If purchasing an existing business seems like the perfect idea to you, you are not alone. Hundreds of thousands of companies 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 advantageous. 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. Specifically, we’ll answer the following questions:
- How Much Does it Cost to Buy a Business?
- How Do I Find Small Businesses for Sale?
- What Questions Should I Ask Before Buying a Business?
- What Paperwork Do I Need to Buy a Business?
- Which Valuation Methods are Used for Buying a Business?
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.
How Much Does it Cost to Buy a Business?
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 company 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. 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 management tools. Then there are 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.
Prepare for Unfamiliar Areas
When deciding what kind of business to buy, it is highly recommended to choose an industry in which you have significant experience. This will reduce the number of unfamiliar areas you will face on the job. Unknown 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 the 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 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.
Hidden Problems Will Arise
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 reasonably obvious flaws like outdated equipment, existing business debts, or a poor location. However, at some point, you’re going to run into issues that 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 more significant 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. The full process of finding and acquiring the right business often exceeds an entire year.
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 prepared for the process of buying a business is a whole other story.
How Do I Find Small Businesses for Sale?
People in your position usually don’t randomly discover successful businesses for sale. You have to search, and that doesn’t just mean on Google. The Internet will undoubtedly lend some help, but not until you’ve exhausted the initial person-to-person steps. As any experienced business owner knows, the most useful information tends to come from speaking to the right people.
Here’s how to maximize your chances of finding established businesses for sale:
Call Local Businesses
Contacting the owners of local businesses direct will give you an idea of what’s for sale in your neighborhood and for what kind of price points.
“Why can’t I just find that information online?” you might ask.
Believe it or not, business owners typically don’t alert the public when they put their businesses up for sale. You won’t see the sale displayed on the business’s front door, nor social media. This might give customers and employees the impression that the business has fallen into financial straits. The business owner doesn’t want to appear desperate to get the company off his or her hands.
If you converse with business owners in private, on the other hand, you’re much more likely to find out if they’ve decided to sell. Real estate agents often utilize this tactic when they go door-to-door in affluent areas. Local business owners could also connect you with other business owners who have recently put their business up for sale or expressed interested in selling.
Additionally, you could attend industry conferences to expand your network and even meet professionals who specialize in finding established businesses for sale. In sum, your pool of available companies becomes much higher when your network does the same. So, do not hesitate to contact anyone who could help you with your search, and that includes friends and relatives.
Contact a Business Broker
Many sellers hire business brokers to help them find potential buyers and negotiate the purchase price. You can make their job significantly more manageable by contacting individual brokers or brokerage firms. Brokers almost always have lists of businesses for sale in the area and will gladly put you in contact with their owners.
In addition to experience, make sure your business broker fully understands and aligns with your goals. You should feel like the broker has your interests at heart, as opposed to the seller’s interests.
The more reputable brokers will even start the partnership by telling you what kind of businesses to stay away from. They’ll let you know how to quickly spot sellers who hide their business’s flaws or have no intention of negotiating an appropriate price. If haggling isn’t your strong point, your broker will also tell you which questions to ask and how much money to offer.
Sometimes, deciding to buy an existing business instead of starting one doesn’t make it any easier to figure out which industry to enter. Business brokers can help you answer this question by identifying which industries best complement your skills and passions.
In terms of price, most business brokers charge 5-10% of the final sales price as their commission. If you need lots of help with this whole process, you will surely get your money’s worth. If not, you probably don’t have to think about business brokers until you’re ready to close the deal on an attractive option. The actual transaction involves substantial paperwork. It’s the business broker’s job to carefully read each page and confirm that you’re making the right decision.
Several websites show the industry, location, and price of thousands of businesses for sale. This information could prove very useful for those who know what they want as well as those who haven’t the slightest idea. If you belong to the latter group, you could use these sites to compare the prices of different locations and industries.
Members of the former group already know which industry and location they want. So, instead of wasting time visiting businesses that don’t meet their criteria, they can simply enter their preferences into different sites.
Websites like BizBuySell and BizQuest will also alert you when businesses that match your preferences go on sale. This particular site can even connect you with affiliate business brokers and show you how to find more who work in your city.
Look for and Put Out Advertisements
Popular sites like Craigslist will undoubtedly have plenty of ads showing local businesses for sale. Local newspapers and industry publications may have for-sale sections as well.
As mentioned in the previous sections, buying an existing business becomes much easier when you make other local business owners aware of your intentions. So, it couldn’t hurt to release your own advertisement. The more effort you put towards finding the right business, the higher the likelihood of that business finding its way to you.
Stay in Touch with Industry Insiders
Each of these initial steps involves expanding your network little by little. Many people you meet won’t have anything to offer in terms of referrals. But that doesn’t mean you should cease contact with them, especially those who work in your desired field. You never know who that game-changing tip will come from. And even if you still don’t hear anything, you will have at least befriended someone who can show you the ropes when you open up shop.
What Questions Should I Ask Before Buying a Business?
The previous section of this guide mentioned the inevitability of hidden problems. Some of these problems can make your life slightly harder, while others can make it downright miserable. The latter scenario refers to someone who has bought the wrong business. How can you avoid problems of this magnitude?
Ask yourself these questions before considering moving forward with any of your options:
Why is this Business for Sale in the First Place?
Business owners put their businesses up for sale for various reasons. Many sell for the right reasons, like retirement or moving on to another venture. Others, however, sell for the wrong reasons. Revenue may have recently started to decline with no solution in sight. Customers may have lost interest in the products, or the location may have failed to attract customers. It’s also possible that the business simply cannot afford to fix its latest issue while maintaining operations.
In sum, you should not consider an option if you don’t know precisely why the business owner has chosen to sell. 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 performed shortly before going up for sale.
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.
What Will it Cost to Make the Business Successful?
The “cost” in this question refers to money, time, and energy. When examining your options, think about what kind of changes you’d have to make to achieve success and how much those changes would cost. In other words, envision the business you wish to create and consider what it’s going to take to turn the current situation more into one that aligns with your vision.
This includes changes to the business’s size, staff, image, revenue, cost of goods sold, profitability, etc. The number of moves 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?
Do I Have Experience in this Industry?
If you’ve never felt passionate about your work, buying an existing business presents the opportunity to do what you love. Taking this route, however, will only achieve the desired result if you choose an industry in which you have significant experience. This makes you less likely to encounter unfamiliar areas.
If you enter an industry in which you have no experience, prepare to learn. Trying to implement your own ideas without first becoming familiar with your target demographic, industry trends, business model, etc. could prove hazardous.
What Paperwork Do I Need to Buy a Business?
Once you have found an attractive option, it’s time to call your lawyer and accountant and look at the hard evidence. These individuals will not allow you to take further action without all the necessary information.
To examine the following documents, you will most likely have to sign an agreement with the seller. This confirms that you will not publicize any confidential information you uncover during this step.
Contracts and Leases
This refers to business partnerships as well as unowned assets like the physical location, equipment, etc. You might discover leases that will expire very soon or contain blatantly unfair terms. In this case, you might have to negotiate new terms 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. What would happen if that client went out of business? Hence, it’s probably best to steer clear of the companies that put so much dependence on one client.
If you find no issues with any existing contracts and leases, make sure the individual or company that drafted the document has no problem transferring it over to your name.
In addition to financial statements, this refers to tax returns, sales records, accounts receivables, accounts payables, and debt disclosures. Many businesses appear successful when, in reality, they just got lucky not too long ago. You can test the legitimacy of an option’s success by examining three years’ worth of financial statements and documents.
Businesses under three years of age might not be profitable. Plenty of people buy young companies, but only if their financial statements denote that they will logistically become profitable in the near future.
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 genuinely add up.
Business Licenses and Permits
After deciding on an industry, you must find out what kind of licenses and permits 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 foodservice, prepare to devote a lot of time and energy to check 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 approved to operate in your state, request a certificate of good standing from your secretary of state.
Status of Current Inventory, Equipment, and Physical Space
The value of these three elements will dramatically influence 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 product has sold in the past, along with its current market value. Then, apply the latter concept to equipment. It’s difficult to determine the exact condition of an option’s physical space. Hence, you might want to enlist the help of an unbiased expert to make sure the space does not need renovations or repairs.
Which Valuation Methods are Used for Buying a Business?
It’s prevalent for buyers and sellers to have different opinions on price. This difference often results in seemingly perfect deals falling apart. You can avoid this scenario by enlisting the help of your business broker, lawyer, or any business valuation professional. These individuals typically use one of three methods for assessing the value of an existing business:
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 companies that are yet to draw a profit, earnings models are implemented to develop forecasts, though their accuracy may vary.
The Assets Method
This method is best for businesses with large capital expenditures or companies 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 an amount 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 ways, the market method accounts for potentially significant local factors like being situated in an up-and-coming neighborhood.
Once the two parties have agreed on a price and you have financing in place, the last 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
- Purchase Price
- Vehicle Ownership
- Intellectual Property
- Franchise Documents
- Non-Compete Agreement
- Employee Agreement
- IRS Form 8594
Closing the Deal
The final three steps may take time, and that’s okay. Once you have all the documents in place and agree to an appropriate price, you just need your lawyer and accountant to make sure everything checks out. Then, you can go ahead and sign the dotted line!
One last reminder: Since many of these steps involved your lawyer and accountant, keep these individuals close as you grow your new business. They will ensure that you stay compliant and continue to make smart financial decisions.