Buying A Business

Buying An Existing Business

Determining The Value Of The Business You Wish To Buy

Buying an existing business can be compared to buying a used car.  Think about it.  Businesses for sale are like used cars—there are plenty of good ones out there, but there are plenty of bad ones too.  Although there are lemons out there, if you have the know-how to buy a business, buying an existing business can be a great opportunity to get into the business arena without having to go through the long and time consuming process of starting from scratch. 

If you buy a turnkey operation (a concept that is complete and ready to go), you can skip the start-up phase completely and begin operations as soon as the sale is complete. If you are considering buying a turnkey operation, this will assure that everything is all set up and ready to go from the start.  Keep in mind that buying an already established business and making it even more successful will only happen if you take the time to fully investigate the business that you’re thinking of buying. 

It is incredibly important that you do your homework when considering buying a business.  Exercising due diligence in this type of transaction is key.  Relevant areas of concern in the due diligence process can include the financial, legal, labor, tax, information technology (or IT), environment, and market or commercial situation of the business.  It may also concern intellectual property, real and personal property, insurance and liability coverage, debt review, employee benefits, labor matters, and immigration.  Using the language we’d use when thinking about buying a used car, let’s take a look at the major steps you need to follow when buying an existing business:

1.) Find out if it’s ever been in an accident.

            In other words, before you buy a business, find out why it’s for sale.  Don’t just take the seller’s word for it, either.  Sure, people do retire, or become ill, but the real reason that it’s being sold may be anything from a large, national retailer moving into town, to the business location being rezoned.  Make sure you discover the true reason or reasons that the business is for sale by talking to people who are familiar with the history of the business you’re thinking of buying, such as local realtors, other business owners in the area, and suppliers.

2.) Find out exactly what’s included in the asking price.

            Find out exactly what is for sale!  Also ask what method of business valuation is being used.  If you buy this business, what assets are you actually getting?  Many people selling businesses have a spec sheet prepared that will list the assets involved and estimate their value.  Make sure that you ask for details if you find anything unclear.  Also make sure to find out if these assets are free and clear of debts and liens; you want to make sure that you are not buying someone else’s problems. A good business lawyer can review the contract to see what is missing that should be there.

3.) Look under the hood.

            Have you ever heard that old joke about the guy who bought the pristine sports car, only to find out that he couldn’t drive it away because it had no engine?  It’s only funny when it happens to someone else.  Before you buy a business, look at the business’s past performance.  Ask for and review the business’s last three years of financial statements.  If you don’t feel comfortable analyzing financial statements yourself, have a professional, such as an accountant, review them.  You will also want to find out who prepared the financial statements for the current business owner—were they prepared by the management of the business, for example, or by an accountant?  If they were prepared by an accountant, the financial statements should be accompanied by documents that will explain how deep the accountant’s review was.  For example, an Auditor’s Report will assure you that a full review of the business has been conducted.  A Review Engagement Report will present the findings of a limited review of the business.  A Notice to Reader will be given when the accountant has only considered information given by the business owner, and will state that the accountant did not conduct any further checks of the business.  Are you seeing things that you don’t like?  Or just not seeing enough information?  You have the option to ask the seller for permission to see the actual business records to have your own audit done.

4.) Find out what it’s actually worth.

            Do some research, and find out what you should be paying for the business.  When you’re buying a used car, this is a simple matter of comparison shopping, but business valuation is much more in depth.  It is common in business valuation to use several different methods of valuation to arrive at a price.  When the seller prepared their spec sheet of assets, they could have used any of the following:  Book Value (based on the company’s balance sheet), Modified Book Value (based on the current market value of the assets), Replacement Value (based on what it would cost to replace an asset), or Liquidation Value (based on what the asset would sell for if the business was liquidated).  Before you buy a business, you will want to know how the seller arrived at his estimate of the valuation for the business.  Remember, it is more than okay to ask questions.  Just because the seller claims that the business is worth a certain amount doesn’t mean it is. A good accountant and an Arizona Business Attorney can help you   The real value of a business depends on the income the business generates.  Taking a look at the business’s financial records should have given you a picture of the business’s revenues, costs, and profits.  You want to buy a business based on the return on your investment, so remember that what you are buying is actually the potential profit of the business.

5.) Get in, buckle up, and take it for a test drive.

            Before you buy a business, get an inside perspective by asking for the seller’s permission to sit in on the business for several days.  If the seller is agreeable, this can be a great way to find out how the business operates.  This can give you great insight into the way the business is doing, and can be a very helpful step in making your final decision to become a business owner.

6.) Look into different financing alternatives.

            Just the same as when you are buying a car, you need to see if you can truly afford the business you want to buy.  If you don’t have the cash in your pocket, this is the point in time to see who is interested in financing the business you are buying, and how much that financing will cost you.  The usual small business financing sources are friends, family, and traditional lending institutions, such as banks and credit unions.  You may find that the banks and credit unions are friendlier than usual, as financing an existing business is generally less risky than financing a start-up.  You may also want to consider asking the seller to finance part of your purchase of his business.  One common arrangement is for the seller to carry a promissory note for part of the business’s purchase price.

7.) Make an offer.

            Assuming that this process is still on track, and you still want to buy the business, it’s time to make your offer and start negotiations.  You make an offer, and the seller will, in turn, make a counter-offer.  The two of you will go through this process, hoping that eventually you will meet on middle ground.  Don’t be surprised if you are asked to accompany your offer with a non-refundable deposit; sellers are typically only interested in dealing with a serious buyer.  There are rules to be followed here as well.  Always be prepared to walk away, and don’t get so emotionally caught up in the process that you pay more than the price you were prepared to pay.

8.) Get a purchase/sale agreement drawn up.

            Once you and the seller have reached an agreement on terms, the details need to be specified in a contract.  Because of the complexities of this type of contract, it should be drawn up by an experienced business law attorney.  Do your research, and find an attorney that will draw up a contract that best fits your needs.

Buy a business the same way you’d buy a car:  CAREFULLY.