How to buy a business
While it's more expensive to buy a business than start it from the ground up, you're paying upfront to take advantage of all the work the current owner has done.
It’s important to be sure the business is solvent and will likely continue to be viable in its current form and location. Before you buy, learn how to find and evaluate a business, then figure out how to negotiate.
Choosing the type of business you want to buy
Much like starting a business, when you’re buying a small business it’s a good idea to go with something you know and understand. Consider businesses related to skills you already have from previous work experience, hobbies, or classes you’ve taken.
Then, as you start considering specific businesses, think about what conditions you do or don’t want in the business:
Location. Is the geographic area a good one for the type of business? What will your commute be like? What about the business’ online presence?
Time commitment. Do you want to be down in the trenches working hard or more of a hands-off owner? If the current owner has adopted your preferred style, the transition may be easier.
Costs. Think about the typical cost of doing business both in your chosen industry and your preferred geographic area. Consider wages, taxes, rent, and anything else relevant to your business.
Size. How many employees do you want/can you handle? How big is the customer base?
If you’re considering a franchise, think about how you’ll feel having the parent company dictate much of your operations. For some people this is ideal. Others prefer to have more control.
Finding the right business to buy
Once you know the kind of business you want to buy, it’s time to find one that’s for sale. There are a few different approaches you can take:
Classified ads. Check newspapers and online ads under the Businesses for Sale section. Not all business owners advertise they’re willing to sell, so you may not want to use only this method.
Your network. If you know people in similar businesses, ask if they know of any owners looking to sell now or in the near future.
Business brokers. These people specialize in business sales and can help you at every step, from finding a business to getting the final paperwork right. You will need to pay your broker a percentage of the purchase price (usually 5 to 10%) as commission.
You can also simply contact businesses you’re interested in to see if the owner is interested in selling. This can be a lot more work than the other options, in terms of identifying, contacting, and tracking communications with the owners.
Evaluating a business for sale
Finding a business for sale in your chosen niche is only the start. Next you’ll need to evaluate the business, also called doing due diligence. This is important so you know exactly what you’re buying and to be sure it makes sense for you to buy it.
The most important part of this is a thorough review of the business’ finances for the past 3 to 5 years:
- Balance sheets
- Cash flow statements
- Accounts payable
- Accounts receivable
- Tax returns
Also look at employee contracts, wages, and benefits. Understand the building’s lease and any major contracts with suppliers and clients.
Talk with customers and suppliers to get a feel for the business’ reputation. Talk with employees to understand the work environment and their satisfaction. You may even want to run a credit history on the owner. Not paying personal bills may suggest using personal funds in an attempt to keep the business alive.
It’s a good idea to have professional help reviewing these documents. Let a reputable CPA audit the financial documents and a lawyer review the legal documents for any problems.
Negotiate the best deal possible
If everything looks good and you’re ready to buy, it’s time to negotiate the deal. The owner will no doubt have an idea for a price, but you’ll want to consider how that compares with what the business can do for you.
There are a number of different ways to determine a fair value for a business, but the most common is Return on Investment (ROI). This refers to the benefit (in this case profit) you are likely to see from your investment (the business) when compared to its cost (your purchase price). For a small business experts consider a 15 to 30% ROI good.
Other methods for valuing a business include:
Capitalized earnings. This method is similar to ROI, but also involves evaluating the risk of investing in this business compared to other investments.
Cash flow. This typically means how big of a loan the business’ cash flow can support.
Balance sheet. Also called “tangible assets,” this method uses the value of the business’ tangible (physical) assets. In addition to negotiating price, you and the owner will need to agree on which assets to include in the sale. These can be anything from essential equipment and intellectual property to company vehicles and office supplies.
Unless you have the money to pay cash, you’ll also need to work out financing. In some cases the seller may finance the purchase. More likely you’ll take out a loan for anywhere from 50% to 75% of the purchase price. You may also want to consider having one or more partners or finding angel investors.
Learning how to buy a business—and then doing it—is hard work, but also exciting. Don’t let your excitement make you impatient and skimp on the work, especially the due diligence. Take your time, and get the financial and legal advice you need to acquire the right business for you.