Making a decision of buying a business for yourself can be one of the most exciting and terrifying things anyone can do. The fears of failure, long hours, and sacrifice are all playing on repeat in many people’s heads as they move toward starting their own companies. Thankfully, with planning and continuous strategic adjustments, opening and staying in business is not only possible but is becoming a reality for more and more people every day.
Starting your own business isn’t the only way to go into business, however, as many people opt for buying a business from someone who is retiring or is ready for something new in their lives. Much like opening your own, buying a business is fraught with risk and can end just as badly as a startup if not handled correctly from the outset. Below, we’ll take a look at some of the most important things to watch out for before acquiring a company. These are tailored to be considered before buying an existing business, but many of these things are applicable to people who choose to start their own company as well.
Let’s dive right in.
1. Your Skills, Background, and Goals
Once you’ve decided that buying a business is a better choice for your current situation than starting a new one, there are still several things that you’ll have to consider to be sure you’re buying the right business for the right reasons. Here are a few:
- Your skills and interests – What are you good at and what type of business or industry do you really want to jump into? Does your professional history and experience give you the tools you need to be successful running this business? Will working at this business several hours every day make you happy?
- Your goals – What do you want to be when you grow up? We don’t mean the fuzzy, fifth-grader kind of question. You need to actually think about what your future goals are for you and your family. Will this business satisfy those goals, or will it tie you down to long hours with basically no downtime for many years to come?
- Financial situation – Can you afford to buy this business and keep it afloat during the transition of ownership? What is the status of your personal financial health outside of this business venture?
- Business outlook – Even if you’re passionate about the business you want to buy, is it sustainable? Do you know what the competitive landscape looks like? Are you ready to dive into the deep end and swim your way out?
2. Do Your Due Diligence
Now that you’ve settled on a particular business to purchase, the most important part of the process begins. You must determine whether the operation you’re thinking of buying is one that has either been run properly or can be made profitable going forward. This part of the process also involves a thorough examination of the current owner’s books, which can include:
- Accounts receivable: How much money does this business expect to collect from its clients, and when? Looking at the accounts, take note of those that have been outstanding for 90 days or more, as it can indicate potential service or collections problems.
- Accounts Payable: Very similar to the receivables, but in some ways more important. How much debt does this business carry, and what is the status of those accounts? Seeing a number of accounts that have gone into collections or are well past their due date can indicate a host of other financial issues with the company, not the least of which is mismanagement.
- Payroll: Who is the company employing? If it’s a family-run operation, are all of the family members contributing employees? It’s important to make sure that all payroll taxes and other finances surrounding employment are sound.
- Taxes: The business should have a detailed record of the tax amounts paid, to whom, and when. A failure to keep these records can indicate an irresponsible owner at best and unpaid taxes or fraud on the other end of the spectrum. You need to ask to see the documentation before you ever agree to buy the company.
3. Mind the Valuation
It’s easy as a business owner to assume that the operation you built and managed for so long is worth a fortune. Obviously, this can be problematic for prospective buyers. Many other times, owners will use a formula to “estimate” their business value, which can also be challenging. The most accurate business valuation methods involve some combination and weighting of these factors among many others:
- Business revenue
- Profits/owner take-home
- Industry type
4. Find Financing
Once the business has been evaluated, both from a due diligence standpoint and a valuation standpoint, the only real question that remains is how to pay for the purchase. In some cases, the potential buyer will come self-financed, or will use some part of their established savings, home equity, or retirement accounts to fund the purchase, but in most cases the buyer will need some degree of financing or investment to get the purchase finalized.
In these cases, the question becomes how much to borrow or how much equity to give away in exchange for outside investment. That choice can be a tough one to navigate, and there is no one-size-fits-all answer. Some banks and lenders won’t issue loans to buy certain types of businesses they deem to be “high-risk” or outside of their established lending policy. On the investment side, many buyers are not comfortable giving up a sizable share of their new business to gain the financing that comes with it.
The right choice will come down to what you can afford and what you’re comfortable with. Take into account how long it will take you to start earning an income from the new business and what debt payments are going to cost each month. It’s also worth it to seek the advice of established business advisors or consultants. Free advice is available from SCORE (www.score.org), but there are a variety of different advisors, many of which specialize in very specific industry types.
5. Get Some Professional Help Before Buying a Business
Deciding to seek a professional business broker can be a tough decision. Their fees can add to the purchase cost and it may seem easier to find the business you want to buy on your own terms. You may be fine without the help of a broker, but there are situations where having their assistance will yield the best deal or the best business outcome. Much like real estate agents, business brokers have their fingers on the pulse of the markets they serve. Sometimes they will know that a business is being sold even before it’s listed, and in other cases, they’ve spent time cultivating relationships with business owners and financing partners to pull together deals in a streamlined fashion. The decision to use a business broker should be made as a conscious and purposeful choice that helps further your interests in the deal, not for convenience alone.
Unlike brokers, legal help is nearly always required to ensure that the transfer of ownership is completed in accordance with state and federal laws and to protect the buyers and sellers from fraud or abuse. Legal services are also needed to wrangle the vast number of documents, permits, licenses and fees that are involved with starting or buying a business.
No matter the type or size of business you’re buying, the process is quite a bit more complicated than just handing over some money. Making sure that your plan and research are in place before making your final decision will help ensure that your decision-making process is well-educated and has a forward-looking strategy, rather than a reactive or impulsive one. Relying on the help of professionals or trusted mentors is an important tool in the process, one whose value cannot be overstated. There is no shame in asking for help, especially when large dollar amounts are on the line. You’ll want to be sure the business you’re buying is one that you can afford, one you’ll love working in for years to come, and one that will eventually become a valuable investment for you and your family.