Buying a Business

Buying a Business

We have talked about selling your business, and we’ve talked about starting a business, but I don’t think we’ve talked about buying a business.  Starting a business from scratch is a long and time-consuming project.  And most businesses take 1-3 years before they are profitable (or salable).  If you add to the likely 2 years of planning prior to opening your doors you may be looking at 3-5 years without a paycheck or with a reduced paycheck from what you are probably earning now in a job.

If you can’t go that long before making a profit you might consider purchasing an existing business that is already profitable or close to being profitable.  If you are better at the operational side of the business it makes sense to buy a business with an established customer base.  If you are better at the sales and marketing, it makes sense to by a business that is struggling with the sales but has a great product and is operationally sound.

However, it requires careful consideration and due diligence to ensure that the investment is sound. Here are the key factors you should consider before purchasing an existing business:

1. Understand Your Motivation and Goals
   1. Clarify why you want to buy a business. Does it align with your long-term career goals, lifestyle, and personal interests?
   2. Consider whether the business has the potential to grow and evolve in a way that meets your goals.
2. Assess the Financial Health
   1. Examine at least three to five years of financial statements, including income statements, balance sheets, and cash flow statements. Look for consistent profitability and healthy cash flow.
   2. Understand the company’s current debts, liabilities, and any potential legal issues.
   3. Analyze the profit margins to see if they are sustainable or if there’s room for improvement.
3. Conduct Due Diligence
   1. Ensure the business is compliant with all local, state, and federal regulations. Verify that taxes have been filed accurately and on time.
   2. Look at all existing contracts with suppliers, customers, employees, and leases. Make sure these contracts are transferable and favorable.
   3. Assess the condition and value of any physical assets, inventory, intellectual property, and other resources the business owns.
   4. Identify any pending lawsuits, disputes, or unresolved issues that could affect the business.
   5. Look for long term liabilities such as gift certificates, or prepaid services.
   6. Understand leases for both location as well as equipment leases.
4. Analyze Market Position and Competitors
   1. Understand the market in which the business operates. Is the market growing, stable, or declining? What is the business’s market share?
   2. Identify the key competitors and analyze the business’s competitive advantages or disadvantages.
   3. Review the customer demographics, loyalty, and satisfaction. Is there a risk of losing customers after the sale?
5. Evaluate Business Operations
   1. Assess the efficiency of current operations, including supply chain management, production processes, and technology.
   2. Review the current workforce, including key employees. Determine whether they are likely to stay post-sale and whether their skills are crucial to the business.
   3. Examine relationships with suppliers and partners to ensure continuity after the ownership change.
6. Understand the Seller’s Motivation
   1. Understand why the current owner is selling the business. Common reasons include retirement, health issues, or a desire to pursue other opportunities. Be cautious if the seller is offloading the business due to declining profits or market conditions.
   2. Determine whether the seller is willing to offer support during the transition, such as training or consulting.
7. Consider the Valuation
   1. Have the business professionally appraised to determine its fair market value. Consider different valuation methods, such as asset-based, income-based, and market comparison approaches.
   2. Be prepared to negotiate the price based on your findings from due diligence and the business valuation.
8. Evaluate Financing Options
   1. Determine how you will finance the purchase—through personal funds, loans, or seller financing. Understand the terms and costs associated with each option.
   2. Ensure you have enough working capital to run the business after the purchase, including covering unexpected expenses.
9. Legal Considerations
   1. Decide on the legal structure of the new ownership (e.g., sole proprietorship, partnership, LLC) and understand the implications of each.
   2. Work with a lawyer to draft and review all legal documents, including the purchase agreement, non-compete clauses, and transfer of ownership forms.
   3. Ensure thorough legal due diligence to avoid inheriting any hidden legal problems.
10. Plan for the Transition
    1. Develop a detailed transition plan to ensure a smooth handover of operations. This should include timelines, training, and communication with employees and customers.
    2. Consider offering incentives to retain key employees who are critical to the business’s success.
11. Understand Potential Risks
    1. Be aware of economic, market, and industry risks that could affect the business’s future.
    2. Consider potential operational risks, such as supply chain disruptions, technological changes, or shifts in consumer behavior.
    3. Assess the financial risks associated with the purchase, including the possibility of overpaying for the business or facing unforeseen expenses.

If you have reviewed the above list of considerations and all were positive, you might come to conclude one of two 2 things; [1] the business is probably not going to be undervalued, [2] the seller must have some extraordinary circumstance wherein he’s willing to sell it. It is incumbent upon YOU to look through the list and decide which of the points presented are areas where you can offer improvement. By understanding the financial health, market position, operational efficiency, and potential risks, you can make an informed decision and increase your chances of success. Surround yourself with the people that will help you navigate through the discovery.

Lastly, when spending the money on an existing business, realize that buying a business is an investment.  And as an investment you need to ask can the same amount of money be earned somewhere else?  If it takes more than 5 years to earn back your original investment, think carefully as you can probably earn the same with less risk and less effort.  Also, do you bring anything to the business that it currently lacks?  Your goal is to build it bigger and faster than the previous owners.  If all you can do is maintain it’s current earnings, then all you’ve done is purchased yourself a job (with risks).

Remember, just because you can, doesn’t mean you should.  And that was never truer than when buying or starting a business.

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