Buying an existing business is a good alternative option for those who don’t want to start from scratch. Read on for some things you need to consider before making a purchase.
In this article:
- Type of Business
- Your Cash on Hand (Or Lack of It)
- Your Financing Options
- Why the Seller Is Selling the Business
- Day to Day Operations
Factors to Consider When Buying an Existing Business
1. Type of Business
Purchasing an established business gives you the advantages and disadvantages of business ownership without starting from scratch. Before buying one, know what type of business is right for you based on certain factors:
- Business Size: A large enterprise has a bigger earning potential than fledging start-up businesses. The trade-offs of buying a bigger company include a larger sticker price and more transition activities to go through between the company handoff from the previous owner to you.
- Location: Location affects how much in taxes you pay, employment laws your company needs to follow, and any regulations you need to be compliant with.
- Industry: Just like in any other investment, you should be buying an existing business in industries you’re already familiar with. If you’re set in a certain industry, make sure you have enough knowledge about it.
- Business Model: Your personality as a business owner also dictates what business model is right for you. For example, if you need consistent income every month, look for a business that uses a subscription model.
2. Your Cash on Hand (Or Lack of It)
Ideally, the potential buyer will have the funds to at least make a down payment on the business, but many buyers would rather not do so. There are four main reasons buyers avoid putting money down when buying an existing business:
- Limited funds: Some buyers who have a good credit score (like many retirees) have limited funding on hand. They would rather delay forking out cash whenever possible.
- Money tied elsewhere: Many buyers have other investments in their portfolio and would rather avoid cashing them out whenever possible. This could either be because the investments aren’t liquid, or they are but can cost the buyer massive taxes.
- Bad credit: Others have both limited funds and a bad credit score (so financing isn’t an option). This is one of the more challenging reasons to deal with, but you often have other options at your disposal.
- Don’t want to risk money: The last reason is that the buyer does have enough finances to buy the business, but would rather use other people’s money in purchasing it. If you’re this type of investor, think about the reasons why you want to buy a business in the first place.
3. Your Financing Options
Successfully buying an existing business with no money is a challenge, but there are ways you can become a business owner without putting your financial future at too much risk.
- Leveraged buyout (LBO): This is when the buyer purchases businesses using a combination of funds from outside sources (like loans).
- Seller financing: Seller financing is when the buyer pays the seller in installments at a certain amount of interest. With this arrangement, the seller’s ties to the business remain as long as financing is ongoing (but most sellers will likely demand a small percentage of the purchase price).
- Venture capital: In this case, you’ll be partnering with another investor who will purchase the business for you while you cover daily operations. While you would have to split profits with your investor, it lessens your risk since you don’t have to fork out all of the cash.
- Small Business Administration (SBA) financing: The SBA offers loans that help small businesses get off the ground. These can range from microloans to a traditional business loan of up to $5 million.
- Borrowing from friends and family: Consider this your last option once you’ve exhausted everything. If you ever chose this option, borrow as little as you can and fund the rest using the other sources.
Study the pros and cons of your financing option and choose the right one for your needs.
4. Why the Seller Is Selling the Business
Also, consider why the current owner wants to sell their business. The reasons will tell you the overall shape of the company and how much work is required from you once you hop onboard.
- Retirement: Operating a business is just like any other job, except that owners always bring their heart and soul into the operation. Unfortunately, many small business owners fail to plan for succession and don’t train an employee to oversee operations once they retire.
- Poor cash flow: For buyers who love a challenge, this can be a good opportunity to breathe new life into a struggling venture.
- Health issues: Small businesses that rely on the owner being there will find themselves struggling when the owner falls ill. If this is the case, move as fast as you can if you’re set on buying the business.
- New opportunities: Maybe the business is profitable but, like many successful entrepreneurs, found a golden opportunity in a new market. They may need to sell the business in order to get new capital.
Make sure to do your due diligence before you buy businesses. Some things to look into when doing due diligence include:
- Assessing financial statements to see its financial shape. Pay special consideration to its balance sheet (the list of the business’s assets and liabilities).
- Checking the businesses’ tax returns to know if they’re paying the right amount of taxes. You don’t want to risk having a tax evasion case.
- Consulting a business acquisition lawyer and asking for a business valuation.
Buying an existing business is always a risk, but knowing what you’re getting into can help you make sound financial decisions and decide if you should move forward with the purchase.
5. Day to Day Operations
Starting a business is only one piece of the puzzle. The real work happens once you commit to a sale since the next challenge is where to get the funds to finance operations.
Many clients pay invoices 1-2 months after they receive the invoice, which can be a long time for those who are just starting out. While you wait for those next payments to come in, here are some options you can consider:
- Equipment rental: You can lease equipment if you can’t afford to buy them. There are also arrangements available where you can purchase the equipment at the end of the lease period.
- Microloans: SBA micro-loans (up to $50,000) is a good option for smaller companies because it’s easier to get approved for one and it can help your cash flow in the short term.
- Invoice factoring: This is where companies sell their invoices to an invoice factoring firm. The factoring firm gives you the amount equivalent to around 80% of the invoice value and will take charge of collecting payment from your clients.
Another thing to consider is the effect of the acquisition on the current employees. Having new business owners and new management can breed fear and uncertainty among employees as their livelihood is on the line, so it’s your responsibility to reassure them and keep them abreast of changes that will be happening.
Buying an existing business is one of the biggest financial decisions you’ll make and it can have a significant impact on your finances and retirement lifestyle in the years to come. Make sure to do your homework and due diligence before jumping right into a sale.
Have you considered purchasing a business? Share your experiences in the comments section below!