Going into business for yourself is a major decision. Whether you’re starting from scratch or purchasing an existing company, the moment you make the choice to pursue life as an entrepreneur is significant.
According to BizBuySell and the U.S. government, more than half a million businesses are sold each year. Thanks to the influx of millennial professionals looking to own their own company, along with the millions of baby boomers preparing for retirement, this number will only increase.
Buying a business can, in some cases, give you the opportunity to skip over the headaches and growing pains every startup encounters. Of course, just because you’ve purchased a business doesn’t mean that the hard work is over.
To get a sense of pros and cons of buying an established business, let’s breakdown the benefits and downsides.
The Benefits of Buying an Existing Business
Inheriting Profits and Cash Flow
If given the option between building something from nothing or continuing to build on an established business, chances are you’ll take the company that’s already off and running.
Sure, there is a significant upfront cost to purchasing an existing business, but starting from the ground floor can be just as expensive. Having the luxury of a consistent cash flow isn’t something that should ever be overlooked.
Established Reputation and Customer Base
Becoming ‘known’ is perhaps one of the most overlooked factors in starting your own company. Establishing who you are and how you benefit your customer base takes time, effort and resources (both human and financial). By acquiring a business, you have the ability to bypass the initial brand building period and use your (hopefully good) reputation to continue building your company.
Employees Who Understand the Business
Even when you’re ready to hit the ground running after you’ve completed the sale, it’s going to take time for you to fully understand and identify with the business. Having experienced employees gives you the breathing room you’ll need to get in sync with the business. While you’re ultimately responsible for their productivity, they have just as much incentive for passing on their insider knowledge. Use your colleagues to your advantage.
Procedures, Systems, & Policies
Knowing what to do in any scenario is all about practice. By taking over an established business, you’re inheriting all of the hard work and due diligence they’ve done internally. While you’ll need to review these systems and procedures independently, the groundwork has already been laid out for you. If you’re looking for ways to improve these policies, make your employees aware that you’re open to suggestions on how operations and guidelines can be improved to benefit the business at any level.
Holding copyrights and patents to specific products and processes can separate your business from the competition. Sometimes getting access to these intellectual properties is worth the cost of buying the business in the first place. Take inventory of these assets and get the most value as you possibly can.
Of course, for every advantage, there is bound to be a drawback. Let’s review some of them.
The Downsides to Buying an Existing Business
Higher Upfront Costs
When you purchase an established company, the majority of your costs will be steered directly into buying out the interests of the current owner(s). While you may not have to deal with the costs of establishing a brand or furnishing your company, you will have to pay a premium for the hard work and intellectual property the seller has produced.
Aside from the tangible assets you’ll be acquiring, you’re also be receiving the following:
- A proven concept
- An established customer base/data list
- Proven products and market testing
- Tried and tested processes and policies
- Assets, equipment, copyrights, and other intellectual properties
The Learning Curve
Even if you’re a seasoned expert in the industry of your new company, there will be some growing pains. Naturally, you will need time to get up to speed on the overall state of the business finances, how your employees have been operating under the previous leadership, and what their obstacles may be.
The Unknown Risks
Regardless of how long you spend doing your research or asking questions, there will always be some kind of uncertainty in buying an existing business. Whether it’s a physical problem with your office that an inspector missed or an application method that wasn’t so proprietary after all, things are bound to be overlooked or oversold.
While it certainly is a challenge, do your homework and have an extra set of eyes with you every step of the way. By doubling down on your examination, you’ll limit your chances of being hit by a major oversight.
Knowing the positives and negatives of buying an existing business can help you determine whether purchasing an existing business is the right move for you. However, it’s not everything you need to know.
To give you a greater understanding of what it takes, we’ve put together a list of the questions you need to ask before you go any further.
The 8 Steps You Need to Take to Buy a Business
Understand Why You Want to Purchase This Business
One of the most common pieces of advice when trying to decide what to do in your career is that you should chase your passions. While it’s not always feasible, buying into a business that matches your experiences and interest is a great idea.
For example, if you’ve been working as a sous chef in a 3-star restaurant for a handful of years but have always had aspirations of running a cafe of your own, buying an existing business would be a great jumpstart to the next chapter in your career.
The more desire you have to make your business succeed, combined with the function industry knowledge you have to make it work, the more likely you are to reach your goals.
But desire and industry expertise aren’t the only factors that should go into your evaluation. You must also consider the following:
Is your dream business right down the street, an hour away, or a 4-hour plane ride from where you currently call home? The location of your business doesn’t just impact who and how people will find you – it will matter to you and your family in your everyday life.
Give this one real careful thought. What are you most comfortable with; a small business that’s more quaint and more likely to demand that you work in the business, or something larger than may allow you focus solely on the big picture but comes with more people to manage? Not only will the sale prices greatly differ, but so could the level of stress depending on how you’re wired.
Being the owner, you’re going to spending a lot of time working to build your business. But even though you’re an entrepreneur, that does not solely define you. Getting a sense of the types of hours you and your family are willing to sacrifice in order to drive a business forward will help you decipher the kind of existing business you should look to purchase.
Determine if the Business Will Be Successful
This is where your budget begins to come into play. Once you have a business in mind that you’re like to purchase, you need to estimate how much you’d want to change about the business, how it operates, what it provides, and the type of employees you’d need to make it profitable.
The biggest factor from a capital standpoint must be how much of a return you expect to see from your investment. No one wants to buy a business where they won’t benefit, so clearly making sure the numbers add up should be your primary concern once you’ve found a company that scratches your entrepreneurial itch.
Of course, the budget is not the only resource you must account for. Your time is an asset that cannot be replenished. Where you spend it is where you should be driving the most value. If you’re not an expert in this industry but are intensely passionate about it, you will need to spend time getting to learn the nuance that surrounds the market, the motivations of every player, and how you can take advantage of any gaps.
Investigate Why the Business Is for Sale
Often times, a business is for sale for the simplest of reasons. It could be that the owner would like to retire, their family is moving, or they’re simply looking for the next great opportunity themselves.Unfortunately, there could also be underlying reasons for why an owner is looking to sell.
During your research phase, it’s best to be on the lookout for these signs:
- Existing business debts
- Poor concept/no market for this product/service
- Competition has far surpassed the business
- Brand reputation
- Poor location
- Inventory Issues
- Equipment Problems
Another great way to uncover some of the reasons a business may be for sale is by talking with neighboring businesses and residents who have likely built a report with the seller. Getting an honest opinion from people without any stake in this potential sale can provide much-needed perspective.
Once you’ve done your homework and your financial due diligence, building a relationship with the seller is perhaps the best way to understand all of their motivations, reasons, or even needs, to sell.
While each point of view may be remarkably different, seeking out these voices and relationships will help you in making your final decisions.
Does this business align with your goals and budget?
The first part of this question calls back to our first question. Knowing why you would like to buy a business for sale is one thing – understanding the goals you have around the company once acquired is another.
The second part of the question surrounding budget needs to be evaluated with the help of an accountant. They will thoroughly review the business’s financials and give you a proper sense as to whether or not they’ll be able to meet or surpass the goals you have in mind.
It may also be wise, depending on your background, to work with a business broker. While a broker most commonly works on behalf of the seller, plenty of brokers are available to work with commercial buyers. They’re able to help you determine the type of business you’d like to acquire, represent you in negotiations, and handle any required paperwork.
When working with a broker, you should always request a written statement. This statement would legally indicate that they are representing your side of the transaction in an effort to purchase an existing business.
Do Your Due Diligence
As we’ve mentioned throughout, gathering as much information about the business up for sale is crucial when deciding whether this is or is not the business for you. This process is known as due diligence.
While you may be more than perfectly capable of tracking down, arranging, and analyzing all of these data points, this is a major business and life decision. We recommend that you work with both an accountant and a lawyer to guarantee that nothing is lost during this vital process.
It’s also good to work legal and financial professional given that it is most likely the seller will request that you sign a confidentiality agreement or nondisclosure agreement.
These documents protect the seller in the event that you decide against buying the business after your review.
What to Look For During the Due Diligence Process
Letter of Intent
Once you have agreed on a price point, the seller will issue a letter of intent. This indicates that the seller is indeed serious about selling their business and you are free to proceed with your due diligence process.
This letter will include all of the business assets and liabilities to be included in the transaction, the price proposal, and the terms and conditions of the sale.
License and Permits
Assuring that a business you’re thinking of purchasing has all of the necessary licenses and permits to operate as a business is essential. These licenses and permits allow the state and local governments to properly tax the business, as well as making sure they are legally capable of operating within a specific industry.
Not having proper licenses and permits can result in significant fines and/or legal action taken against the business.
Paperwork and Certificate of Good Standing
If the business is registered as an LLC, they will need to prove that they have founding papers filed with the state. Similarly, a corporation will need to show that they have paperwork known as the articles of incorporation, detailing that they are a corporation in the United States.
The business may also hold a certificate of good standing, which would indicate that they are an entity that exists in their specific jurisdiction, have paid their appropriate dues, and are authorized to conduct business in the state. A certificate of good standing (also known as a Certificate of Status, a Certificate of Existence, or a Certificate of Fact) provides evidence that a company has submitted all required reports and paid all required fees to the state. If the business you’re purchasing does not have official founding documents on file, proof of their establishment, existence, and their repute can be made proofed through the state.
Zoning is the legislative process for dividing land into sections for different uses, specifically residential and commercial. These ordinances regulate the use of land and structures built upon it and are established to protect the health, safety and general wellbeing of the people living in or near a particular zone. For business purposes, office buildings, shopping centers, bars, hotels, vacant land and certain types of warehouses and apartments can be zoned as commercial.
Parking can also affect the type of commercial zoning that is permitted (each municipality will differ, but this has to do with the number of parking spaces available for residents compared to visitors). Additionally, there can also be rules regarding the proximity of certain types of businesses to others. Bars, for example, are not allowed to operate within a certain distance of existing schools or churches. Since zoning laws are typically controlled at the local level, check with your local city planning office to learn more about the zoning laws in your area and to make sure your new business is not at risk of being fined.
This portion of the due diligence is dictated by the local rules of the Environmental Protection Agency. Essentially, you want to make sure that the company has not been purposefully and ignorantly harming the environment.
Contracts and Leases
When you agree to purchase an existing business, you want to make sure that you’re acquiring as many valuable assets as possible. This would include any leases for the location (office, storefront, etc.) and equipment.
In addition to assets of value, be sure to ask about specific contracts or agreements that the business may have with current clients. Regardless of whether these arrangements are beneficial or detrimental to the business, these are details you will absolutely want to know before your negotiations.
Before you purchase an existing business, you will clearly want to review the company’s financials with a fine-toothed comb. This will allow you to see the overall health of the business.. We recommend that you have your own CPA audit these documents to vet and assure the accuracy of the information presented.
During this audit, you and your CPA will want to review:
- Tax returns
- Balance sheets
- Sales records
- Cash flow statements
- Accounts receivables
- Accounts payables
- Debt disclosures
- Advertising costs
Since this is a business that has been in operation for some time, the employees who you will now be responsible for will presumably already have an operational approach to their work.
Not only do you want to get to know your employees as people, but you’ll also want to know company hierarchy, salary information, benefits, accrued vacation time, and more.
Given the amount of upfront capital you’ll be using to purchase the business, you’ll want to make sure that each asset you’re acquiring is as valuable as it can possibly be.
The four largest assets, by cost, that you’ll want to be critical of are:
If the assets you’re acquiring don’t match your vision of the business, you’re able to sell these items after purchase. As you review the quality and condition of these supplies, you’ll need to ask yourself these questions.
- How sellable is this?
- What is this worth in the market?
- How quickly has this sold in the past?
- What’s it’s original selling price vs price in its current condition?
- Does it need repair?
- How useful is this for your company?
- How useful could this be to a competitor?
- Will this need upgrades
- Other questions along these lines
A sales agreement will establish the final sale price along with everything you have agreed to purchase. Most commonly, this includes all customer data, tangible (inventory, equipment) and intangible (brand reputation, customer loyalty) assets, and any intellectual property.
Before you sign the sales agreement, be sure to have your lawyer review it for outstanding details. With a process this involved, you’ll want to make sure that every T has been crossed and every I has been dotted. This may technically be the end of the due diligence process, but there are still plenty of verifications remaining.
Determine the Business Value
In both the letter of intent and the sales agreement, there will language clearly indicating that both you and the seller have agreed on a fair price for the business. Before you arrive at this price, however, there are three pieces you should evaluate to guarantee you’re making the fairest offer.
This view the best way to analyze a business that is already turning a profit or anticipates a strong year.
The capitalized earnings method and discounted cash flow method are avenues that allow you to review a business’s historical, projected, and current profits. These models and forecasts are used to give you an idea of the earnings of the company and therefore a more accurate valuation.
For businesses operating in industries like manufacturing and other utilities that require a lot of capital, focusing on assets is a much more appropriate approach.
The asset approach takes into account the value of the business’s assets, tangible and intangible, minus debts and liabilities.
The market approach takes a look at comparable businesses that have recently been sold and determines an average value based on previous sales. While the earnings and asset approaches are good methods to understand a company’s value in a vacuum, the market approach provides a fair market value for the business for both the buyer and seller.
The market approach can be used for any business, regardless of the assets being evaluated, as the assessments simply adjust for contrasts in size, quantity or quality.
Regardless of the method, when both you and the seller reach a price point that you’re comfortable with, that will be the final and most likely fairest price. Now all you need to do is secure the capital you need to purchase the business.
Secure the Working Capital You Need
With the final price agreed to, the time to put up the money has arrived. Whether you’re using your own money or using outside financing, there is a slew of ways you can fund your purchase.
Let’s take a look at the ways you can finance your purchase:
If you’re able to finance the costs of purchasing the business without using all of your personal savings, funding the acquisition independently is an option. Even if you are only using a small portion of the total amount of your total capital, talk to your accountant before paying cash upfront. Running a business requires you to be comfortable with the amount of working capital you have available (we recommend having at least 12 months of working capital in order to handle unexpected issues and the like), so consider every factor before using your own money.
You can also use financing that you’ve borrowed from family or friends. Again, speak with your accountant so both you and those close to you are both aware of the tax implications for family loans and gifts. Follow the IRS rules for family loans and be sure that everything is in writing.
One last reminder before using your own capital, of course; running your new business will require you to have working capital, so don’t use it all just to acquire the company.
Sellers can offer potential buyers the option to cover either the entire purchase or a portion of the final price through seller financing. Also known as a seller carry back, this loan option provides benefits to both buyers and sellers. For buyers, they gain access to more capital to complete their transactions, while sellers have the ability to generate more interest through this financing.
Angel Investing/Venture Capital
Depending on the level of growth you hope to achieve and can see in the business for sale, working with a venture capital firm or with a single angel investor can make a lot of sense.
Not only will they be able to support you with the financing you need, but you’ll also be able to draw from their years of business experience and expertise.
Much like turning to an investor, adding a partner can help you in more ways than just minimizing your upfront costs. Taking on a partner can help by diversifying the skills at the top of the organization and potentially provide access to specific expertise.
There are a variety of business loans that can help you secure the financing you’ll need. Fast Capital 360 has helped thousands of owners and entrepreneurs just like you find the best loan options for their business needs. Through one quick online application, you will have access to evaluate the best loan options available through the industry’s top lenders.
Before applying, let’s get a better understanding of the different business loans you could use to buy a business.
- Term Loan
Similar to a traditional bank loan, a business term loan provides flexibility and stability with access of up to $2,000,000. Term loans give business owners up to 5 years to repay and feature interest rates starting at 7%.
- Short-Term Loan
Perfect for when you need to secure upfront capital to buy a business immediately. Get access to the funds you need as soon as the same day, with repayment terms between 3 – 18 months.
- SBA Loans
SBA loans provide more opportunities to businesses who may not have been able to secure a traditional bank loan. While SBA loans are loans that originate from a bank, these banks are participants in the SBA loan guarantee program.Through this program, the Small Business Administration promises it will buy a portion of the loan back from the bank, guaranteeing up to 85% of the total loan amount up to $3.75 million, if your business were to fail to repay the loan.
- Business Line of Credit
A business line of credit provides you with access to funds as your company needs. You are never obligated to withdraw the entire credit line amount and you will only ever pay interest on what you use over the term of the loan.
With the knowledge of all of the financing options available, it’s time to finalize the sale.
- Term Loan
Finalizing the Purchase
You’re almost finished! You’ve agreed on a price and found the best way for you to fund the purchase.
Here are the documents you might need to finalize your purchase of an existing business:
- Bill of Sale
This document will prove that the business has been sold, officially placing ownership of the company and all agreed upon assets in your name.
- Adjusted Purchase Price
Once you’ve considered the final price of the company, including any standard, apportioned operating costs, such as inventory, rent, and other utilities, the final note will reflect the adjusted price.
Just as we discussed during the due diligence phase, you will need to make sure that any building(s) your company operates out of now includes your name. Inform the landlord of the sale so they are aware of the transaction and they are not surprised. Of course, you are free to negotiate a new lease, if needed.
If you are acquiring vehicles in your purchase, you will need to inform the Department of Motor Vehicles. Any documents that need to be completed must be finished at the time of sale.
- Patents, Copyrights, & Trademarks
As you would for any lease or vehicle, you will need to make sure any necessary documentation and paperwork for these assets is completed and in your name by the time of the sale.
- Non-Compete Agreement
Asking for a non-compete agreement is not only a good idea, it’s standard practice. This will protect you and your new business from potentially having to face the seller as a competitor within your industry.
- Consultation/Employment Agreement
If the seller has agreed or would like to stay on as an employee or consultant, you will need to file a consultation/employment agreement.
- Asset Acquisition Statement
Using IRS Form 8594, you will need to list all of the assets you have purchased and the price at which they were sold.
- Bulk Sale Laws
Just as you with many other pieces of this process, you will need to inform the local tax and/or financial authority about the sale. These laws prevent business owners from avoiding any taxes assessed to their company after a sale.
Now that we’ve thoroughly broken down the 8 steps to buying a business, as well as all of the other details and documents you could possibly need and know, it’s time for one last summary on purchasing an existing business.
- Bill of Sale
The Bottom Line on Buying a Small Business
Clearly, buying a business can sometimes be a long, potentially exhausting process that can lead you down the path to creating rewarding results. At the end of it, you will have a greater appreciation for the work that your predecessor has done and the legacy that you hope to build upon and improve.
As an entrepreneur, you will be responsible for the success of a company, meaning that every major decision and action begins and ends with you. While it can be overwhelming at times, everything is worth the effort when you read positive reviews from your customers, see smiling and dedicated employees in your offices, and get to associate your name with a business you’re proud of.
When starting or buying an existing business, having access to working capital that matches the scope and speed of your goals is important. Online lenders are able to support small business owners by providing access to a variety of options using an expedited approval process and state of the art technology.
Fast Capital 360 uses a simple online application that takes only minutes to complete and can even provide you with your approved funds as soon as the same day. We use the latest in bank-grade encryption and SSL technologies to not only get you a financing decision within hours, but also to keep your data secure. We work with the the industry’s top lenders to provide you with the best options to grow your business.