How to Buy a Business: 7 Business Acquisition Tips You Need to Know
Take these steps to acquire a business.
- November 6, 2019
- Starting Your Business
- 15 min read
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You don’t have to start with a completely clean slate to be an entrepreneur. Buying an existing business, in fact, has some notable advantages over starting a business from scratch. When you buy an existing business you’re taking over an operation that’s already generating cash flow, so it can be inherently less risky than starting a brand-new business. When buying an existing company, you often get an established customer base and reputation, as well as employees who are experienced in the business and industry. But there’s still a lot to know before you decide to purchase a business.
One of the drawbacks of buying a business is that it tends to be more expensive than starting from scratch. On the other hand, it is very often easier to get financing to buy an existing business than for a new one. When you think about it, this makes sense because bankers, investors and lenders are more comfortable working with a company that has a proven track record, not to mention plenty of financial documents and history for them to assess.
Financing the purchase of a business, however, is only one step in the overall process. Find out how to buy a business with this business acquisition checklist. Here are seven steps you must take when buying a business:
Right from the get-go, when you decide you want to buy a business, you’ll hit a fork in the road. You’ll have to choose between buying a franchise or an existing business.
Recognizing the difference between franchising and buying a business is an important first step in figuring out what type of business you want to take on. According to the Small Business Administration (SBA), a franchise is a business model in which the franchisor — the business owner — sells the rights to their business name, logo and model to the franchisee — an independent entrepreneur. This business structure is very common in restaurants and fast food, hotels, car rental and many other service-oriented industries; think of places like McDonald’s, Hertz, Subway and T-Mobile stores.
Whereas a franchise gives you more guidance and less control, buying an existing business gives you more control and less guidance. Choosing between these two models is a matter of your budget, lifestyle and understanding of each type of business structure.
Another less tangible factor to consider when you want to buy a business is if the business’s products, services and goals align with your interests. Buying into a business you have little knowledge of is unwise, but so is buying into one whose values you don’t agree with or whose methods are questionable. Make sure that the business you want to buy aligns with your interests beyond just the financial.
If you’re interested in buying an existing business, then the next step is to search for businesses for sale.
Related: The Best States to Start a Business
You can find businesses for sale in a number of ways. A good place to start searching is online such as through online business marketplaces like BizBuySell.com, or simply through sites like Craigslist. Newspaper classified ads also can be a source, as well as asking friends and acquaintances in your network.
Business brokers are another key way to find businesses for sale. Business brokers are professionals who are actively involved in helping clients buy and sell businesses. In California, for example, you can find both business brokers and businesses for sale on the California Association of Business Brokers website. Another useful website is BusinessBroker.net, where you can search for businesses for sale, franchises for sale and business brokers based on your city and state.
Also, keep an eye out on businesses you admire or are within your area of interest or personal network. Just because a business isn’t listed for sale doesn’t mean they won’t accept a great offer. It might be a more costly and challenging process, but it’s one that might lead you to a better match.s
Once you’ve found a few businesses that you’re interested in, the next step is to understand “the why.” Why is this business up for sale? The reason could be as innocuous as the current owner wanting to retire. But the reason could also be more ominous, such as fundamental problems with the business model or poor equipment. Knowing why a business is for sale could discourage you from buying it altogether.
Here are some of the most common reasons why business owners sell their businesses:
- Company isn’t making enough money
- Business owner is retiring
- Business owner is relocating
- Business owner is burnt out
- Business owner is dealing with health problems
- Business owner is pursuing other opportunities
- Company has reached a high point for the business owner
- Business owner is having issues with partner
- Business owner has died
- Business owner is looking for a change
For you as a prospective buyer of the business, you should be on the lookout for various issues they may be hiding or evading. This includes fundamental issues, such as a poorly conceptualized business plan or no market for the product or service. Issues could be more specific, such as problems with the location, brand, inventory, equipment and business debt.
Examine the businesses you’re interested in for red flags. You can use these issues — along with criteria like your budget, resources and lifestyle — to narrow down your choice of businesses to the one you really want to buy. Plus, any issues you spot can be used as points of negotiation to lower the acquisition price.
When you’ve zeroed in on the one existing business you want to buy, it’s time to conduct thorough due diligence.
Doing your due diligence when you want to buy a business is more than just background research on the company. It’s a full dive into specific financial and legal aspects of the business, a step that is best taken with the help of an attorney and an accountant. Doing your due diligence means investigating everything from business financials to customer lists and even to furniture.
Here are some of the key items you will review while doing due diligence for buying an existing business:
The first step is to make sure you get any business licenses and permits from the current owner. If you don’t receive the business license from the current owner, then you must apply for them yourself. Permits are important too, especially in highly regulated industries like restaurants and childcare, in which you need a valid permit to operate.
Organizational documents are not essential if the business you want to buy is a sole proprietorship or partnership. On the other hand, when buying a business that is an LLC or corporation, which are registered business entities, you must have organizational paperwork on file with the state. In the case of an LLC, these documents are the articles of organization, while for a corporation, they are the articles of incorporation.
Another common document is a certificate of good standing for the existing business. Generally, you can get a certificate of good standing from the office of the secretary of state in your state in which the business you’re interested in buying is located. In a few states, it is an agency other than the secretary of state, so research your state’s specific requirements to find the correct office.
A certificate of good standing essentially states the following about the existing business you wish to buy:
- The company is properly registered with the state
- All state registration fees and required document filings are up to date
- The company is legally permitted to conduct business in the state
Keep in mind, however, that a certificate of good standing is not like a business license, which you’re required to have by the state in order to operate legally. You can legally conduct business without acquiring a certificate of good standing. This is due in part because not all types of business entities need to be registered with the state, and thus not all types can get a certificate of good standing. Sole proprietorships, for example, do not need to be registered in any state. LLCs and corporations, on the other hand, must be registered and usually have certificates of good standing.
Find out more about the different types of business structures and their various implications for taxes and organization.
Whenever you buy, build, rent or plan to operate your business from a physical property, you need to understand local zoning law. Be sure to check with your area’s local zoning regulations. You don’t want to buy a business that is violating any restrictions.
Zoning regulations depend on local laws, while environmental regulations come from both the state and federal level, according to the Environmental Protection Agency. Make sure that the business you’re buying conforms to all federal regulations as well as state-based rules.
A letter of intent, or LOI, is issued by the seller and indicates that they are committed to moving forward with the business deal. The seller issues this when both sides have agreed on a price, as well as other aspects of the sale. The LOI should include details on the proposed sale price plus the terms and conditions of the business sale.
It’s important to get the most critical information in writing should something go sideways. Having a qualified attorney and accountant by your side can be expensive, but it can also save you from making an even costlier mistake.
Counterpoint: How to Sell a Business
When you buy a business, there are usually various attachments that come along with it. An obvious one is the building lease if the company operated out of an office or workplace. There could also be leases and contracts on equipment or with vendors employed by the business. Make sure key players like your landlord and vendors are aware of the change in who they’re dealing with regarding leases and contracts. They’ll need an up-to-date point of contact for all important matters.
You would absolutely not be doing your due diligence if you don’t review all of the existing business’s financial statements, including but not limited to:
- Tax returns
- Balance sheet
- Cash flow statement
- Sales records and accounts receivable
- Accounts payable
- Debt disclosures
- Advertising costs
- Payroll costs
Your accountant and attorney, who should both be a part of your buying team, should review all financial statements. The business you’re buying needs to pass an audit conducted by a CPA. Accepting financial statements solely from the sellers is not enough to pass muster.
Getting your hands on a business organizational chart is highly advisable if you buy a business with existing employees. You’ll want to see who they work with and answer to, their hierarchical rank, the department they work in and which other departments they work with. This is a good stage to also compile information on compensation, management practices, standard processes, benefit plans and insurance.
This will give you an idea of ongoing payroll costs and help you plan for the future including if you’ll need to hire more staff or maybe make layoffs.
Physical assets like inventory, equipment and even the furniture are important consideration when you buy a business. The value of these assets will factor into the overall cost of the business. In this step, you need to assess the quality and condition of these items, how sellable they are in terms of market value, whether they need any repair or maintenance. In addition to this, you need to assess the building you’ll be working in too, both for damages and necessary modifications.
If the business still looks promising after doing all your due diligence, you and your accountant should start examining the business’s potential returns and its asking price.
At this stage, in addition to your accountant, it can be good to employ an independent business valuations firm to help determine the value and health of the business. These firms can value the business, but also assess the value of the current owner’s influence and connections. For instance, when a business is built upon long-standing relationships between the firm’s owner and clients, a change in ownership could have a massive impact on the business in a negative way if the clients or partners leave.
The most important part of this step is the valuation of the existing business you want to buy. You’ll assess not only how the business makes money, but also its existing debts and liabilities. Here are some of the business valuation methods accountants and valuation firms can use to value a business, according to the SBA:
- Capitalized earnings method: Based on the return on investment an investor in the business expects
- Excess earning method: Very similar to the capitalized earnings method, but it separates the return on assets from other earnings
- Discounted cash flow method: Used often for measuring how much of a loan the business’s cash flow can sustain
- Tangible assets (balance sheet) method: Values the business based on tangible assets
- Value of specific intangible assets method: Values the business based on comparing buying a desire intangible asset versus creating that asset
Often the type of industry the business is in will dictate the best method for business valuation. For instance, when buying a capital-intensive business, such as manufacturing and transportation companies, the asset-based method might be the best approach to valuing a business.
After you have valued the business, and you and seller settle on a number, the next step in buying a business is to get money for the business purchase. There are several methods for raising the capital you need for buying an existing business.
Seller financing is when the business’s original owner offers you — the buyer — a loan to cover a portion of the price of the business. In this way, you can purchase the business in the form of staggered payments, with interest of course, but generally at a low rate. The critical step here, however, is that you make a down payment in cash once the deal closes. In seller financing, the seller of the business can use the business itself as collateral, which can be taken back if you default on your payments. Bear in mind seller financing usually doesn’t cover the whole cost of the business purchase, so it’s best used in combination with other methods.
Debt financing is merely the technical term for getting a loan from a bank or financial institution to buy a business. Banks can be very cautious when it comes to extending loans for starting a new business. However, when buying an existing business, the attitude of the banks is usually different. The advantage of buying an existing business is that they supply you with tons of financial documents that a bank or lender can review to give you a loan. And since the business is currently operating, an existing business has a longer history of finances that banks can work with.
Here are a few financing options that you can pursue when looking for a small business loan:
- Term Loan: With a traditional term loan, you’ll borrow a set amount upfront, then pay it back with interest over a predetermined amount of time. This is a pretty ideal format for buying an existing business since you pay back the lender over time as the business brings in money. Another benefit here is that banks are often more willing to lend money to buy an existing business because it has already established it can generate revenue.
- SBA Loan: An SBA loan is one of the best ways to get financing, usually offering the largest, lowest-cost and most affordable loans available. Unfortunately, they are also some of the hardest loans for which you can qualify. When buying an existing business, the 7(a) loan program is what you’re looking for.
- Asset-Based Financing: An innovative approach to financing is an asset-based loan. These types of loans work by borrowing capital against a certain asset, which acts as collateral in case you default on your payments. In the case of buying an existing business, you’re acquiring the whole company’s assets, which allows for plenty of options as collateral. Like seller financing, these types of loans usually aren’t intended to cover the whole cost of a business purchase. Some basic kinds of business assets you can use as collateral include equipment, inventory and unpaid invoices.
Related: What Is Alternative Lending?
If you manage to attract angel investors with venture capital, you’re also essentially partnering with someone else to purchase the business. In this case, they act as a financial investor while you act as the business operator.
Taking on a partner as an investor when buying a business isn’t only useful to cut costs. Bringing on a partner who’s more experienced in the industry or field of business than you is a huge gain. And if they bring venture capital with them, even better. That said, it will impact the level of control you have. With investors, even the CEO answers to someone.
In an employee stock ownership plan, also called ESOP, a company gives employees the opportunity to buy stock, and thus share ownership in the company. You can also finance the purchase of an existing company by selling company stock to the employees. This can often result in a discount on the price of the business price. In order to do this, you must organize or re-organize the business as an S corporation or C corporation.
After all the blood, sweat and tears, you’re finally at the point of closing the deal. Like with most steps in buying a business, there are some key documents and agreements you’ll need to complete the process.
The bill of sale is the document that certifies the actual sale of the business. It officially transfers ownership of the business and its assets from the seller to you.
The adjusted purchase price is the full total cost of buying the business, including all expenses such as rent, utilities and inventory. In general, buyers use purchase price adjustments to protect themselves against a decrease in the value of the existing company between valuation and closing.
When buying a business, there’s a good chance you’ll take over the business’s lease for the property they operate out of. Also, depending on the company, you could also inherit vehicles, too. In both cases, you need to make sure you’re on top of all the documents and key players, such as making sure the landlord knows you’re taking over the lease. With vehicles, you’ll like have to transfer ownership at the local DMV, with all the requisite paperwork filled out, of course. Plus, you’ll need to contact the insurance companies.
Patents, trademarks and copyrights are a critical aspect of a business acquisition that often require specific forms to get them officially transferred to you as the new business owner.
Besides being standard practice, getting a non-compete agreement from the former owner is also usually a good idea in general. The reasoning behind this is simple. You don’t want the previous owner to be able to establish a new, competing company next door.
This is an important item on the checklist because it involves tax forms. IRS Form 8594 is the asset acquisition statement. It will list the assets you are acquiring, and how much you’re paying for them. Stay on top of this step in the process of buying an existing business because it impacts your tax returns.
Related: Your Guide to Small Business Taxes
Bulk sale laws are involved with the sale of business inventory. Namely, bulk sale laws exist to prevent business owners from being able to elude creditors by transferring ownership of the business to the new owner. Potential business buyers should notify the local tax authority about the imminent sale.
If you’re thinking about buying a business, there are many critical factors to consider. The financials of the existing business and your method of financing the purchase might stand out the most, but each and every step in the process is important. Although every business venture carries risks, buying an existing business does come with some inherent advantages in this regard. The most decisive factor is whether your interests, budget and resources align with the business you’re looking to buy.
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