Buying an Existing Business

In purchasing an established business, you can eliminate some of the issues associated with starting a brand new business, such as building a customer base or brand and developing products. However, you may also acquire its debts and, possibly, a bad reputation. While the opportunity may be less risky in some respects, you must perform due diligence to ensure that you are fully aware of the terms of the purchase. This process can be complex, and you should consult an expert before beginning. Keep in mind that you will eventually want to employ the services of your banker, accountant, and lawyer before closing the sale.  

There are favorable aspects to buying an existing business, such as drastic reduction in startup costs and the ability to increase cash flow quickly. In addition, it’s generally easier to get financing for an existing business than to start a new one. Bankers and investors often feel more comfortable dealing with a business that already has a proven track record. You may even acquire potentially valuable and profitable copyrights and/or intellectual property.

On the other hand, purchasing costs may be much higher than that of starting a new business because of the initial money that has been invested in the business concept, customer base, brand, etc. Also, be aware of hidden problems associated with the business like uncollectible accounts receivable. If you don’t do your due diligence, you could find yourself dealing with unforeseen and costly issues like obsolete products or insurmountable debt.

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As with any purchase or business endeavor, you want to be selective about the type of business you purchase. You can ask yourself the following questions: Am I familiar with the industry? Does my skillset and disposition match the type of business? Will I enjoy being the owner of this business? What size business will I be comfortable operating? Is the business in a good commercial location? These are just a few suggestions to get you started asking the right questions. You can visit the U.S Small Business Administration’s website for more tips on this topic.

Other than the traditional ways of finding a business to purchase (want ads, for sale signs, Internet listings, etc.), you can reach out to a business broker. Business brokers are generally paid a 5% - 10% commission of the sale price, and can potentially make the purchase process easier for you. They are knowledgeable in negotiating the terms of sale, prescreening businesses, helping you pinpoint your interests and matching them to appropriate businesses, and more. 

Research consists of gathering all of the information specific to the business under consideration for purchase, learning about the industry, market, and all aspects of the business’ operations. Due diligence is the analysis of all of this information to ensure that the purchase agreement is fair to both parties, that the business is viable, and that no information is left uncovered.

A good place to start is by gathering all of the information about each item on the balance sheet and income statement, which can be provided to you by the seller. For the sake of brevity, we will discuss a few key pieces of information to gather and how it will help you in the process of due diligence. An exhaustive list can be found on the SBA website, and online by conducting a simple search.   

  • You will want the details on all of the company’s assets (equipment, products, anything that is owned or leased by the business) in order to determine its condition, value, and how much has been invested in these assets. This will reveal any future costs associated with upgrades, modifications, or remodeling. Inventory is also important so you know how much you will have at the time of purchase, the strength of inventory turnover, its current condition/quality/age, etc. Assigning a value to the inventory can be complex, so you will most likely want to have it appraised.
  • Look at the business’ liabilities. Make note of the type of loans or other debt as well as any past, present, or future legal cases. Accounts receivable and accounts payable should be evaluated to determine how quickly the company gets paid by their clients and how quickly the company pays their own bills. You should investigate any accounts that are older than 90 days. Keep in mind there may be purchase agreements between the company and its clients, so be sure to request copies of contracts and legal documents.
  • Financial statements and tax returns from the past five years are also necessary to get a good picture of the business’ financial and operational health. This information will aid you in determining the value of the company. Verify that the business is currently meeting all of the regulatory and legal requirements for operations. You can ask the company for documents related to this, but it is a good idea to find out the requirements on your own. Conduct your research carefully because it is ultimately your responsibility to understand the risks of your current or future business.

Once you have all of the information you need, you can start analyzing the company based on the research you have done. The due diligence process is vital to your success and you should consult experts to assist you. Have a third party assess the value of inventory, assets, and the accuracy of financial statements for objective results. This will help you in the negotiating process. The seller will most likely have a different idea of the value of his business than you will, and any discrepancies found in the due diligence process can be discussed in negotiations.

SOURCES: Due Diligence - DD found on Investopedia and How to Buy a Business found in Entrepreneur Magazine.

  • Seller Financing: As a buyer of an existing business, you have options available for financing other than traditional forms such as bank loans and credit. Under certain circumstances, the seller may be willing to finance your purchase. In this arrangement, the seller will accept payments from you over a specified period of time until you have paid off the debt. Both parties can benefit from this as it guarantees the seller of future income and can reduce the amount of money the purchaser will need as a down payment.
  • Use Your New Assets: If you are purchasing a business with valuable assets, you can use these as collateral to obtain a loan.
  • Find a Partner: Purchasing a business with a partner can cut your costs significantly. If you don’t know someone who would be a likely partner, you can ask the seller for the contact information of others interested in his business who could not afford to make the purchase themselves. Not only will you save some money, but you will decrease your workload and potentially form a long-lasting and valuable relationship with your partner.
  • Lease Option: You may have the option to lease a business with the option to purchase. In this case, the lessee makes a down payment and runs the business as if it were his own. The lessor retains the responsibilities and costs of ownership (expenses, taxes, etc.) until the lessee becomes the purchaser.
  • Assume Liabilities or Decline Receivables: Another possible way to reduce the cost of purchase is to absorb the business’ liabilities or request that the seller absorb the receivables. 

​SOURCES: Lease Option or Seller Finance? found on Note Investor.

Common Mistakes

As you may have guessed from our emphasis on the importance of researching and due diligence, one of the most common mistakes is the failure to verify all data. Many potential purchasers will accept information given to them as accurate without personal or professional verification. This can lead to a burdensome future with your new purchase. Below are a few other mistakes purchasers often make.

  • Not Allowing for Adequate Cash on Hand: Having as much cash available as possible is just as important when buying a business as it is when starting one. Don’t be tempted to use all of your cash in one place – even for a down payment on a purchase. You will need cash for operating your business before you can start to rely on income. Prepare your financial statements carefully and refer to the cash flow statement as a guide for how to use your cash.
  • Unrealistic Payment Schedules: Those who purchase established businesses tend to overestimate short term revenue projections, which can lead to overcommitting on payments. Remember that this is a new venture for you and you will likely experience growing pains and unexpected costs within the first year. Give yourself some room to financially prepare for unforeseen events.
  • Buying Uncollectible Receivables: Do not think that because you are buying a business, you have to purchase everything that comes along with it. Always remember you have room to negotiate. This is a common mistake with a company’s accounts receivables. On one hand, you want receivables because it is a source of income, however, if they are 90 days or older it is likely that you will not be able to collect on them. Therefore it is not wise to purchase them. Arrangements such as having the seller warrant the receivables will ensure that if the accounts are indeed uncollectible, you will not have to pay for them.
  • Failing to Make a Smooth Organizational Transition into Ownership: Purchasing an existing business is not only new to you; it is also new to the employees who work there. It is a big change that can be met with heavy resistance if it is not handled with care. Build relationships with the seller, employees, and suppliers of the company before the sale is final, and have conversations about the operations so you have an idea of the culture before you take over. Share your ideas with them about your vision for the business, listen to their feedback, and learn from them.