Steps to Buy a Small Business:
- When you’ve found the business you want to buy, assess the business environment that it will be operating in. Understand what makes the business successful so that you can replicate that success.
- Perform due diligence with an accountant, lawyer, and other consultants. Review all financial records and documents. Consider liability factors. Review the operation of the business, including the facilities and customer lists. Undertake a competitive analysis of key employees’ salaries and benefits. Work with your consultants to make sure your due diligence is thorough.
- Get a business valuation. A range of valuations makes sure you’re paying a fair price for the business. From here you can negotiate a selling price with the seller.
- Find financing – look for forms of financing that don’t make you risk your house as collateral and keep debt low as to not tie up your operating funds in loan repayments.
Buying an existing small business to buy can be a great way to get into small business ownership. If the business already has a proven track record of success, you can build on that success. If the business needs some updating or expansion, you can develop it further and put it on a solid footing. Buying a small business that’s already operating can eliminate a lot of challenges that plague start-ups. Or worse, even lead to their failure – like struggling to ensure product viability or growing a customer base from scratch.
Business advisors call existing companies “turnkey” businesses, because the products, services, and physical plant are already in place. All that’s required is to open the business under new management and to continue the same level of quality and service. Franchises, where everything from building specifications to product manufacture can be determined by the franchisor, are examples of turnkey businesses.
But settling on the business you want to buy is just the first step.
Understand Why the Business Is Successful – And Be Ready to Replicate
Once you’ve determined the business you want to buy, assess the business environment it will be operating in. Understand the factors that made the existing business or franchise successful so that you can replicate them. As part of your assessment, you also want to be able to predict any potential bumps in the road – and plan to avoid them.
For example, viable businesses need a strong customer base and a product that people want to buy. But you need to think through all the possible factors that can affect a customer base, demand, and other aspects of your business. What is your competition like? Do you have any reason to think that competition could be growing or shrinking in the future? Competition could be growing if new, similar businesses are coming into your region. Competition could be shrinking if you live in an area where physical, brick-and-mortar establishments are closing up.
Learn more about small business ownership with our Complete Guide to Becoming a Small Business Owner.
Analyze the competitive picture. Have plans to deal with both the current environment and challenges on the horizon.
Complete the Due Diligence Process
Next, it’s time to perform due diligence. “Due diligence” is a thorough examination of an individual business or franchise. It’s often performed in conjunction with an accountant, lawyers, and other consultants. Due diligence is a crucial part of buying a business. It often provides the grounds to establish the valuation and the purchase price. Because of this, a due diligence process needs to take place before any formal purchase agreements are signed.
What happens in due diligence? First, a review of all financial records and documents should be undertaken. You and your advisors should analyze balance sheets and income statements for at least the past three years. Verify profitability, cash flow statements, and all other financial data. Look at the projected financial statements and ensure that they’re reasonable. Verify the owner income regarding business profits. Check that taxes have been filed regularly.
Review any factor that might result in liability for your new company like contracts or other ongoing agreements. Is the business in compliance with zoning and other regulations? Check if the business has any liens on assets. Verify that there are no current or potential lawsuits and any recent litigation.
Second, review the operation itself. Explore the facilities and any property. They need to conform to the specifications and condition, as reported in the sales documents. If you’re purchasing a franchise, you need to conform to the franchisor’s requirements. Will you need to upgrade or expand? That needs to be factored into the sales price. Spend time at the business location, talking to managers and employees. Check sales against customer lists to verify that the business does indeed have the customers it says it does.
Third, review the marketing and competitive documents, such as business plans. The business’s mission statement and short- and long-term goals need to be assessed. Has a review of company strengths, weaknesses, opportunities, and weaknesses (SWOT) been done? A SWOT can be invaluable as a blueprint for your business going forward.
Finally, will you be keeping key employees? Do a competitive analysis of their salaries and benefits.
Establish a Valuation for the Company
It’s extremely important to value the business accurately and appropriately so that you are paying a reasonable price for the business. An inaccurate valuation can mean that you pay more than the business is worth. It can also mean that other aspects of the business based on valuations, such as insurance coverage, will be inaccurate.
Business owners should ask for a range of valuations. Why? Because valuations determined by assessing multiple factors will provide a more accurate picture of what a business is worth.
For example, three widely accepted approaches to valuing a business are Income, Asset, and Market. They each take a different approach to determining valuation. An Asset approach, for instance, uses the company’s balance sheet to calculate the value of assets and then subtracts the value of the liabilities. A Market approach, on the other hand, provides a valuation by comparing similar businesses.
Arrive at the Purchase Price
Once the valuation is completed, you’ll be able to arrive at the purchase price. Be prepared to negotiate with the seller given the results of the due diligence process and the valuation.
If you are purchasing a franchise, be sure to factor in franchise costs into the purchase price. Most franchisors provide a detailed breakdown of requirements and associated costs.
Explore Funding Options
Once you’ve valued the company or franchise appropriately, you’ll likely need to find financing. Finding funding to purchase a small business can be challenging, frankly. That’s one of the reasons that one-third of current and aspiring business owners surveyed in 2019 Small Business Trends named lack of capital and cash flow as their biggest concern. While loans may seem the obvious route, you also need to ensure that ongoing loan payments don’t strap your company of needed ongoing cash flow.
Forms of Small Business Financing
- ROBS (Rollovers for Business Start-ups)
ROBS (also known as 401k Business Financing) is a method of using your eligible retirement funds, such as 401(k)s or traditional IRAs, to purchase a business. ROBS lets you leverage your existing funds, which eliminates the potential drawbacks of a loan – such as starting a business with debt that will tie up some of your business’s cash flow in loan payments.
- SBA Loan
Business owners can apply for bank loans of up to $5 million guaranteed by the U.S. Small Business Administration (SBA). The SBA guarantees from 75 percent to 85 percent of the loan in the event of a default. SBA loans offer attractive interest rates and other terms. SBA loans are flexible and can be used for ongoing capital needs as well as real estate or expansion.
- ROBS as a Loan Down Payment
Approval for both traditional small business loans and SBA loans can be difficult to get. Only about 25% of SBA loan applicants are approved, for example. A bank’s financial requirements for a traditional small business loan can be difficult to meet, as requiring a 20% to 30% cash down payment is fairly common. Using the ROBS method to access the money for a down payment can make approval more likely and reduce the amount of debt that needs to be paid off.
- Unsecured Loan
An unsecured loan can offer up to $150,000 of financing can be offered without the collateral requirements required for conventional business loans. Often, banks considering traditional small business loans want to see a high percentage of collateral, in assets or property. But an unsecured loan focuses on the business owner’s creditworthiness rather than collateral. A minimum credit score of 690 is required, along with a credit utilization score of under 50 percent and minimal credit inquiries.
- Portfolio Loan
If you have a portfolio of stocks, bonds, mutual funds, or other eligible securities, you can borrow against as much as 80% of the portfolio’s value. The advantages are that you don’t have to sell your portfolio; portfolio loans operate something like a revolving line of credit, in which you pay back what you’ve accessed at a low-interest rate.
Valuing a business and obtaining funding can be challenging parts of buying an existing small business. Guidant Financial is here to help with both. Our business valuation solutions provide the valuations you need to understand the value of a business and a dedicated valuation specialist to guide you through the process. Our financing experts are also here to you understand the forms of funding available to you – funding that lets you purchase a business that is cash-rich and debt-free or that maximizes cash flow and keeps debt low.