
Buying an existing business can be a fantastic way to become an entrepreneur without starting from scratch. However, it requires careful planning, evaluation, and execution. Here are some essential tips and strategies to guide you through the process.
1. Evaluate Financial, Market, and Operational Strength
Financial Evaluation:
- Review Financial Statements: Analyze the balance sheets, income statements, and cash flow statements of the business for at least the past three years.
- Profitability: Determine the business’s profitability trends. Look for consistent profits or a solid growth trend.
- Debt and Liabilities: Assess any outstanding debts and liabilities. Understand the debt structure and payment schedules.
- Cash Flow: Evaluate the cash flow of the business to ensure it can cover operating expenses and potential new debt from the purchase.
Market Evaluation:
- Market Position: Understand how the business is positioned within its market. Is it a market leader, or does it struggle to compete?
- Customer Base: Analyze the customer base for diversity and loyalty. A concentrated customer base can be risky. Better to have a wide variety of customers to reduce risk.
- Market Trends: Research industry trends to ensure the business has growth potential in a stable or expanding market. Watch out for fads.
Operational Evaluation:
- Business Model: Understand the business model and how it generates revenue. Ensure it aligns with your skills and interests.
- Operational Processes: Review the operational processes and identify any inefficiencies or areas for improvement. Is is a business that has not been modernized? If not, that can often present a great opportunity for a buyer.
- Employees and Management: Assess the skills and stability of the current employees and management team. Employee turnover can be a red flag.
2. Perform Due Diligence on Legal and Tax Documents
Legal Due Diligence:
- Contracts and Agreements: Examine all contracts and agreements, including leases, vendor agreements, and customer contracts.
- Intellectual Property: Verify ownership of patents, trademarks, copyrights, and any other intellectual property.
- Litigation: Check for any ongoing or past litigation involving the business.
Tax Due Diligence:
- Tax Returns: Review tax returns for at least the last three years to identify any potential issues.
- Tax Liabilities: Assess any outstanding tax liabilities or disputes with tax authorities.
- Tax Compliance: Ensure the business is compliant with all relevant tax laws and regulations, including, but not related to income, payroll and sales taxes.
3. How to Finance the Purchase
Self-Financing:
- Savings: Use personal savings to finance the purchase. This option can reduce debt but may limit available capital for other uses.
- Retirement Funds: Consider using retirement funds, such as a 401(k) or IRA, though this can come with risks and tax implications. I am not a huge fan of using retirement funds to finance a business due to risk but I have seen many clients use retirement funds successfully.
Debt Financing:
- Bank Loans: Apply for a traditional bank loan. Ensure you have a strong business plan and financial projections. Look for smaller community banks and credit unions. I advise business buyers to stay away from the larger banks because in my experience those banks just don’t provide the same personal service on approvals.
- SBA Loans: Consider loans backed by the Small Business Administration (SBA), which often offer favorable terms. Remember though you’ll probably need to provide a second mortgage on your home when using the SBA.
- Seller Financing: Negotiate seller financing, where the seller provides a loan to the buyer. This can be a flexible and advantageous option, often with better terms than traditional bank loans. Seller financing can also show the seller’s confidence in the continued success of the business.
Equity Financing:
- Investors: Seek out investors who are willing to provide capital in exchange for equity in the business.
- Venture Capital: For businesses with high growth potential, venture capital can be an option.
4. Work with Professionals
Business Brokers:
- Finding Opportunities: Brokers can help you find businesses that are for sale and match your criteria.
- Negotiation: They can assist in negotiating the terms of the sale, although I think it’s better to engage your lawyer for those negotations.
Lawyers:
- Legal Review: A business lawyer will review all legal documents and contracts to ensure your interests are protected. The business lawyer can also help with negotiations. Make sure you use a business lawyer. Don’t hire a friend who practices personal injury, divorce, criminal law, etc. Get a business law specialist to work with you.
- Compliance: They ensure the transaction complies with all relevant laws and regulations.
Accountants:
- Financial Review: An accountant will analyze the financial health of the business.
- Tax Implications: They can advise on the tax implications of the purchase.
Bankers:
- Financing Options: Bankers can provide information on financing options and help secure loans.
- Financial Advice: They can offer financial advice tailored to your situation.
5. Finalize the Purchase Agreement
Purchase Agreement:
- Terms and Conditions: Clearly outline the terms and conditions of the sale.
- Assets Included: Specify which assets are included in the sale (inventory, equipment, intellectual property, etc.).
- Price and Payment Terms: Detail the purchase price and payment terms.
- Warranties and Representations: Include any warranties or representations made by the seller.
- Non-Compete Clause: Consider including a non-compete clause to prevent the seller from starting a competing business. Make sure the non-compete is for at least a five (5) year period and covers a territory sufficient to protect your business.
Closing the Deal:
- Due Diligence Completion: Ensure all due diligence is complete and satisfactory.
- Financing Secured: Confirm that financing is secured and ready for disbursement.
- Legal Documents Signed: Sign the purchase agreement and all necessary legal documents to finalize the transaction.
Buying an existing business is a significant investment and requires thorough preparation and professional guidance. By carefully evaluating the financial, market, and operational aspects, performing due diligence, securing financing, and working with experienced professionals, you can make a well-informed decision and increase your chances of success.