How to Buy a Small Business
If you have your heart set on working for yourself, buying an existing business might be just the ticket–or it can be a nightmare if you’re not prepared. Know what you want and investigate your options aggressively. First, read How to Finance Your Business Idea. Then, do your research–the more you learn, the better your chances for success.
- Analyze why you want to buy a business. Are you looking for greater independence or the possibility of increased income?
- Consider your background. It’s more likely you’ll do well if you choose a business you’re familiar with. Are you interested in a specific product, or an operation that’s service-oriented?
- Check Web sites such as BusinessesForSale.com to find interesting companies, and contact local business brokers to identify companies that may be on the block.
- Perform a complete financial review of the business. This will typically include the company’s past income statements, balance sheets, and statements of cash flow, as well as its projected financials going forward. Look closely at all liabilities; as the new owner you are inheriting the company’s debt as well as its business. Work closely with an accountant familiar with businesses in the same field.
- Get a Dun & Bradstreet (dunandbradstreet.com) credit report on the company to evaluate its track record and to double-check its reported numbers.
- Ask for a due diligence package, which should include past tax returns, any significant contracts the company has signed (including office or store leases) and any employee or contractor agreements. It will also include legal documents, such as filings, articles of incorporation and any past or pending lawsuits the company is involved in. Work closely with a lawyer to evaluate these and other documents.
- Ask why the business is for sale. Is the current owner retiring, or hoping to pass off some ongoing problem–or worse, a fatally flawed business or location–to an unsuspecting buyer?
- Focus on the problems. It’s easy to be blinded by the appeal of a business, but pay just as much attention to the flaws. Are they correctable or likely to be a constant headache?
- Observe the business. If you’re considering buying a restaurant, for example, watch the customer traffic for a week to see if it measures up to the revenue the current owner claims. Talk to customers to get their honest take on the product or services.
- Use a business broker or consultant if you feel you need some help locating potential businesses for sale or determining if the asking price is reasonable.
- Prepare a comprehensive business plan if you need to raise capital. Banks and other lenders will want to see detailed plans of how you envision future growth. Calculate what you can afford to invest. Read How to Finance Your Business Idea.
- Determine a valuation for the business. Most industries have a standard method and concentrate on a multiple of the previous year’s revenue (the exact multiple will depend on the industry). If the business has a lot of capital equipment (a manufacturer, for example), the market value of the equipment is taken into account. Fast-growing businesses in a hot market are usually valued higher, as future potential is factored into the selling price.
- Justify the purchase price to yourself. Once you’ve determined a valuation, or come to an understanding on price, run your own analysis to see if it fits your needs. Calculate a break-even on the business. If you’re 10 years from retirement, does it make sense to buy a high-priced business that won’t show decent returns for 15 years?
- Ask if the current owner will consider financing part or all of the sale. That can mean a low down payment and an attractive payment schedule for you.
- Consider proposing that the current owner stay on for a while after you buy the business if he or she is a real asset. Many owners stay on as consultants to smooth the transition. This can be an effective way to smooth over problems that may crop up during a transition of ownership.
Gustavo A Viera CPA
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