Buying an existing company is a simple solution for those who want to own a business without having to build it from scratch.
One of the biggest benefits is obviously that your business can skip the grueling startup phase and jump straight into making money.
That said, making a successful purchase isn’t easy and there are a lot of different factors to consider.
Without careful planning, buying a business can be just as treacherous as starting one.
In this article, we’ll provide a tutorial on how to buy an existing business. Plus, we’ll cover the advantages and disadvantages that you need to consider.
The essential 6-step checklist for buying a small business
So, you want to buy a business.
But before you go any further there are a few things to consider.
When you’re buying, business factors need to be closely examined. Whether you’re buying a franchise or buying an existing business, you need to follow these steps:
1. Decide the type of business that is right for you
Before you buy a business, first figure out what kind of business you want to run.
Here are some important factors to consider that will help guide your decision:
- Industry. Do you want to have an online store, a creative agency, or a restaurant? Make sure the field you want to participate in aligns with your knowledge and interests.
- Skills. If you have little to no education in business or management, it might be best to look at buying a smaller existing business. Also, ensure that you have knowledge in the industry of the business you want to buy.
- Lifestyle. Some industries allow for a nine-to-five schedule, while others require you to work long and odd hours, so before you pick any of the businesses for sale out there make sure you know what you’re getting into.
- Location. Where the company is based can determine the costs of operations, cash flow, and labor among other things.
- Size. Think of the number of employees, locations, and current growth when buying an existing business. Though a large business can be more profitable, it can also be harder to manage.
2. Find businesses that are available for sale
Let’s get searching. There are three ways to find businesses for sale:
If you’re reading this article, chances are you already have an existing business in your network that you want to purchase. In that case, consider asking the owner whether it’s available to buy.
If the business is poorly managed and not making any profit, you can try negotiating for a lower price.
On the flip side, if the company is doing well, the price to buy an existing business will surely be higher.
A business that is performing well will already have a loyal customer base and good cash flow management. On the one hand this will make it easier for you to take over but on the other you will be looking at a much larger investment.
As with pretty much everything these days the best place to look when buying an existing business is online.
Business-for-sale marketplaces provide credible and verified listings of real business owners that are looking to sell and have plenty of features to make your searches easier. Search by business name, email, or location to narrow things down.
Consider getting a business broker.
Business brokers can provide you with an expert perspective of what type of business would suit your interests and where you might be able to find them.
A business broker will make the entire buying process easier since the main role of a broker is to vet companies that you’re interested in and help you negotiate the purchase price.
Usually, you pay them once you’ve successfully bought a company and their commission rate tends to be around 10-15% of the purchase price.
To find business brokers, check out online directories like IBBA.
3. Conduct your due diligence
Once you’ve found a business you like, you need to take your time to really check it out in detail.
Before you buy any sort of business – large or small – you must investigate whether the business has any problems that could make it difficult for you to take over.
Start by contacting the current owner.
At this stage they will probably ask you to sign a confidentiality agreement so that any information discovered during the investigation will remain private.
Then it is time to employ a business broker, a certified public accountant, and an attorney.
Their job will be to help you conduct a business health check and figure out why the company is for sale in the first place.
Some of the elements you need to inspect are:
To ensure that the business has no law-related issues, here are some documents you need to check:
- Licenses and permits. Check whether the company has registered with the local, state, and federal governments and has acquired the documents to operate its business.
- Organizational documents. If the business is an LLC or corporation, it should have a certificate that shows its incorporation.
- Certificate of good standing. This document will show that the company has paid all their taxes and obeyed all the regulations to run the business.
- Zoning compliance. If the business has a physical store, make sure the building follows the local rules for opening a commercial property.
- Business insurances. These may cover protection for the property, workers, data, and so on.
- Intellectual property documents. Such as trademark registration, which protects the company’s branding and product.
- Lease agreements. Check whether the business leases the property or any equipment used for operations.
- Employment contracts. See if the documents follow local labor laws.
These records can provide insight into how the business makes money and whether it’s generating a profit. They’re also vital for determining if the business is legitimate.
Review the following documents to determine the company’s financial position:
- Balance sheet. This financial statement comprises the company’s assets and liabilities. It will also show its net worth or the monetary value of the business.
- Income statement. It will tell you about the company’s profits and losses. You should ask for income statements made in the past three years.
- Cash flow statement. This document discloses how much cash goes in and out of the business to keep operations running.
- Taxes. Make sure the company has passed a tax audit and has not conducted any evasion practices.
- Sales trend analysis. Use this to determine future sales patterns, as well as to compare the company’s performance with its competitors.
Remember to be critical when checking the financial statements. Though the numbers may look good, the previous business owner might have tweaked them to make them seem more appealing to prospective buyers.
Hard assets are any physical items that a business owns to support its operations. This may include:
- Store building
- Storage facility
- Production equipment
- Office tools
Examining these assets is important to determine how many improvements and modifications you have to make once you’ve acquired the business.
In the case of inventory, the current owner might use it to add value to the business. The reason is that you can use the inventory provided to begin operations or sell the excess to get cash.
When examining these assets, pay attention to the aspects below:
- Age. How old is it? What is the lifespan of the item?
- Quality. Is it well-maintained? How much has the owner spent on upkeep?
- Market value. How much would it sell for now? How much did it cost when it was first purchased?
- Health and safety. Do the facilities meet the standards for a hazard-free work environment?
Competitive advantage is any element in a business that makes customers choose one product or service over that of its competitors. It could be anything from:
- The product or service’s quality
- Pricing model
- Customer service
Discovering the business’s competitive advantage can provide insight into what encourages its buyers to shop with the company.
Taking the time to examine the competitive edge is an effective method in finding out which current practices can continue and which need to be optimized.
What’s more, it should help you to understand the business’s current reputation. To find out how customers perceive the business, check out the platforms below:
- Company website
- Social media networks
- Review platforms
4. Determine the right value and your maximum offer
At this point, you will have enough information to evaluate the business in terms of price.
Typically, business owners will have done their own valuation to decide on an acceptable purchase rate.
Nonetheless, you’ll need to perform a valuation as well to know how much you can offer. It’s also useful if you’re planning to take a loan to fund the business.
There are three approaches to business valuation:
This approach determines the company’s worth based on how much other, similar, businesses have been purchased for. It’s a good way to decide on a starting point for your offer.
That said, this valuation only works if you have enough data for comparison.
Factors such as business location are important when considering whether the comparison is justifiable.
This approach measures a business’s value by looking at its growth potential.
The company’s value is then based on the company’s past, present, and future earnings.
It’s a great option to evaluate businesses that have a stable performance. A common valuation method used in this approach is discounted future earnings.
However, since it partly relies on projections, the calculation might not be accurate. In reality, many unforeseen factors could impact the business’s income.
As the name implies, this approach uses the company’s assets to figure out its worth. This includes:
- Tangible assets, such as equipment and inventory
- Intangible assets, like intellectual property and brand reputation
With this valuation, you have to calculate the total of assets, subtracted from the total value of liabilities.
However, this approach works better with LLC or corporation companies. If the business you’re buying is a sole proprietorship, it could be hard to separate personal from business assets.
Keep in mind that no approach is better than the other. For most businesses, you would have to use them all to find the right purchase price.
5. Collect the funds to buy the business
After agreeing on the purchase price, you can prepare the money to buy the business. Here are some ways you can collect the funds:
- Use your own money. If you do, it’s best not to spend all of it. Leave some room in the budget to begin operations.
- Borrow from your family. Be sure to understand your local tax rules of family loans to avoid any issues.
- Ask for seller financing. The seller will lend you money and you will pay them back over a period of time with interest.
- Look for angel investors or venture capitalists. These investors usually target small businesses or startup companies and help them jumpstart their operations.
- Take out a business loan. To do this, you’ll need the evaluation report, a new business plan, as well as your personal and business credit history.
6. Close the deal
It’s time to close the deal. But before finalizing the purchase, make sure that the necessary paperwork is ready. Here are some documents that will need to be reviewed:
- Bill of sale. This will indicate that the ownership of the business has been successfully transferred to you.
- Sale and purchase agreement. This is a legal contract between the buyer and seller that shows both have agreed upon the terms and conditions.
- Non-compete agreement. It will prevent the seller from opening a competing business nearby.
- Employment or consultation agreement. You will need this document in the case that the previous owner will stay on as an employee or consultant.
- Asset acquisition statement. This will record all the assets you have purchased as well as their value.
- Assignment documents. You will need these to officially become the owner of the business’s facilities and intellectual property rights.
Once everything is signed, the company is officially yours.
However, buying a business is just a start. Now, you will have to run it.
Advantages and disadvantages of buying an existing business
Overall, before buying a business, you need to weigh up the main advantages and disadvantages that I have listed below:
- Lower risk. In most cases, the product or service has been released and made some sales. This means you’re less likely to gamble on its success.
- Established brand and market. It already has an existing list of customers and reputation.
- More likely to get a loan. Lenders are more confident to give you money if you already have existing financial statements for reference.
- Knowledgeable employees. Your staff is already trained to help you operate the business.
- High costs upfront. For instance, you will have to pay your accountant, business broker, and attorney after making a transaction.
- Expensive improvement expenses. You might need to do a complete revamp if the business has been performing poorly under previous management.
- Underlying issues. Even if you have completed your due diligence, you could discover some unmentioned problems after you’ve acquired the company.