Want to buy an existing business? Here’s what you need to know.
BY KEY DAWSON, SENIOR BUSINESS ADVISOR, BUSINESS DEVELOPMENT.
KEY OFFERS A WEALTH OF ENTREPRENEURSHIP EXPERIENCE AND OPERATIONS EXPERTISE. AS AN ENTREPRENEUR AND BUSINESS OWNER, KEY HAS SUCCESSFULLY PURCHASED AND SOLD A NUMBER OF BUSINESSES.
Buying an existing business has many advantages over starting an entirely new one. Existing businesses typically already have employees, clients, inventory, processes, cash flow, and historical financial performance. While operations can begin right away, buying an existing business presents several challenges that should be understood before you begin the process.
For example: How do I know if I’m ready to buy a business? How much should I pay for a specific business? What professional assistance do I need?
Buying an existing business will often cost more money upfront than starting one from scratch. But, much of the startup legwork is already done. It is important to explore the business opportunity thoroughly and with professional guidance to understand potential problems or debts that will come with the business purchase. Existing problems can remain hidden until after the final sale, like damaged or outdated equipment or inventory, issues with real estate property or location, or heavy dependence on a single client.
If you’re uncertain about your readiness to buy a business, take SBA’s online course: Buying a Business. This free 30-minute overview is a great resource to get started.
Think you’re ready to purchase a business?
Here are 8 key steps to buy an existing business:
Step 1: Narrow your search to the types of businesses that fit your interests and talents.
Be honest with these assessments and try to pick an industry that you have some experience with. If you plan on applying for a loan to cover the business acquisition cost, lenders will often take into account if you have industry experience and/or relationships with vendors and customers. To get ideas, think of a customer base you’re familiar with and any skills you’ve picked up over your career.
Step 2: Determine how much time and money you (and your family) are prepared to invest into a business.
Owning and operating a business can be time-consuming and stressful. Let’s start by comparing a franchise to an independent business. While pursuing a franchise opportunity gives you less control, you’ll receive more hands-on support and guidance for running the business. On the other hand, buying an independent business gives you more freedom and control over the branding and operations, but without the infrastructure of a larger brand.
As the buyer, you’ll have to take into account the amount of time you currently have available. It would be very helpful to find out how much time the current owner has been investing into the business.
The size, location(s), and maturity of a business will all affect the commitment. Consider how hands-on you want to be with your business and again, be honest and realistic about your expectations of becoming an entrepreneur. You might consider hiring a business broker who can help you explore available businesses as they compare to your interests and ideal business plan, and negotiate deals when the time comes.
While evaluating the amount of time you have available, you’ll also want to set a budget with the money you have saved and determine the capital you’d need from a lender or through seller financing.
Step 3: Form your team of experts to advise you throughout the process and to help you with business valuation, due diligence, and legal documentation before investing into a business.
The initial research phase of buying a business is critical. Due diligence includes exploring why the business is for sale, the immediate and long-term profitability of the business, its perception in the marketplace, the overall value, and any potential problems associated with the business or property.
Your acquisition team should include the following professionals:
With your team’s help, perform due diligence and lay out a buying plan you’ll use to negotiate critical terms and conditions of the purchase, including price, payment terms, and legal structure. Find out why the business is for sale, how the current customer base and vendors perceive the business, the ownership and operation structure of its current and previous owner, what is the business’s outlook and business plan for the future, and if the business is projected to stay profitable. Either you or your accountant should review financial statements and tax returns from the prior year as a starting point to determining how much the business is worth. Better yet, review those financial statements and tax returns together so you can make an informed decision.
The business may very well be for sale because the seller or prior owner has received a new opportunity. However, it’s very important that you discover if the business for sale was experiencing a dying profit or other possible money problems. This way, you’re protecting yourself as the buyer and can be fully aware of the investment you’re making.
Step 4: Locate a business to buy and gather all the information on your Business Acquisition Checklist.
Thousands of businesses are posted for sale online and in classified sections of the newspaper, whether you’re looking for a franchise opportunity or independent business. Alternatively, you can target businesses that fit your criteria but are not advertised for sale. A third option is to hire a business broker to help you with this process of purchasing an existing business.
Here is a starting checklist of things to gather before you buy an existing business:
- Balance sheets and income/financial statements for at least three years so you can see the type of profit that the business was earning.
- Projections for current year to give you an idea of the cash flow that will be moving in and out of the business.
- Tax returns for at least three years and confirmation of historical payment on all state and federal taxes
- Full list of business obligations or debts.
- Proposed selling price and what’s included (property, equipment, inventory, as well as the market value of all assets), schedule of accounts receivable and account payable, inventory schedule, any previous purchase prices, and any analyst reports.
- Possible additional capital that will be required to operate the business moving forward.
Industry and market information:
- List of product and services offered, including the pricing matrix and strategies, pricing system, and how much inventory is included in the sale.
- Competitive analysis, including list of suppliers, customers, and competitors.
- Clear definition of market and distribution area and well as research on the history, trends and future performance of the industry.
Operations and business background:
- Complete history of business, including articles of incorporation, bylaws, list of shareholders, a Certificate of Good Standing from the Secretary of State, and registration paperwork. Consider interviewing the owner as well as current and past customers for helpful insights.
- List of required licenses needed to operate the business (along with current status and costs of maintaining all licenses for compliance).
- Investigation of leases, deeds, and zoning laws.
- Request an explanation for the reason the business is being sold and a copy of the unsigned buy/sell agreement (and franchise agreement when applicable).
- Details on use of the seller’s intellectual property, goodwill, and relationships after the sale, and consider a non-compete agreement from the seller.
- List of any future obligations including upgrades or customer warranties.
Personnel and Management:
- Complete history and forecast for staffing, including roles, salaries, contracts, and benefits packages for all employees.
- Determine if seller is willing to stay for a set amount time after the sale to provide direction. Also investigate the likelihood that key personnel and employees will stay on after the acquisition.
Learn as much about the business as possible before you commit to purchasing it. The Westmoreland Chapter of SCORE has an incredible due diligence checklist on their website.
Step 5: Determine the value of the business
Use your due diligence findings to help determine the value of this business, and be sure to consider liabilities, debt, market history, all assets including real estate and inventory, and overall market history. Determining the business valuation will also give you a better idea about the business’s liabilities (if any), as well as its advantages. This way, you’ll have a clear picture before signing on the dotted line.
There are three common methods for determining the value of a business:
- Asset-based approach
- Market-based approach
- Income-based approach
For more information on calculating the value of a business, you can check out this article from SCORE or read this “How to Value a Business” resource from BizBuySell.com.
Step 6: Secure any financing necessary to close the purchase.
Operating a business takes more money than just the purchase price. You’ll need capital to run the business successfully once the purchase is complete. Luckily, there are several options you can use to finance the business. For example, you can form a partnership or secure a business loan if you don’t already have the necessary money on-hand.
Financing options include bank financing and seller financing, in which the seller agrees to accept part of or the entire purchase price over time. If your banker is unable to help you with financing, you can apply for a Business Acquisition Loan from Pathway Lending. We serve as a hands-on lender to entrepreneurs who fall outside the credit box of traditional banks. We offer technical assistance and guidance throughout the process. You can also visit SBA.gov to learn about available SBA bank loan programs.
Step 7: Determine the purchase option and finalize the sales agreement.
Buyers have several options for transferring ownership rights of a business:
- Outright sale – ownership is transferred immediately, payment is expected at time of sale, and business is bought in-full. In this case, you’ll be the new owner the moment the sale is final.
- Gradual sale – through a long-term payment plan, ownership rights are transferred over a period of time.
- Lease agreement – both parties agree to a contract that details conditions and payments that give the lessee temporary rights to the business.
The agreement should accurately reflect your understanding and intentions regarding the financial, tax, and legal terms of the purchase. At a minimum, have your attorney review and approve the final sales agreement before signing. Make sure the transition process starts before you close the deal. Make sure the previous owner feels good and comfortable about what is going to happen once he/she is gone. Be sure you have a comprehensive checklist for closing on the business that both you and the seller have agreed upon.
Step 8: Close on the purchase with the assistance of your attorney.
Congratulations! You are now a proud business owner and have successfully completed all of the steps to buy a business. We encourage you to explore small business support and education in your area to learn how to maintain proper cash flow, keep track of all your assets, and gain extra help with managing employees and other related tasks.
Need help purchasing a business?
Pathway Lending offers business acquisition loans and hands-on support to help you along the road to small business success.