Buying An Existing Business
Doug Boehme – So you have decided that business ownership is something you want to pursue. To fulfill that dream, you have three business ownership options:
- Start from scratch
- Buy an existing business
- Buy a franchise/license
Each has different levels of risk and associated costs, which makes for a discussion at another time. If you have decided that buying an existing business is the direction you want to choose, here are the steps to accomplish that objective.
Determine the right type of business
This initial step takes self analysis regarding your abilities and goals. What is your skill set – selling, operations, finance? Of course, as a business owner you will be wearing many hats, but certain businesses will require specific skill sets of their owners. For example, if a particular business requires the owner to be heavily involved in sales and that’s not your forte, maybe it’s not a fit for you.
If your exist strategy is to work 8-10 years fully engaged in the business, but then be able to back away from the day to day operations, make sure that you focus on the type of business that is conducive to that arrangement.
If your lifestyle is conducive to working M-F, focus on a b-to-b business rather than a b-to-c business which may give you more flexibility but will require your attention on evenings and weekends.
Determine your investment level
Businesses are typically priced for sale based on a multiple of the earnings they are generating. Thus, based on your income requirements, you should be able to roughly calculate the price range of a business you need to purchase. An accountant qualified in business valuations should be able to assist you with this calculation. Remember – the earnings the business produces not only provides your income, but also needs to provide for debt service if you are financing the purchase.
Focus your search
As you can guess, most business owners don’t publically announce that their business is for sale. They don’t want to deal with the fallout from nervous employees, concerned suppliers, anxious customers, or aggressive competitors. So without a “for sale” sign in the window, how do you know what’s available? Historically, the local newspapers contained classified ads of numerous businesses for sale with enough detail to arouse your curiosity but not enough info to disclose the exact business. However, these days the newspaper classifieds have been replaced by websites listing the businesses. www.bizbuysell.com is one such source which lists business for sale by owner and by business brokers.
Contacting business brokers directly is also an option – however, be aware that brokers typically only represent the sellers. Thus, they will show you only their own listings or their firm’s listings.
Networking with small business accountants, attorneys, and business coaches is an excellent way to connect with business owners who are planning their exit strategy. But be prepared to be patient for this will take time.
Investigate the business
Typically before a business’s identity is disclosed the prospective buyer will sign a confidentiality agreement. Again, this is to protect against those nervous employees, concerned suppliers, etc. finding out that the business may be changing hands. Usually a summary of the business is available for review along with financials. Three years of P&Ls and balance sheets are useful to see a breakdown of the financial health as well as the cash flow the business is generating. However, make sure that tax returns accompany these documents to insure that the numbers are valid. If the seller is not willing to share these, look for another business opportunity.
This is the time to ask the owner questions about their operation. Inquire about all facets of the business that he or she is willing to discuss. But realize that certain information will not be shared with you at this point in the process. For example, it’s doubtful that a seller would share any type of specific customer information at this time. This is also the time to physically take a tour of the business. This will probably happen after hours so as not to disrupt operations or raise suspicion among employees.
Negotiate the LOI
Very much like a real estate transaction, the prospective buyer makes an offer on the purchase of the business detailing the price they are willing to pay, the terms, what’s included and what’s not included. And just as important, what contingencies will be incorporated. An example of an important contingency would be the ability of the buyer to obtain financing. Another would be the ability to obtain or extend an existing lease for the location. And of course, the opportunity to conduct due diligence on the business’s financials and operations. Be prepared to enlist the services of an attorney at this point.
After the LOI is acceptable to both parties, the buyer has the opportunity to conduct their due diligence which means they have access to the seller’s books and financial records. If you do not have an accounting background or are strong with financials, I would strongly suggest enlisting an accountant to verify the numbers. Other due diligence items may include verifying customer data, speaking with employees, and inspecting inventory – however, this needs to be spelled out in the LOI beforehand.
If the buyer will be utilizing a bank or third party for financing, now will be the time to apply for the funds. Be prepared to present a well thought out business plan, resume, and personal financial statements. The above mentioned financing contingency allows the buyer to kill the deal without penalty (losing a deposit) if financing cannot be obtained, but understand that typically the seller will require their own contingency stating that the buyer has a given period of time to secure the financing. So be prepared to approach the bank immediately after the LOI is agreed upon.
Closing the deal
So you have gotten this far – now it should be a piece of cake, right? Unfortunately, about 50% of the deals that are agreed to between buyer and seller never get to closing. Other than issues that come up during due diligence, financing, etc., the biggest deal killer is the disagreement on the terms of the final purchase agreement. This agreement should follow the theme of the LOI, but realize that it will be much more detailed. This is when buyer’s remorse and seller’s second-thoughts get magnified. In other words, emotions run high! An experienced attorney in business transactions is critical at this stage to protect your interests, but also keep the deal together.
Seek professional advice
As I mentioned above, the small business accountant and attorney should have key a role in the purchase of a business. Since it’s typically the largest transaction a person will make in their lifetime, make sure you have a team working for you.
Doug Boehme is a Business Advisor for the Central Indiana Small Business Development Center, an organization with the mission of having a positive and measurable impact on the formation, growth, and sustainability of small businesses in Indiana, and to develop a strong entrepreneurial community. Doug can be reached at email@example.com.