How to Buy a Business
There are a host of legal, financial, and other decisions involved in buying a business. From the initial letter of intent all the way to the close, here’s what you need to consider before deciding whether the new venture is the right business for you.
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Businesses in the United States are constantly changing. From industry ebbs and flows to ownership and management, it’s nearly unheard of for a business to stay exactly the same for decades. Technology forces evolution, acquisitions create bigger corporations, and, in some cases, businesses simply fold.
To get an idea of just how volatile the business world can be, consider that since 1985, more than 325,000 mergers and acquisitions have been announced in the United States alone — with a total value of nearly $35 billion. In 2017, a record number of 15,100 deals occurred; although those numbers are expected to drop slightly in the future, it shows that for many businesses, change is the only constant.
With so much flux in business, some entrepreneurs and potential new owners have a decision to make. Should they purchase an existing business?
On this page:
- Why Should You Consider Buying an Existing Business?
- How to Evaluate a Business Acquisition
- Negotiating an Acquisition Deal
- Understanding Legal and Miscellaneous Requirements and To-Dos
- How to Finance a New Business Acquisition
- How to Make Sure It’s All Worth It
Why Should You Consider Buying an Existing Business?
There are several reasons you might consider buying a business that’s already in operation.
Extend Your Brand’s Reach
Purchasing an existing business can help you expand your own. If you only have one location, for instance, purchasing other businesses for sale can extend your brand’s awareness and can lead to better revenue. Consumers like convenience; if they can buy your product or service while having to travel less time to get it, that’s a win-win for you.
Reach Out into a New Industry
Even if you don’t need or want to run multiple locations of the same business, buying another business can still be a good option if you want to get into a new or related industry.
Whether you want to branch out slowly into an industry that complements your existing type of business and can tap into your current customer base or you want to do something completely different, purchasing a profitable existing business can help you do that.
Remove Competition Early
If you run a fantastic Italian restaurant but hear about a pizza place going up a bit too close for comfort, you might want to look at buying out the current owner right away before they get established. It allows you to hang on to your market share while expanding your offerings.
Acquire Competitor Ideas
It’s generally considered bad form — and in many cases, it’s illegal — to simply steal your competitors’ ideas. If you purchase their business, however, those ideas can become yours, free to use in your own way.
The Time is Right
Even if you aren’t looking to expand or get into anything new, sometimes it’s just a good time to make the leap. Perhaps you heard about a business with a great location and potential that’s up for sale. Perhaps you’re sitting on a large cash surplus and are looking for a new investment, and the potential value of the business is enough to pique your interest.
Whatever the situation, it might just be the right time to make a move.
How to Evaluate a Business Acquisition
Acquiring an existing business isn’t as simple as making an offer and exchanging some cash. There are quite a few steps you’ll need to take throughout the process.
Long before you decide to acquire a business, there is a large amount of information you’ll need to understand about what you’re buying so you can decide if the price of the business is worth it. Most information about business assets can be gleaned via balance sheets and other financial statements.
A few questions you’ll need to ask while evaluating the financial health of the business are:
- How much annual revenue does the business bring in?
- What’s their cash flow analysis?
- What assets does the business own, and how much are they worth?
- What about earned multiples, such as price/earnings ratio?
Understanding these answers will give you an idea of the business’ existing metrics and track record and whether you’d be buying the business at a fair price. Reviewing the business’ recent tax returns can also help.
Consider Assumed Responsibilities
The bottom line numbers are just the beginning. You’ll also need to know about the existing business model, overhead, employment agreements, and other operational details that go into the day-to-day aspects of running a business.
Is It Worth Your Time?
If you’re already a business owner, you remember well the massive time and sweat equity involved in getting your business off the ground and into profitable territory. Although taking over an existing business can be easier, it’s not painless. Before you take on the new venture, you’ll need to decide if you have the time and willingness to put in the work.
During the evaluation process, don’t be afraid to consult a professional about your business plan if you need to. There are acquisition consultants all over the country who can advise you.
Negotiating an Acquisition Deal
As you move through the business purchase, over a period of time you’re going to arrive at the negotiation stage, during which you and the business’ current owner start talking terms before drawing up a sales agreement. Here are a few tips to consider:
- Address the cost of acquisition early. What are they asking for the business, and what will that price cost you in terms of financing if you need it?
- Consider implementing holdbacks. This is when you literally hold back a portion of the purchase price at closing to ensure the seller meets a certain condition, such as having a specific working capital threshold.
- Verify business ownership. You could find out the person running the business has another partner, or it’s owned by a family rather than one person.
- Outline future liability and risk. Buying the business isn’t the goal; making or keeping it profitable is.
- Discuss current employees and benefits. Make sure you understand what the current owner offers their employees.
- Consider the assets of the business and overall terms of the deal — not just the price. The price might be great, but you’ll want to ensure that all of the other terms of the deal are also to your liking.
- Keep contingent concessions but use them sparingly. If the current owner simply won’t budge on a point, have something up your sleeve they may want more.
- Consider termination provisions. Even after you’ve signed the papers, you may learn information that causes you to want to get out of the whole deal. Make sure your non-negotiables are spelled out in the deal upfront.
Understanding Legal and Miscellaneous Requirements and To-Dos
When you purchase an existing business, it’s more than just understanding financials and terms. There are a host of legal considerations as well, and they aren’t the kind of thing you’ll want to forget about.
Licensing and Permits
If the business you’re purchasing needs licenses or permits to operate, you’ll need to get those in your own name. They often come with additional fees and waiting periods, so you’ll want to be on top of those early to make sure the ownership transition is seamless.
State and Local Laws and Ordinances
Your town or city can shut you down if you run afoul of any ordinances or local laws, so make sure you are up-to-speed on what they are and how they affect your business.
Depending on the industry you’re getting into, you may have environmental laws to comply with, especially if your business deals with hazardous or industrial materials.
If you’re involved in more than one acquisition at a time or have other existing contracts, you’ll need to find out how your new venture will affect them.
Letter of Intent
Before you engage in any acquisition, you’ll need to write a letter of intent that announces your plan to explore an acquisition. You want to be able to sit down on good terms with the seller to work out the details, and this is the first step in doing that.
How to Finance a New Business Acquisition
There are all kinds of ways you could fund your new venture.
You might have a surplus or can borrow from friends or family. Buying a business outright with cash is the cheapest way to do it; in some cases, a seller will drop their price if they know they’re getting all of the money upfront.
Small Business Loan
Small business loans are available from both your bank and the federal Small Business Administration (SBA), which guarantees term loans for small business owners. You can get a low-interest loan to help afford your business and pay it back over time. If you have some cash available, you might consider making a down payment and financing the rest.
Some sellers may be willing to let you finance your purchase with them directly. Instead of getting a loan from a bank, you simply make payments to the seller themselves. This is a slightly less desirable option because you’ll probably pay more over time if you go this route.
Small Business Grants
The federal government, as well as many third-party organizations, offer grants to small business owners who want to expand or get into a new industry. You’ll need to research what each small business grant requires to see if you qualify before applying.
In a leveraged buyout, you’ll use your own debt to finance the transaction by combining it with equity. The business’ cash flow is the collateral used, and these types of transactions are usually done by a business broker.
Assumption of Debt
With this type of acquisition, you’ll take over the debts the seller incurred with his business. This is done either in lieu of payment or in return for a significantly reduced price. For this type of deal, you’ll need to work with the seller’s creditors and make sure they’re willing to get on board.
How to Make Sure It’s All Worth It
Business acquisitions aren’t easy, and they aren’t simple. In fact, they’re a lot of work — and that work doesn’t end once you own the new business. Once you’ve done your due diligence and decided to take the plunge, you’ll want to keep that success going. By continuing to invest your time and money into the new venture, you may see it pay off in a big way.
Author: Jeanette Perez