If buying an existing business seems like the perfect idea to you, you are not alone. Hundreds of thousands of businesses are reportedly sold to new owners every year. You can expect that number to go up as more people discover how buying a business compares to starting a brand new one.
Buying a business allows you to become an entrepreneur without going through the countless obstacles that come with starting from scratch. But that doesn’t mean buying a business is easy. This journey is long, arduous, and full of potential speed bumps. Some individual stages can last over a year. But so many people wouldn’t get themselves into this mess if it wasn’t extremely rewarding. And you can always tell yourself that starting a new business would have undoubtedly been much harder.
In this guide, we’ll lay out everything you need to buy an existing business and how to make sure you’ve made the right decision.
Step 1: Are You Sure You’re Ready?
Like any other major business-related decision, you should only consider buying a business when you are well-aware of the drawbacks. Once you’ve accepted the following risks and inevitabilities, the rest of the process will seem much less intimidating. So, let’s go over the negative aspects of buying a business and how to prepare for them.
Massive Upfront Expenses
In terms of costs, buying a business is somewhat of a double-edged sword. You are saving money on operational costs because several essential elements of the business are already in place. For example, you probably won’t have to hire an entire team of workers, purchase expensive equipment, order inventory, or launch a mass advertising campaign to introduce your business to potential customers.
Sometimes, however, the costs associated with purchasing an existing business can be nearly or just as high as the costs of starting a new business. You might have to pay for renovations or the materials required for testing out new products. In order to grow or at least maintain your customer base, you’ll have to ramp up your marketing efforts. If you intend to improve productivity to serve more customers, you’ll have to increase staff or implement new tools. Then there’s the costs of renewing your rights to intellectual property like patents and trademarks.
Certain assets may be negotiable but rest assured, many factors can raise the final purchase price little by little. The seller can even justify a higher price simply because of the considerable income stream you’ll be inheriting as the new owner.
When deciding what kind of business to buy, it is typically recommended to choose an industry in which you have significant experience. This will reduce the amount of unfamiliar areas you will face on the job. Unfamiliar areas are an inevitability with buying a business. You’ll have a lot less, however, if you choose a business that is very similar to one you’ve already worked for.
Plenty of people buy businesses solely because of an attractive ROI. If this is your intention, prepare to take on the role of a student. You cannot run a business by being an expert in just one or a few areas. Unless you are familiar with primary elements like the business model, industry trends and target demographic, trying to implement your own ideas without this knowledge could prove fatal.
In summary, buying a business requires a great deal of learning, which is a skill in itself. You probably shouldn’t buy a business at all if this skill is not among your best.
Another inevitability in this journey is the discovery of previously-unknown problems with your new business. This will happen no matter how much time you spend checking for potential red flags. Sure, you’ll probably be able to detect fairly obvious flaws like outdated equipment, existing business debts, or a poor location. But at some point, you’re going to run into an issue that, for one reason or another, flew under your radar.
For example, you might find that the business’s top competitors have become much more aggressive as of late. They may have launched new strategies or products with the potential to take up an even bigger share of the market. There’s also the possibility that the company’s longstanding business model has run its course. What worked fabulously ten years ago is now achieving the opposite result.
So, before buying a business, make sure you have the patience and ingenuity to solve unexpected problems at any moment.
Mental and Emotional Toll
As you can see, the process of buying a business is extremely stressful and emotionally draining. People who work hard are used to being tired. But this is one task that requires the utmost energy and focus.
For that reason, you should not begin this journey if your mental and emotional health are not in top shape. Lacking in these areas runs the risk of careless decisions. You might think you are ready to buy a business, but being ready for the process of buying a business is a whole other story.
Step 2: What To Ask Yourself Before Buying A Business
Now that you’ve decided that you are ready to buy a business, the next step is to figure out what to look for in potential options. Odds are, your decision will come down to the option that poses the least amount of unnecessary stress and hidden problems. Answering the following two questions will help you arrive at that conclusion.
What Will It Cost To Make The Business Successful?
The “cost” in this question refers to money, time and energy. When examining every option, think about how much you’d have to change the business to achieve success and if you are capable of supporting those changes. In other words, envision the business you wish to create and consider what it’s going to take to turn the current business into your vision.
This includes changes to the business’s size, staff, image, revenue, cost of goods sold, profitability, etc. In addition to monetary cost, consider how much of your own time you are willing to invest. Some business owners prefer to be highly involved in the business’s operations, while others prefer to crunch numbers and develop strategies in their back office.
The amount of changes you’ll have to make will likely depend on the resources currently in place. Are the business’s top employees capable of executing your ideas? Does the business’s current brand identity need a makeover? Are the business’s vendors or suppliers still reliable?
Why Is This Business For Sale In The First Place?
Business owners put their businesses up for sale for a plethora of reasons. Many sell for the right reasons, like retirement or moving on to a new venture. A great deal of others, however, sell for the wrong reasons. The business may have started out well but is currently in decline with no clear solution in sight. Customers may have lost interest in the products, or the location may have proven to be incapable of generating sufficient foot traffic. It’s possible that the business ran into a problem that was too expensive to fix while simultaneously maintaining operations.
No matter the reason, you should not buy a business unless you know exactly why it is up for sale. Sometimes, the only way to obtain this information is to ask the right questions. Thus, you should ask the seller about any problems they’ve encountered and how the business was performing going into its final months.
Even if you feel that the seller has divulged enough information, you should still speak to employees, longtime customers, fellow local business owners, etc. This collection of perspectives will ultimately determine the accuracy of the seller’s answers. After all, sellers are naturally biased since their goal is to convince you to take their offer.
Step 3: Examine Critical Documents and Information
As you can see, the length of this journey can be attributed to the need to gather as much relevant information as possible. Once you have found an attractive option, it’s time to look beyond the surface and into the hard evidence. This step is particularly crucial and therefore requires the help of an accountant and lawyer. These individuals will not allow you to take further action without all the necessary information.
In order to examine a business’s documents, you will most likely have to sign a confidentiality agreement or nondisclosure agreement with the seller. This confirms that you will not publicize any confidential information that you discover during this step.
Here are the most important documents to examine before buying a business:
Business Licenses and Permits
After deciding on an industry, you must find out what kind of permits and licenses are required by all businesses from that industry. These are the first documents to examine because if one is missing, you would be buying from someone who has broken the law. If you are looking at a business in a highly regulated industry like food service, prepare to devote a lot of time and energy to checking for licenses and permits.
If you are considering buying an LLC or corporation, the business will have documented proof that it is registered with the state. LLCs must have articles of organization whereas corporations must have articles of incorporation. Like the previous section, an LLC or corporation without these documents is breaking the law.
Certificate of Good Standing
This also only applies to registered business entities like LLCs or corporations. To confirm that they are indeed approved to operate in your state, request a certificate of good standing from your secretary of state.
Every locality has zoning laws, so you must make sure the business is not violating any laws for your area. Some localities have restrictions for where certain businesses, like bars, can be situated.
Much like zoning, localities have their own environmental regulations for small businesses as well. So, check to make sure the business is not violating any local environmental laws.
Contracts and Leases
The first term deals with business partnerships, while the second deals with unowned assets like the physical location, equipment, etc. You may find that a certain lease is almost up or obviously unfair to your end. In this case, you might have to negotiate a new lease and add one more thing to that aforementioned list of costs.
As for contracts, you may find that the business obtains the majority of its products or revenue from one client. If that client was to go out of business, you’d be in trouble. It’s probably not a good idea to buy a business that puts so much dependence on a single partner.
If you find no issues with any existing contracts and leases, make sure the individual or company that issued the document is willing to transfer it over to your name. The answer will most likely be yes, but remember: the mantra of this stage of the journey is “better safe than sorry.”
In addition to financial statements, this refers to tax returns, sales records, accounts receivables, accounts payables, and debt disclosures. You are looking for a business that is doing well, but a business can only be legitimately granted this status if it has been on the upswing for at least three years. So, before buying, examine three years’ worth of the business’s financial statements and documents.
If you have no issue buying a young business, you should also have no issue buying a business that is operating at a loss. The business’s financial statements, however, should at least denote that it is on track to becoming profitable.
A glance at the business’s receivables could reveal one of those pesky hidden problems: late paying customers. This could be one of the reasons behind the sale and therefore must be solved immediately to prevent further damage.
And even if the tax returns and financial statements look good, pass them to your accountant just to be 100% sure. Only an expert can tell you if those numbers truly make sense.
A business organizational chart shows employee-related data such as hierarchy, compensation, benefits, and other policies like overtime or vacation. You should also ask the seller about his or her management tactics and how they are typically received by employees.
Status of Current Inventory, Equipment, and Physical Space
The value of these three elements will have a major influence on the final selling price. You should therefore assess their quality and relevance compared to the rest of the industry.
As for inventory, check how quickly each type of product has sold in the past and whether they are more or less valuable in today’s market. The same assessments can be applied to equipment as well.
The true condition of a physical space is often difficult to determine for someone who doesn’t work in a related field. What looks fine to the average person could actually be on its last legs. Hence, you might want to enlist the help of an unbiased expert to make sure the business’s physical space does not need renovations or repairs.
Step 4: Agree On A Price
Now comes the fun part: Agreeing on a final sales price. This price will encompass all of the assets you are acquiring, which includes the value of the brand name, existing customers, relationships with vendors, and tangible assets like inventory, equipment and furniture.
It’s extremely common for buyers and sellers to have very different opinions on price, which often results in seemingly perfect deals falling apart.
The likelihood of this misfortune is much lower when you enlist the help of a private business valuation professional. Their services cost at least a few thousand dollars but figuring out a reasonably advantageous price can you save much more in the long run.
Business valuation professionals typically use one of three methods for assessing the value of an existing business. Here they are:
The Earnings Method
This method is best for businesses that are either profitable or on track to becoming profitable. The value is derived from the business’s previous, current, and projected profits. For historically profitable businesses, figures from the past few years are used to create projections. For businesses that are yet to draw a profit, earnings models are implemented to create projections, though their accuracy may vary.
The Assets Method
This method is best for businesses with large capital expenditures or businesses that are still operating at a loss. The value is derived from all of the business’s assets and how valuable those assets will be in the coming years.
The Market Method
This method is best when your business’s value is influenced by many local factors. It can also be used solely to confirm a value that was determined by one of the other methods.
With the market method, the value is derived from the final selling prices of other businesses in the same industry and general location. Unlike the previous two methods, the market method accounts for potentially significant local factors like being situated in an up-and-coming neighborhood.
Step 5: Obtain Financing
One of the most popular and highly recommended purposes of small business loans is buying an existing business. Being approved is usually not difficult since the financial institution can base their decision on the existing business’s extensive history.
While banks might offer the lowest interest rates, companies like United Capital Source can offer something that is particularly appealing for someone in the middle of buying a business: convenience.
You’ve spent months mulling over document after document, so it’s safe to say that the last thing you want to see is more paperwork. Unlike banks, companies like UCS require minimal paperwork and you don’t even need a business plan. You may also be able to negotiate a lower purchase price since you can have the money ready in a matter of days. Bank loans, on the other hand, can take several months to be approved. You’d have to gather all that paperwork on top of everything else you’re dealing with.
You may have already spent a lot of your own money throughout this process. While banks are notorious for rejecting applicants who lack massive bank balances, companies like UCS do not discriminate based on net worth. We regularly approve cash-strapped applicants for high borrowing amounts and longer terms.
Step 6: Closing The Deal
Once the two parties have agreed on a price and you have financing in place, the final step is yet another checklist of documents. Much like the previous checklist, the final sale cannot take place without the following paperwork:
Bill of Sale
This document officially makes you the new owner of the business’s assets.
This is the final purchase price, with all assets and expenses included.
Whether you are taking over an existing lease or have negotiated a new one, this confirms that your landlord is aware of the sale.
Is a vehicle among your new assets? If so, you must register as the new owner with the DMV.
This refers to the transfer of all patents, trademarks and copyrights to your name.
If you are buying a franchise, you may need to file certain documents required by the Federal Trade Commission.
This legally prohibits the seller from opening up a competing business.
If the seller is staying onboard as an employee, this document shows that both parties are in agreement.
IRS Form 8594
Also known as an Asset Acquisition Statement, this document lists all the assets you’ve acquired along with their value. Having all this information in one place will come in handy when you do your next tax returns.
Bulk Sale Laws
“Bulk sales” or “bulk transfers” refer to the transfer of large amounts of assets, most notably inventory. Federal bulk sales laws typically only apply to businesses in bankruptcy. State bulk sales laws prevent businesses from doing bulk transfers solely to avoid state sales taxes.
Will you be inheriting a large amount of inventory? Depending on your state, you may have to obtain a special certification to prove that the seller is not indeed transferring over the inventory solely to avoid paying taxes on it.
As you can see, this journey mainly involves finding the right business and obtaining all the hard evidence you need to confirm your decision. This can take time, and numerous steps will require the advice of your lawyer or accountant. These individuals will also ensure compliance with all local laws. So, as long as each step receives attention it deserves, the many rewards of owning an existing business are well within your grasp.