Buying a Small Business: Everything You Need to Know

Buying a Small Business: Everything You Need to Know

Buying a Small Business: Everything You Need to Know

Do you dream of owning your own business? There’s more than one way to make this dream come true. Some entrepreneurs launch a business from scratch, while others buy an existing business.

There are certainly advantages to buying a business that’s already established…but is it the right move for you? Let’s find out.

Pros and Cons of Buying an Established Business

If the idea of starting a new business isn’t your cup of tea, you might consider becoming the new owner of an existing business. Let’s look at the benefits and drawbacks of doing so.

Pros

An established business has already done the hard work of getting set up, establishing customers, and generating revenue, so you have less work to get up and running. Contrast this to launching a startup, which will require a lot of capital up front, as well as a lot of strategy and planning to be a success.

Another benefit is that you can have a clear understanding of what sort of revenues you can expect. Smart business buyers ask existing owners to see their accounting. Looking at the business’ financial statements, such as cash flow statements and profit and loss statements can help you see how financially healthy the business is.

Cons

On the other hand, you may not be able to find the type of business you’re interested in for sale, or at a price you can afford. 

You may also inherit liabilities like debt from the current owner, which can add to the cost of buying a business. And you may not be aware of any issues with staff, suppliers, or location until you take over ownership and see for yourself.

Consider why this person is selling the business. Is it because it’s flailing and they want to get out before the ship sinks? You don’t want to be the one to go down with the ship!

What to Consider Before Buying a Business

If you are considering buying a business, here are some things to consider.

What’s the Real Story?

As I said, it’s important to consider why small business owners sell their businesses. If they’re planning to retire, that’s one thing. But if they’ve racked up debt and can’t afford to run the business, that then becomes your problem.

Do your due diligence to find out as much as you can about the business. Don’t just look at the balance sheet; also talk to employees to see how they like the company and how it’s run. Examine equipment to see what kind of shape it’s in.

What Will it Cost?

The purchase price is just one expense you’ll have in buying an existing business. If equipment is outdated, you may soon need to replace it. And consider that some employees might leave when you take ownership, so you may need to invest in hiring new ones.

Also, consider other fees or licenses you may need to transfer or get under your name as a new license. Review the requirements for business licensing in your state so you know those costs ahead of time and can ensure you have the cash flow to cover all these expenses.

Is There Any Debt?

If the business has outstanding loans or other liabilities, what are they, and will you be responsible for paying them off? You may be able to negotiate this as part of the sales agreement so that you’re not saddled with another business’ debt, which may start you off on the wrong foot when it comes to building business credit.

What Work Needs to be Done?

You may be able to step into this business as a turnkey operation and do nothing more than put your name on your office door…or you might have major renovations, hiring, training, or purchases to make. Consider your new ownership as an opportunity to make design improvements if the location you’re buying is run down or in need of a coat of paint. A few cosmetic tweaks can communicate to customers that there’s a new owner in town eager to serve them well.

Do You Need Help?

You certainly can buy a new business on your own, but it may be helpful to hire a business broker. Business brokers know how to find the kind of business you’re looking for, and they can help you with due diligence and the negotiation process.

How to Buy an Existing Business

Now let’s look at the steps for how to buy a business.

Step 1: Do Your Due Diligence

It’s your responsibility to dive deep into learning as much as you can about this business as you can. That means carefully analyzing financial records (or having a CPA do it, if you aren’t clear what they tell you about the business’ financial health), looking at all assets, including intellectual property, and being aware of all liabilities.

Also check the business’ credit history, because you’ll be inheriting it. If the owner didn’t pay bills on time, that will be reflected in the business’ credit scores and may impact your ability to secure financing down the road.

Step 2: Review the Business Plan

You’ll want to know as much as possible about business operations, so if the company has a business plan, ask to see it. This can give you insight into the previous owner’s vision for the company, and you can see how well it is aligned with where the business is now.

Step 3: Conduct a Business Valuation

The owner will have given you the sale price, but now it’s up to you to do a business valuation to see how accurate that price is with the market value of the business. A business valuation should include both tangible and intangible assets, including real estate, monthly retainers and accounts receivable, and debts.

A business broker or accountant can help you with these calculations. Ultimately, you’re trying to determine whether, at the asking price, you would be able to see a solid return on investment within a few years.

Step 4: Give Your Letter of Intent

This is a letter that, as you’d guess, states your intent to purchase the business, though you can opt not to if you decide it’s not the right business for you later. Some business owners won’t give you tax returns and other financial information until you give them your letter of intent.

Step 5: Get Your Financing Together

We’ll cover this more in depth in the next section, but before you can buy a business, you need to ensure you have enough to cover not only the sale price but also those other costs you’ve calculated. If you don’t have cash on hand, you may need to take out a small business loan.

Step 6: Sign on the Dotted Line

Now comes the reward! You’ll sign the required legal documents to seal the deal. Once both parties have signed, the business is yours!

Financing Options for Buying a Business

If you don’t have the working capital you need to cover the value of the business and other startup costs, consider these options for financing.

Term Loan

Banks and online lenders are willing to finance a business acquisition if you qualify. You’ll generally need good to excellent credit to get the low interest rates that banks offer. Consider these lenders as an option for term loans:

SBA Loan

Another option for small business loans is a loan backed by the Small Business Administration. These loans also offer low rates for those who qualify. Here’s a lender to consider:

Seller Financing

Some sellers, particularly those who are motivated to sell, may be willing to finance the deal themselves. If you don’t qualify for a low-interest loan, this may be a good option. You may be asked to provide a down payment based on the asking price and then make monthly payments for a predetermined period of time.

Find the Business That’s Right for You

Finding the right business that fits your needs and fulfills your dream will take time, but if you do your due diligence, you have the potential to build on top of a well-established business with your own unique flair.

This article was originally written on March 17, 2022 and updated on March 21, 2022.

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