When most people think of buying a small business they quite often get confused or compare what they believe would be the investment to start a business. They think there is a saving by beginning from scratch, developing your own ideas and building the company from the ground up. But starting from scratch presents some distinct disadvantages, after you are ready to open the doors you must fund the fixed costs while you include building a customer base, marketing the new business, hiring employees and establishing cash flow…all without a track record or reputation to go on.
Unless you have some extraordinary skills or a duplication of a proven business model your first 12 to 18 months can be a struggle and many fail.
Buying an Existing Business
In most cases, buying an existing business is less risky than starting from scratch. When you buy a business, you take over an operation that’s already generating cash flow and profits. You have an established customer base, reputation and employees who are familiar with all aspects of the business. And you don’t have to reinvent the wheel, setting up new procedures, systems and policies, since a successful formula for running the business has already been put in place.
On the downside, buying a business is often more costly than starting from scratch. However, it’s easier to get financing to buy an existing business than to start a new one. Bankers and investors generally feel more comfortable dealing with a business that already has a proven track record. In addition, buying a business may give you valuable legal rights, such as patents or copyrights, which can prove very profitable. Depending on your relationship with the Vendor or their advisors you may request some assistance or mentoring as part of your offer. Of course, there’s no such thing as a sure thing, and buying an existing business is no exception. If you’re not careful, you could get stuck with obsolete inventory, uncooperative employees or outdated distribution methods. To make sure you get the best deal when buying an existing business, be sure to follow these steps.
The Right Match for Your Skills or Requirements
Buying the perfect business starts with choosing the right match business for you. The best place to start is by looking at an industry with which you’re both familiar and which you understand. Think long and hard about the types of businesses you’re interested in and which best match your skills and experience. Also consider the size of business you are looking for, although confronting, part of a Broker’s Duties is to qualify that the Buyer has sufficient Funds or Borrowing Power to not only settle the sale but also have sufficient surplus for working Capital.
Size matters, will it be a family business, or have to employ many staff, have a number of locations?
Next, choose the geographical area where you want to own a business not necessary where you wish to live. Investigate the costs of doing business in that area, including available skilled staff, wages and taxes, to make sure they’re acceptable to you. Once you’ve chosen a region and an industry to focus on, investigate every business in the area that meets your requirements. Start by looking in the local newspapers classified section under “Business Opportunities / Investments” or “Businesses for Sale”, next are the numerous Businesses for Sale Websites.
Astute Sellers will engage a Qualified Business Broker to prepare and present their business to the market, they primarily use Internet Marketing.
The identity of those businesses that are for sale is often kept very confidential to protect the Vendors and minimise any insecurity to Staff, Clients and Suppliers. Talk to business owners in the industry; many of them might not have their businesses up for sale but would consider selling if you made them an offer. Put your networking abilities and business contacts to use, and you’re likely to hear of other businesses that might be good prospects.
Contacting a Business Broker is another way to find businesses for sale. Most brokers are hired by sellers to find buyers and help negotiate deals. You can hire a broker, he or she will charge you a commission, typically 5 to 10 percent of the purchase price but they prefer to work for the Seller so that they can offer it to a larger audience. The assistance brokers can offer, especially for first-time buyers, is often worth the cost. However, if you are really trying to save money, consider hiring a broker only when you are near the final negotiating phase.
Brokers can offer assistance in several ways including;
- Shortlisting businesses for you. Good brokers turn down many of the businesses they are asked to sell, whether because the seller won’t provide full financial disclosures or because the business is overpriced. Going through a broker helps you avoid these bad risks.
- Helping you match your Skills or wants. A good broker starts by finding out about your skills and interests, and then helps you select the right business for you. With the help of a broker, you may discover that an industry you had never considered is the ideal one for you.
- Negotiating the Offer. The negotiating process is really when brokers earn their keep. They help both parties stay focused on the ultimate goal; keep the process flowing and smooth over any problems that may arise between all parties. They will formalise the offer by preparing a Draft Contract.
- Assisting with paperwork. Brokers know the latest laws and regulations affecting everything from licenses and permits to financing and application acceptance. They also know the most efficient ways to cut through red tape; this can slash months off the purchase process. Working with a broker reduces the risk that you’ll neglect some crucial step that can hinder the process.
A Closer Look will include
Whether you use a broker or go it alone, you will definitely want to put together an “acquisition team” your finance provider, Accountant and Commercial Solicitor to help you. These advisors are essential to what is called “due diligence”, which means reviewing and verifying all the relevant information about the business you are considering. When due diligence is done, you will know just what you are buying and from whom. The preliminary analysis starts with some basic questions. Why is this business for sale? What is it you are buying? What is the general perception of the industry and the particular business, and what is the outlook for the future? A Registered Business Valuer calls this the “Future Maintainable Income”.
Does or can the business controls enough market share to stay profitable? Are raw materials needed in abundant supply? How have the company’s processes, products or services provided changed in line with Technology?
If the business still looks promising after your preliminary analysis, your acquisition team should start examining the business’s potential returns and its asking price. Whatever method you use to determine the fair market price of the business, your assessment of the business’s value should take into account such issues as the business’s financial situation (from their Balance Sheet), its earnings history and projections, “Future Maintainable Income”.
Quality Businesses should have a written “Business Plan” which will include expansion options and future cash flow to get an idea of the company’s anticipated returns and future working capital needs. Combined with Balance sheets, income statements, cash flow statements, footnotes and tax returns for the past three years are all key indicators of a business’s health. These documents will help you conduct a financial analysis that will spotlight any underlying problems and also provide a closer look at a wide range of less tangible information.
The ultimate purchase opportunity may include an “Independent Business Valuation”; subject to the scope of this document it may contain many useful KPI’s, Industry Statics and results of independent investigations.
Last and certainly not least, the assistance offered by the Vendor or the relationship that you would like to maintain must be kept in mind when making your final offer. A Vendor that is comfortable with the final settlement will be more inclined to steer the staff, clients and suppliers during the agreed handover your way. Some buyers may insist on Vendor remaining on board for an agreed period in a Management position as part of the Contractual Agreement.
Things to Consider or Investigate
(A professional Business Broker will supply an “Information Memorandum” which will summarise most of this information)
Following is a checklist of items that you should verify before making a decision to buy and making your offer:
- Inventory or Stock included. Refers to all products or materials required to conduct business or service a client. Important notes include; stock turn, stock age and shelf life: The asking price is usually expressed in two ways; Walk in – Walk out (WIWO) which includes all stock on hand at time of Settlement. Secondly and more often the practice is “Plus Stock at Value” (SAV). You would be wise to employ a qualified industry representative be present during any examination of inventory to verify saleability and value. You can request reports to show status of inventory, what’s on hand at present, and what was on hand at the end of the last financial year and the one preceding that. After all, this is a hard asset and you need to know what dollar value to invest and return expected.
- Furniture, fixtures, plant and equipment, and if included the building. This includes all Vehicles, Machinery, Office equipment and assets of the business. Get a list from the seller that includes the name and model number of each piece of equipment. Then determine its present condition, market value when purchased versus present market value, and whether the equipment was purchased or is leased. Find out how much the seller has invested in leasehold improvements and maintenance. Determine if possible the Capital Expenditure required for improvements you’ll have to make to the building or layout in order for it to suit your needs or future requirements.
- Copies of all contracts and legal documents. Contracts would include all lease and purchase agreements, supplier terms, distribution agreements, subcontractor agreements, sales contracts, employment agreements and any other instruments used to legally bind the business. If you’re considering a business with valuable intellectual property, have a solicitor evaluate it. In the case of a real-estate lease, you need to find out if it is transferable, how long it runs, its terms, and what the landlord needs to give his or her permission for assignment of the lease.
- Incorporation. If the company is a corporation, check to see what state it’s registered in and whether it’s operating as a foreign corporation within its own state.
- Financial Adjustments; Many small business owners make use of the business for personal needs. They may buy products they personally use and charge them to the business or take vacations using company funds, go to trade shows with their spouses, etc. You have to use your analytical skills and those of your accountant, to determine what the actual financial net worth of the company is. This Business may be a supplier to your leisure interests which will provide fringe benefits.
- Financial statements for the past three years. Evaluate these statements, including all books and financial records, and compare them to their tax returns. This is especially important for determining the earning power of the business. The sales and operating ratios should be examined with the help of an accountant familiar with the type of business you are considering. As a Registered Business Valuer I use the most recent sales date as an indication of growth or decline.
- Sales records. Although sales will be logged in the financial year reports and BAS statements, you should also compare the YTD sales by month to the records for the past 18 months or more. This will indicate any seasonal fluctuations that cause peaks and lows. Also a break down by product or categories, if several products are involved, as well as, by cash, credit card or in-house account. This is a valuable indicator of current business activity and provides some understanding of cycles that the business may go through. Also, obtain the sales figures of the 10 largest accounts for the past 12 months, the vendor doesn’t wish to release his or her largest accounts by name, that’s fine, you’re only interested in the sales pattern.
- Complete list of liabilities. Consult your solicitor and accountant to examine any abnormal liabilities on the Balance Sheet to determine potential costs and legal ramifications. Find out if the owner has used assets such as capital equipment or accounts receivable as collateral to secure short-term loans, if there are liens by creditors against assets, lawsuits, or other claims. Your accountant should also check for unrecorded liabilities such as employee benefit claims, out-of-court settlements being paid off, etc.
- All accounts receivable. Break them down by 30 days, 60 days, 90 days and beyond. Checking the age of receivables is important because the longer the period they are outstanding, the lower the value of the account. Is this the cost of doing business with the existing clients?
- All accounts payable. Like accounts receivable, accounts payable should be broken down by 30 days, 60 days, and 90 days. This is important in determining how well cash flows through the company. On payables more than 90 days old, you should check to see if any creditors have placed a lien on the company’s assets.
- Marketing practices. How does the owner obtain customers? Does he or she offer discounts, advertise aggressively, or conduct public-relations campaigns? You should get copies of all sales literature to see the kind of image that is being projected by the business. What future Marketing Liabilities are being inherited.
- Pricing Strategies. Evaluate current price lists and discount schedules for all products, the date of the last price increase, and the percentage of increase. You might even go back and look at the previous price increase to see what percentage it was and determine when you are likely to be able to raise prices. Here again, compare what you see in the business you are looking at, with standards in the industry or your closest opposition.
- Industry and market history. You should investigate the industry as well as the specific market segments of the business trading area. Compare what suppliers are saying to what Vendor believes is the future in the industry, have they been growing, declining, or have remained stagnant. This is very important to determine future profit potential.
- Reputation of the business. The image of the business in the eyes of the community and suppliers is extremely important. As we mentioned, the image of the business can be an asset, or a liability.
- Seller-Client relationships. Vendor should be asked to disclose any customers that are related or have any special ties to the present owner of the business. How long has any such account been with the company? What percentage of the company’s business is accounted for by this particular customer or set of customers? Why will this customer continue to purchase from the company if the ownership changes?
- Staff. A list of current employees and Job Descriptions should be supplied even if only their Initials are supplied pre Contract. Long term employees’ especially key personnel can be a valuable asset. Understand the Duties involved and responsibility delegation to understand who is responsible to whom. You must also look at the management practices of the company and know the wages of all employees and their length of employment. Seek advice on any management-employee contracts that exist as well as details of any employee benefits or profit-sharing commissions. A buyer must also understand “long service” entitlements aside from accumulated Sick Leave and Holiday Pay.
- OH&S requirements. Find out if the facility meets all occupational safety and health requirements and whether it has been recently inspected. If you feel that the seller is “hedging” on this and you see some things you feel might not be safe on the premises, you can ask for an independent inspection as part of the due diligence.
- Insurance. Establish what type of insurance coverage is held for the operation of the business and all of its properties as well as who the underwriter and local company representative is, and how much the premiums are. Some businesses are underinsured and operating under potentially disastrous situations in case of fire or a major catastrophe. If you come into an underinsured operation, you could be wiped out if a major loss occurs. Product liability insurance is of particular interest and should be part of the coverage.
- Offering a Fair Price. No decision is more important and needs to be unemotionally charged; The Vender has an idea of how much the business is worth and what they may need which may differ from their Asking Price while the buyer will typically have another viewpoint. Each party is dealing from a different perspective and usually the one who is more eager will not have the most leverage when the process enters the negotiating stage. The Business Broker is ethically required to ensure that they work for the Identity who appoints them whilst maintaining control of both parties. Most Vendors or their Advisors determine the price for their business as a “Multiple of Profits” or through a special formula (A Rule of Thumb) that may apply to that industry only.
Ultimately the Buyer will dictate what price the business in question is worth on the “Open Market”.
There are a few factors that will influence price, such as economic conditions or supply and demand. Usually, businesses sell for a higher price when the economy is flourishing and for a much less during recessions. Motivation also plays an important factor. How badly does the seller want out? If your investigations indicate that the seller has non business related personal financial problems, possibly a marriage or partnership break up you may be able to buy the business at a discount rate.
It is said that buyers should fall in love with the “Profit not the Product”. Buy the Business that best matches your “Skills and Abilities”. Don’t buy on price; buy on “Return on your Investment”. Small businesses are different. The small business should typically earn a bigger return because the risk of the enterprise is higher. The important thing for you, as a buyer of a small business, is to realise that regardless of industry practices for big business, it’s the ROI that you need to worry about most. Is it realistic? If the price is realistic for the amount of money you have to invest, then you can consider it a viable business.
The Takeover. The transition to new ownership is a big change for employees of a small business. To ensure a smooth transition, start the process as soon as you are committed. Make sure the Vendor feels good about what is going to happen to the business after he or she leaves. Spend some time with them talking to key employees, customers and suppliers before you take over; tell them about your plans and ideas for the business’s future. Getting these key players involved and on your side makes the takeover a lot easier. Most sellers will help you in a transition period during which they train you in operating the business and perform introductions to Clients and Suppliers. Make sure you and the seller agree on structure of this training and write it into your contract.
You’re on your own. If you buy the business lock, stock and barrel, simply putting your name on the door and running it as before, your transition is likely to be fairly smooth. On the other hand, if you pay little respect to the existing Goodwill, rely only on other business assets, such as its client list or employees, then make a lot of changes in how things are done, you’ll probably face a more difficult transition period.
Many new business owners have unrealistically high expectations that they can immediately make a business more profitable. Of course, you need a positive attitude to run a successful business, but if your attitude is “I’m better than the Vendor ever was” you’ll soon face resentment from the Clients and employees you’ve acquired.
Instead, look at the employees as valuable assets. Initially, they’ll know far more about the business and the clients than you will; use that knowledge to get yourself up to speed, and treat them with respect and appreciation. Employees inevitably will feel worried about job security when a new owner takes over. That uncertainty is multiplied if you don’t tell them what your plans are. Many new bosses are so eager to start running the show, they slash staff, change prices or make other radical changes without giving employees any warning. Involve the staff in your planning, and keep communication open so they know what is happening at all times. Taking on an existing business isn’t always easy, but with a little patience, honesty and hard work, you’ll soon be running things like a pro.