How to Buy an Existing Business: A Complete Guide

Every year, hundreds of thousands of small businesses change hands. Why? For the same reasons that many people purchase an already-built home instead of building one from scratch — because building a home or business takes a lot of time and work and has lots of potential for problems.

We don’t mean for you to take this building analogy too far. After all, you can start most small businesses without drawing on your carpentry skills. However, as with buying an existing home, you may find that the advantages of buying an existing business outweigh the advantages of building one yourself.

As if the issue of saving time and energy in the building process isn’t enough, another reason for buying a business is that, historically, the failure rate is twice as high for starting a business as compared to buying one. 

So why doesn’t everyone buy a business rather than start one? Because not that many good businesses make it to the auction block. Many of the good ones never hit the market; instead, they’re passed on within the family or are sold in private transactions without ever being listed for sale.

Find out everything you need to know before buying a business of your own to avoid buyer’s remorse. We offer a step-by-step guide on how to buy an existing business. Lastly, we’ll discuss the pros and cons of buying a business when you’re still thinking about it, and how to buy a business when you’re ready to sign the papers and get the keys.

Buying an existing business checklist

If you’re set on the idea of buying a business, then you must make sure you pick the right one. Buying a business that you want to improve and take to the next level is the easiest way to set yourself up for success. Passion is not enough – you must also know which questions to ask when buying a business if you want to make the best decision.

The following is your buying an existing business checklist:

1. Figure out what type of business you want to buy

Focus on your skills, interests, and passions. You will be happier if you buy a small business that combines your interests and your experience.

Perhaps you’ve worked as a line cook at a restaurant for several years and have decided you’d like to own your own restaurant. Maybe you worked for a company on the market for a long time. Who better to buy the business than you who are intimately familiar with it?

While you might be drawn to a business based solely on its financials – its expected return on investment – you should also align yourself with the business’s immaterial goals. Your new ideas will be more innovative and successful if you are familiar with the model, products, customers, industry, and trends of the business.

2. Search for businesses that are for sale

There are a variety of ways to find the right business for sale that fits your criteria. Some of them are:

  • There are many online business marketplaces, including bizbuysell.com, which has more than 45,000 active listings.
  • Ads on Craigslist.
  • Ads in the “Businesses for Sale” section of classified newspapers.
  • Asking people in your network who own small businesses.
  • Attending meetups or industry conferences to ask other business professionals.
  • Consulting a business broker.

Business brokers are legal representatives of the seller, so you should be careful about telling them certain information (like how far you’re willing to negotiate). However, a broker can help you determine what kind of business you want, help you screen businesses to cut out all the failed ones, keep the negotiations civil and smart, and assist you in the necessary paperwork. It’s true that brokers earn commissions when a sale goes through, but the seller usually pays them.

3. Understand why an existing business is up for sale

As part of your due diligence on a potentially attractive business, you must try to find out why the owner is selling. Small business owners may be selling for reasons that shouldn’t matter to you (e.g., because they’ve reached an age and financial status where they simply want to retire), or they may be selling for reasons that you should think twice about (e.g., because running the business is an endless headache, because it’s not very profitable, or because competition is changing the competitive landscape).

Just because an owner wants to sell for a negative reason doesn’t necessarily mean you shouldn’t buy the business. If the business has low profitability, it’s not necessarily a clunker; it’s entirely possible that the current owner hasn’t taken the right steps (e.g., cost management, effective marketing, etc.) to increase profitability. They may well be able to overcome hurdles that the current owner cannot. 

However, before you make an offer to buy and then implement it, it’s essential that you investigate many aspects of the business, including, most importantly, the reasons why the current owner wants out.

Be on the lookout for:

  • A poorly conceived business plan (the product or service simply has no market).
  • Far-ahead competitors.
  • Existing debts of the business.
  • Problems with the location.
  • Brand issues.
  • Inventory difficulties (cost of production too high, poor quality loses business customers, storage difficulty, no balance between supply and demand, etc.).
  • Outdated equipment (too expensive to upgrade).

In your discussions with and investigations about the current owner, also reflect upon these final, critical questions: How important is the current owner to the success of the business? What will happen when he or she is no longer around? Will the business under new management lose key employees, key customers, and so on?

4. Choose a business that fits your budget, goals, and resources

You might have been considering several businesses until now, but now it’s time to pick the best one. We recommend you choose a business that aligns with your budget, goals, and resources.

You should determine the ideal size, location, sales, staff, and so on of your prospective business when you’re shopping for one, since it gives you a scale to keep in mind while you’re looking. Assess how much it will cost you to change a business in the ideal world.

You’ll be spending more than money. Consider the time and energy you’ll need to invest to make the business your own. It is not uncommon for managers to be in the weeds with their employees all the time, while others prefer delegating their responsibilities and, one day, owning multiple businesses.

You’ll need to invest resources in part based on the people and processes already in place and the industry experience you have. You will need to learn the ropes or hire people with the necessary experience if you’re purchasing a tech company but lack technical expertise.

5. Do your due diligence

After spending months searching for the right business to buy and finding one that fits your fancy, you may well spend weeks negotiating an acceptable deal. Just as you’re about to stumble across what you think is the finish line, you realize you have plenty more work left to go.

After all, now is the time to get out the microscope and really nitpick. Before you go through with the deal and fork over the dough, you have one last chance to discover any hidden problems that exist within the business you hope to buy. Of course, all businesses have their warts, but better for you to uncover them now so that the purchase price and terms reflect those warts.

The process of thoroughly investigating your prospective business is called due diligence. During due diligence, you need to answer important questions like these:

  • Is the business as profitable as the financial statements indicate?
  • Will the business’s customers remain after a change in ownership?
  • What lease, debt, or other obligations will you be assuming when you buy the business?

Due diligence typically lasts for 30 to 60 days, depending on the complexity of the company you’re hoping to purchase.

The same experts you’re working with to put together a good deal for your small-business purchase will form your due-diligence team. 

We recommend that you take some additional due-diligence steps before making an offer. We go over these steps in the following sections.

Think about income statement issues

The profitability of the business is probably the single most important aspect you need to consider during due diligence. To help you deal with income statement concerns, we suggest that you take the following steps:

  • Have an experienced small-business tax advisor review the company’s financial statements. She’ll know what to look out for. Just be sure to agree on a budget for the cost of the advisor’s services (and, therefore, the time she will spend) upfront.
  • Adjust for one-time events. If necessary, factor out one-time impactful events from the profit analysis. For example, if the business got an unusually large order last year that is unlikely to be repeated, subtract the amount of that order from the profitability analysis.
  • Check the owner’s compensation. Examine the owner’s salary to see whether it’s too high or low for the industry the business is in. Owners can pump up the profitability of their company in the years before they sell by reducing or keeping their salary to a minimum or by paying family members in the business less than fair-market salaries.
  • Consider how the building expense will change. Consider whether the rent or mortgage expense will be different after you buy the business. Any large change in that cost will clearly affect the profitability of the business.
  • Factor in financing expenses. Be sure to calculate what will happen to profits when you factor in the financing costs from borrowing money to buy the business.
  • Pay attention to trends. How are the sales and the profits trending? If this year’s profits were, say, $80,000 and last year’s were $100,000, the trend is unfavorable. On the other hand, if this year’s profits were $70,000 and last year’s were $50,000, you’re looking at a good trend. Knowledgable buyers are generally willing to pay a higher multiple for favorable trends.

Consider legal and tax concerns

Before you make a deal, follow these steps to research any legal or tax issues the business may have:

  • Look for liens. Check to make sure that no liens are filed against assets of the business and, if you’re buying real estate, that the property title is clear. A competent attorney can help with this tedious and important legal task.
  • Get proof that all taxes are paid. Get the seller to provide proof, certifying that federal and state employment, sales, and use taxes are all paid up.

6. Evaluate the price of the business 

There are several factors that determine the value of a business, and many buyers and sellers place different values on the same company. This is where many deals fail.

In order to frame negotiations, buyers and sellers usually use some sort of pricing model. A professional business valuation can be very helpful in determining the value of the business during this process. You can find valuation services online or through word-of-mouth for about $3,000 to $5,000, but they can help you save thousands more if they provide a good estimate.

A basic understanding of business valuation methods is helpful regardless of whether you do it yourself or hire someone. 

There are three main approaches to valuing an existing company when considering how much to pay for a business acquisition:

Earnings approach

The best use is to buy existing businesses that are already profitable or forecast to be profitable in the near future.

Based on its historical, current, and projected profits, the earnings approach values a company. The capitalized earnings method and discounted cash flow method are examples of methods you may come across that fall under this approach.

Businesses with a history of relatively stable profits may be able to project future earnings and value the business based on that history. Earnings models can be used to determine how much a business may earn in the future even if it hasn’t yet generated a profit. The earnings approach has the disadvantage of relying on an inaccurate prediction of future earnings.

Assets approach

Capital-intensive businesses, such as manufacturing and transportation companies, and businesses that are not yet profitable are best suited to this method.

This approach measures the value of a business’s tangible and intangible assets, minus its debts and liabilities. A tangible asset is something like equipment or real estate, and an intangible asset is something like a patent, trademark or software. The assets approach focuses on the current fair-market value of a business’s assets as well as its future return on investment.

Market approach

This approach is best used to account for local factors or to confirm a price that you arrived at based on one of the other two approaches.

Based on how much comparable businesses have sold for, the market approach measures the value of a business. Using this approach can provide a ballpark estimate of a company’s value and account for local factors that other approaches might overlook, such as a company’s location in a particular neighborhood.

All of these approaches may seem confusing, but the purpose of them is to assess the current financial health and growth potential of a company. However, none of these approaches exists in isolation, according to Bilby. A reasonable business price can be determined by any of these methods. However, the final price is always determined by agreement between the buyer and the seller.

7. Obtain capital to make the purchase

The next step in buying a business is to get the money after you and the seller have agreed on a price. You can raise capital in a few ways for buying a business – some are specific to buying an existing business, while others are pretty standard.

The following are some ways to finance a small business acquisition:

Savings, investments, and salable assets

This is always the first place to look. Theoretically, all you’re doing here is transferring your assets from one investment (your savings account) to another (your new business). Okay, so you’re increasing your risk by a quantum leap, but you’re also increasing your opportunity for reward.

The family and friends network

Be sure to make your relationship loans as official as possible; always create a promissory note complete with a fixed interest rate (at least 1 percent over prime to avoid IRS scrutiny) and include cast-in-stone payback terms. Consult a lawyer when larger loans (in excess of $10,000) are required.

Home equity

Proceed with extreme care when borrowing against home equity. A misstep can cost you the roof over your family’s head. Remember that home prices can go down and you may find yourself in a situation where you’re unable to refinance and are stuck with a larger, riskier mortgage. Don’t even consider this option until you’ve thoroughly reviewed your overall personal financial situation

Asset-based financing

The situation whereby a lender accepts the assets of a company as collateral in exchange for a loan. Most asset-based loans are collateralized against either accounts receivable (money owed by customers for products or services sold but not yet paid for), inventory, or equipment. 

Accounts receivable are the favorite of the three because they can be converted into cash more quickly (theoretically within 30 days, if you’re offering these terms). Banks advance funds only on a percentage of receivables or inventory, the typical percentages being 75 percent of receivables and 50 percent, or less, of inventory.

SBA loan

An SBA loan is a loan made by a local lender (bank or nonbank) that is, in turn, guaranteed by the SBA. The SBA provides its backup guarantee as an inducement for banks to make loans that otherwise may be too risky from a banker’s perspective. Only in rare cases does the SBA actually provide the money itself.

SBA loans usually provide longer repayment terms and lower down-payment requirements than conventional bank loans. They’re available to most for-profit small businesses that don’t exceed the SBA’s parameters on size (which can vary depending on the industry). SBA loans can be used for a number of reasons, including (in rare cases) start-up monies if, as with all SBA loans, you have sufficient collateral in long-term, tangible assets, such as real estate, machinery, and equipment.

Getting an SBA loan isn’t a sure thing; on the contrary, the agency is extremely selective about whom it approves. Consider the primary criteria the SBA looks for when considering guaranteeing a loan:

  • The owner must have invested at least 30 percent of the required capital and be willing to guarantee the balance of the loan.
  • The owner must be active in the management of the business.
  • All principals must have a clean credit history.
  • The business must project adequate cash flow to pay off the loan, and the debt/net-worth ratio must fall within the SBA’s approved guidelines.

Learn more about how to get a business loan.

Sharing ownership with partners or minority shareholders

Partners make sense when they can bring needed capital, along with complementary management skills, to the business. Unfortunately, partners also present the opportunity for turmoil, and especially in the early stages of a business’s growth, turmoil takes time, burns energy, and costs money — all of which most small-business founders lack.

If you’re one of those rare individuals who is fortunate enough to have found the right partner, go for it; work out a deal. We’ve seen this proven many times over: A partnership in the right hands can outperform a sole proprietorship in the right hands.

Having minority shareholders (any and all shareholders who collectively own less than 50 percent) can also make sense, especially after the business is out of the blocks and has accumulated value. The most common methods of putting stock in the hands of employees include stock-option plans, bonuses, and Employee Stock Ownership Plans (ESOPs).

8. Close the deal with the appropriate documents

Closing the deal is the final item on our checklist for buying a business.

You’ll need all of these documents, notes, and agreements in place before you officially buy a business after you’ve found the right business, done your due diligence, agreed on a fair price, and gathered the cash you need:

Bill of sale

If you are purchasing an existing business, this document will prove the sale of the business and officially transfer ownership of the assets from the seller to you.

Adjusted purchase price

Including all prorated expenses — like rent, utilities, and inventory — this is the final cost of your purchase.

Vehicle documentation

Are there any vehicles included with the business you’re buying? To transfer ownership, you might have to contact your local DMV – make sure you have the correct forms filled out before the sale.

Patents, trademarks and copyrights

The transfer of patents, trademarks, and copyrights may also require certain forms when buying an existing business.

Lease

Make sure your future landlord is aware of your plans to take over the business’s lease. Similarly, make certain that everyone understands the lease terms if you are negotiating a new one.

Franchise paperwork

If you need to file franchise documents, consult the SBA’s Consumer Guide to Buying a Franchise.

Consultation/employment agreement

Assuming that the seller will stay on as an employee, this document should be drafted. If so, it should be filed.

Asset acquisition statement

The IRS Form 8594 will detail the assets you have acquired, as well as how much they are worth. If you are purchasing an existing business, this document plays a major role in your tax returns, so don’t forget about it.

Non-compete agreement

Asking for a non-compete from the former owner is standard practice – and generally a good idea. In this way, the previous owner won’t open up a competing shop nearby.

Bulk sale laws

The purpose of bulk sale laws is to prevent business owners from evading creditors by selling off business inventory in bulk. Prior to closing, prospective buyers usually have to notify the local tax authority or financial authority.

That’s all you need to know about buying a small business. Knowing how something should be done is one thing, but knowing why it needs to be done is quite another. Let’s take a look at some of the main reasons to purchase a business.

Reasons to buy a business

Being in the market for a business is like shopping for a house. While some people love the history and character of an older home, others prefer a turnkey home without the baggage of an older home. When you purchase an existing business, there are many advantages, but there are also drawbacks.

Pros of buying a business

To reduce start-up hassles and headaches

Running a business is always a juggling act, but you often have more balls in the air during those start-up years than at any other time in the life of the business. Beyond formulating a business plan, you have to develop a marketing plan, find customers, hire employees, locate space, and possibly incorporate. Although you still need a game plan when buying an existing business, many of these start-up tasks have already been done.

Consider the learning curve for the type of business you’re thinking of purchasing. Buying an existing business makes sense if the business is complicated. For example, purchasing a business that manufactures an intricate product makes more sense than purchasing a house-painting business, which doesn’t require much more than the necessary tools and equipment and painting know-how. 

Also, unless you have already built the product the company manufactures and you understand the intricacies of the production process, starting such a complicated business from scratch is quite risky and perhaps even foolhardy.

To lessen your risk

In situations where a business has an operating history and offers a product or service with a demonstrated market, you remove some of the risk when you buy an existing company (compared with starting from scratch). 

Although no investment is a sure thing, the risk involved in an already-established business should be significantly lower than the risk involved in a start-up. Because an existing business has an operating history, you can use past financial statements to help you make more accurate financial forecasts than you can with a start-up venture that has no history.

To increase profits by adding value

Some business owners who decide to sell their company don’t see the potential for growth or don’t want to grow their business. They may be burned out, content with their current earnings, lacking in needed business-management skills, or simply ready to retire. 

Finding a business that has the potential to improve operating efficiency and expand into new markets is difficult but not impossible — if you have the time and patience to wait for the right one to come along. In fact, finding small companies that are undervalued relative to the potential they have to offer is probably easier to do than finding undervalued stocks or real estate when investing in those markets.

To establish cash flow

One of the biggest unknowns involved in starting a business from scratch is estimating the new business’s cash flow, otherwise known for sale or acquisition purposes as EBITDA. Will the business generate cash quickly, or will it take a long time? How long will collecting monies due from customers (receivables) take? How long will selling inventory take? How much will you have to invest in fixed assets? How quickly will your sales be established?

With start-up businesses, estimating these figures is fraught with the potential for wide margins of error. Fortunately, that’s not the case when you buy an existing business. The track record of the previous owners has already answered most of these questions. Assuming that you don’t walk in and make immediate, glaring changes to the business’s products or operations, the cash flow pattern should continue somewhat as it has done in the past. 

Take it from us: As a small-business owner, you’ll feel reassured by having a reasonably predictable cash flow. You and your family, your banker, and other investors will deeply appreciate it. Conversely, unpredictable cash flow is troublesome at best and will keep you from sleeping at night. (Just remember that your cash flow needs may be higher than the current owner’s because you may have to repay the loan you used to buy the business.)

To capitalize on someone else’s good idea

We’ve said it before: You don’t need an original idea to go into business for yourself. Plenty of successful small-business people enjoy running a business; whether they sell tires or trim trees doesn’t matter.

If you know you want to own a business but you lack an idea for a product or service to sell, chalk up another good reason to buy an existing business. Just make sure that you have some passion and expertise for the industry you’re thinking about joining.

To open locked doors

In certain businesses, you can enter geographic territories only as a result of buying an existing business. For example, suppose that you want to own a Lexus dealership within an hour of where you currently live. If Lexus isn’t granting any more new dealerships, your only ticket into the automobile industry may be to buy an existing Lexus dealership in your area.

To inherit an established customer base

If you’re not good at selling (maybe because you dislike it), buying a business may be the best way for you to enter the world of business ownership. After all, buying an existing business gives you a ready-built stable of customers, which means you don’t have to recruit them yourself. Then, if you can provide quality products or services and meet customers’ needs, you can see your business grow through word-of-mouth referrals.

Cons of buying a business

Higher upfront purchasing costs

Why do a lot of people start a business instead of buying one? Because they simply don’t have enough cash — or credit potential — to buy one. Existing businesses have value over and above the value of their hard assets, which is why you generally need more upfront money and credit to buy a business than to start one. 

Although you may feel like you’re more the business-buying type than the business-starting type, if you don’t have the necessary dough, and if you can’t find investors or lenders to provide it, then your avenue to business ownership may be decided for you, regardless of the avenue you’d prefer.

When purchasing a business, as in purchasing real estate, you generally must make a significant down payment on the negotiated purchase price. In most cases, you need to put down at least 25 to 30 percent of the total purchase price. 

Bankers and business sellers who make loans to business buyers normally require down payments to protect their loans. They’ve learned from past experience that small-business buyers who make small down payments are more likely to walk away from a loan obligation if the business gets into financial trouble.

Unfamiliarity with the details

You need to have the necessary business experience and background if you want to buy a business. If you were an economics or business major in college and you took accounting and other quantitatively oriented courses, you’re off to a good start.

If you’ve worked on business-management issues within a variety of industries (as consultants who work as generalists do), you also may have the proper background. However, one danger in having done only consulting is that you’re usually not on the front lines where you confront most of the serious day-to-day operational issues. We’ve seen plenty of sophisticated consultants who didn’t have the foggiest idea how to meet payroll or decipher an accounts receivable aging report.

If neither of these backgrounds applies to you, you won’t necessarily fail if you decide to buy a business, but the odds against you increase. If you don’t have a business background and work experience, you may still succeed. However, you’ll probably simply survive (and just surviving probably isn’t what you’re after). Plus, your prospects for outright failure are relatively high, as compared to your experienced competitors.

Risk of a hidden problem

If you think buying a company is easy, think again. Before you sign on the dotted line, you should know exactly what you’re buying, so you need to do a comprehensive inspection (also known as due diligence) of the company you’re buying.

For example, you (or a competent financial/tax person) need to analyze the existing business’s financial statements to ascertain whether the company really is as profitable as it appears and to determine its current financial health.

However, no matter how much information you uncover, you always run the risk of assuming responsibility for something you don’t understand or that turns out to be more serious than you anticipated. It is possible, for instance, that the equipment is damaged or that the brand is not reputable. As soon as you buy a business, you also buy its issues.

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