How to Buy a Business
80 percent or more of new business startups fail within the first five years. Buying an existing business rather than starting one greatly increases the probability of success.
Small businesses change ownership an average of every seven years. The challenge for a prospective business buyer is to locate the business that best suits his or her profile. Here are a few steps that can make the buyer's search more enjoyable and productive.
Know what you want. You'll avoid wasting time and increase your likelihood of a successful match if you start the process by working up a "buyer's profile" on yourself.
Successful entrepreneurs not only have self-confidence, a high energy level, and a strong will, but also a strong preference for "independent thinking” versus corporate "group think." Are you ready to expose your decisions publicly and risk your own capital and reputation?
Begin by listing your past work experience, your strengths, and your weaknesses. Matching your strengths with the needs of a business simply adds value while making your new ownership experience more meaningful to you. Conversely, if your weaknesses are the same as the business' needs, then you and the seller are in for a difficult experience.
Write down your likes and dislikes. For example, do you enjoy working on details rather than public relations? Obtain from a broker, banker, or accountant a SIC code listing of various types of businesses and check off your order of preference.
Don't be too concerned about entering a different business. Over 70 percent of all buyers end up buying a type of business that's different from their background, yet the majority are successful.
The healthier the business, the higher the price. Are you willing to buy a turnaround situation? Sometimes risk diminishes when you buy a floundering company versus buying a company making large profits due to a maverick owner. Do you want management to remain? What skill sets are required that you don't have?
Review your finances. Are you willing to mortgage your home? If you are married, be sure your spouse is involved in the process and is supportive. Decide how much cash you can provide for a down payment and how much of your borrowing capacity you want to tap (leave some for personal and business surprises).
How much personal income do you need to take out of the business? Normally the first few years provide meager income if you're still paying off the previous owner. Decide if you want partners; this can increase your financial strength but diminish your independence.
The search begins. For every business that is for sale, there are two or more serious buyers (10 buyers if you count the "tire kickers"). Oftentimes, the businesses that sell weren't even for sale until a qualified buyer entered the picture. So don't get frustrated if you don't find the business you want "listed" or advertised in a newspaper. Most businesses don't want to spend time talking to "tire kickers," nor do they want buyer traffic causing concern among employees and customers.
Find an experienced business broker who knows the local businesses and has a reputation for doing the homework that eliminates wasting time. If you're a qualified buyer, then a serious broker will seek out your match even if it requires uncovering a business not presently on the market. In certain situations the broker may charge a small retainer.
Ask a lot of questions. Most businesses will require you to sign a confidentiality agreement before providing much information. Expect some proprietary information to be withheld until after the price and terms have been agreed upon (subject to due diligence). Now the investigation begins. Being thorough will build your credibility with the present owner, plus save you the costly disappointments that often plague a buyer who wasn't thorough.
You'll learn a lot by asking about the personnel. Find the real reason why the owner is selling. What does the owner suggest regarding his duties and time required during the ownership transition period? Is a formal organization chart available? Who are the key employees and what is their attitude toward the sale? What has employee turnover been?
Check out the products, services, and their markets. Is the revenue from products or services cyclical? What are the sales and profit trends? How is the product sold and how much is being spent on advertising? Review the agreements regarding sales territories, advertising, and incentives. Who are the major customers and what are their plans? Are they financially stable? What percentage of revenue does the largest customer account for? Are repeat customers increasing or decreasing? Are their demands changing?
Get a list of competitors and compare them with the business. How do their products compare in quality, delivery, and price? What appears to be the competition's market strategy? How do customers and suppliers perceive the competition?
Reviewing the financial reports will generate a lot of good questions. Don't hesitate to call in an accountant. Your broker can help you select one experienced in business acquisitions. Study at least three years of financials while looking for trends and sudden jumps. Ask for tax returns and compare them with the company's financial statements. Your banker or broker can provide some industry averages for you to compare with as well.
Make sure you understand the cash-flow statement. Any shortage in working capital is your responsibility after the sale. Are any major expenditures required in the near term? Where is the profit being made and how can you improve it? Make sure you got a list of the assets being offered. (Note: Refuse to pay for anything that's being skimmed off the top; pay only for what the reported numbers justify.)
Inspect the facility and any lease agreements. Is an environmental assessment needed? Is the location and size adequate for the future?
Check out the price. Do your homework on valuing the business. Time invested now may save you a lot money and will increase peace of mind during and after the sale. Talk to a professionally trained business appraiser; this could be your broker, a CPA, or a full-time business appraiser. Ask for comparable sales information. If your broker doesn't have local data, it's available from other parts of the country for a small service fee. Beware of rules of thumb; they're valuable, but only as a reference.
Structure the deal. Offers with earnest money are normally made in one of two approaches: 1) A letter of intent, which is non-binding upon either party and states the price and some general terms of sale; or, 2) A purchase and sale agreement, which is binding upon both parties subject to certain contingencies. Once your preliminary offer is accepted, you have access to all of the remaining documentation required to finish your evaluation. Also, by this time you should have provided your financial statements to the owner.
It's still not too late to involve your accountant and attorney; this is money well spent. Your attorney has a long list of items that should be reviewed, including corporate minutes; copies of existing leases; and contracts and agreements related to employee benefits, advertising, unions, and patents. Public records must also be checked for liens and taxes due.
Be prepared to negotiate and stay calm. Remind yourself that the owner is dealing with a lot of emotional issues. Your sensitivity to the owner's financial and tax considerations encourage a better deal for both parties. The final price will probably include an amount for the business as well as payments to the owner for not competing after a period of employment or consulting.
A total cash payout to the owner reduces the price an average of 20 percent. It's difficult to obtain bank financing to buy a business, so if you can't offer all cash you will need to look to the owner. Commonly, the owner wants all cash but will consider financing 20 percent to 70 percent of the purchase with monthly installments over three to 10 years at the prime bank rate or below. In return, the owner expects a lien on the company's assets.
You'll probably need to offer a down payment, which at the minimum equals the value of the liquid assets. See why it's prudent to talk it over and get your spouse's support before beginning this process.
Congratulations. You've just bought a business! Most of the due diligence you performed will now pay off because your competition was consumed in daily routines while you were taking time to analyze your business and its industry.
General Disclaimer
This information is presented for the use of customers and clients of Professional Business Brokers, Inc. and is presented for informational purposes only. It is not intended to supplant the need for consultation with other licensed professionals. We strongly advise all customers and clients to seek the assistance of a licensed attorney or a certified public accountant, licensed to practice within the State of Florida.
