is standard practice and generally a good idea to ask for a non-compete from the former owner. This way, the previous owner will not set up a competing shop right across the street.
(viii) Consultation/Employment Agreement
This document should be drafted in the case that the seller is staying on as an employee. Make sure to file this agreement if so.
(ix) Asset Acquisition Statement
The IRS Form 8594 will list the assets you have acquired, and for how much. This document is pretty important in the “buying an existing business” checklist for your tax returns, so do not forget it.
(x) Bulk Sale Laws
Bulk sale laws have to do with the sale of business inventory and are designed to prevent business owners from evading creditors by transferring ownership of the business to someone else. For obeying and following, prospective buyers usually have to notify the local tax or financial authority about the pending sale.
And that is everything you need to know about how to buy a small business. But knowing how to do it is one thing, knowing why you are doing it is another.
Let us now also talk about some of the reasons for buying a business. Buying a business is kind of like being in the market for a home. Although some people like the history and character that come with an older home, others do not want the baggage that can saddle an older home and prefer something turnkey. Similarly, there are plenty of advantages when you buy a business that is already been around for a while, but there are drawbacks, as well.
Now that you know how to buy an existing business, let us go over why you might want to. Here are some benefits to buying a business:
When launching a brand-new business, the bulk of your time will be spent on the planning phase. You will have to write a business plan and figure out how to turn that plan into a reality. But when you buy a business that’s already up and running, you will typically have all of this in place:
Granted, each of these things may not be in great condition and the business might not be turning a profit yet.
However, buying an existing business means it has some structure already in place, which will save you time upfront, letting you quickly see what you need to zero in on. Particularly if you are testing a new market or entering an industry that you do not have much experience in, zipping past the difficult start-up phase can be a huge advantage.
One of the major benefits of buying a business is that the operating costs are lower. For example, start-up costs for a brand-new restaurant can run upward of $450,000 for initial supplies, food and beverage, signage and customized kitchen design.
With an existing business, your initial operating costs are lower because unless your acquisition is pretty atypical, many parts of the business are already in place and ready to go once you are at the helm.
Specifically, you do not need to spend as much of your budget on hiring employees, developing marketing strategies, or building a customer base because those come with the transaction. Rather, you can pour more cash into expanding the business and adapting it to your vision.
While the move to buy a business is not always a safe bet, lenders and investors see it as lower-risk than launching a new company. This is because there is a history of financial performance that a lender or investor can use to gauge how the business has performed to date and to predict future performance. Plus, as we mentioned, there are also existing data around the company’s market position, competitors, brand recognition and customer base.
All this makes investors more likely to invest in the business and can make lenders more comfortable in giving you a business acquisition loan. The current owners can even participate in financing the transfer of ownership by giving you a loan.
If your business-to-be has patented their products or has a copyrighted slogan or trademarked logo that wins over customers, then that intellectual property value will probably transfer over to you in the acquisition. That means when you buy a business, you sometimes buy more than what the eye can see.
This is not on the table with every business acquisition, but it could be critical if you are dealing with something that you think could be expanded even more. What if you turned this small business into a national franchise? Out of nowhere, that patent and copyright become a lot more valuable. Patents, copyrights, and trademarks are often included in sales of software companies, tech businesses and creative businesses (e.g., music, design and art).
What goes up must come down, right? Now for the drawbacks of buying a business:
By buying an existing business, you will be able to save money on operating costs, such as inventory and equipment. However, you will probably face some pretty sizeable purchasing costs. In fact, those purchasing costs might be greater than what it would take you to start a new business.
That is because, in addition to the obvious assets, you are also buying ownership over the following:
All of these items will be the subject of negotiations between the buyer and seller and factor into the final purchase price when buying an existing business.
If you are buying a business you did not start, you will understandably be a bit less familiar with its inner workings and the details of its products, processes, employees, and financials than if you built the business yourself. This could be a bit of an obstacle, especially when you are just starting out. This is especially true if you are entering an industry that you lack experience in. You will need to spend a lot of time learning the ropes and prepare for the learning curve to be steep.
Ever watch a show where the second a buyer closes on a house, they find out the inspector missed a massive crack in the foundation? Too late to go back on that purchase now! Well, as a prospective business buyer, you will also go through a fairly intensive due diligence process, where you will gather information about the business and the current owner. But no matter how much information you uncover, you always run the risk of taking on an issue that you are not aware of or that’s worse than it appeared.
For example, the equipment could be damaged, or the brand might have a bad reputation. Once you buy a business, you buy those issues, like it or not. You will also learn how to catch most of these problems before it’s too late.
It is the time that demands you to know about how to buy a business safely, smartly and successfully.
Here are some pointers to remember:
Although there is a lot involved in buying an existing business, you will be rewarded when you are finally at the helm. You will be able to revitalize what might have been a stale company with fresh ideas and fresh leadership.