Buying a business

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How to Buy a Small Business

If you know what to look for and how to buy a small business, buying an existing operation can be a great opportunity to step into the company without having to start from scratch. If you buy a turnkey operation, you can skip the startup phase entirely and begin operations as soon as the sale is complete; everything is already set up and ready to go.

Unfortunately, businesses for sale are like used cars; there are lots of them out there, but some of them are lemons. To avoid getting stuck with a bad bargain, you need to fully investigate the business you’re thinking of buying. Here’s how you can tell if that small business for sale is a good deal or a clunker.

Find out If It Has Been in an Accident

In other words, before you buy a business, discover the real reason the small business is for sale. Don’t just take the seller’s word for this. Sure, people do retire or become ill, but the real reason may be anything from a big-box retailer moving into town and taking away customers to losing a lucrative, traffic-driving contract, such as being a postal outlet.

Discover the true reason(s) 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 people, the local chamber of commerce, and suppliers.

If the business resides in a mall, talk to other business owners in the mall about mall management, lease rates, anchor tenants, etc. A departing anchor tenant can mean a huge drop in business traffic for the mall or management may be in the process of renewing leases at a higher rate.

Step 3. Do Your Due Diligence

OK, you’ve thought about what kind of small business you should buy and how much you can afford. Then you’ve identified an existing business that you want to own.

Well, buying a business is a little like dating someone for a long time before putting a ring on their finger. You’ve got to take the time to get to know them and uncover and resolve any, err, issues before you put a ring on that finger.

As we said earlier, you need to do your research. Due diligence is a fancy word for research. There’s a lot of research that goes into evaluating an established business for sale. Don’t let it put you off though, it’s actually a good thing!

“Approximately half of all deals fall apart during the formal due diligence stage, and one of the most common reasons this happens is due to the buyer uncovering an issue which the seller did not disclose earlier.”

What to look for when buying a business

Financial history

We previously mentioned that 65% of small business owners have never had their financials audited. That means they have been running the business books according to their own rules. If the business has a bookkeeper or accountant, have them take you through the financials.

To be sure that you get an honest view of the business performance, you’ll need to see several years of financial records including cash flow statements (most important), balance sheets, accounts payable and receivables, and debt.

Look for patterns in the financials such as increasing debt or increasing receivables that might signal trouble. Are sales and net income growing or declining? Likewise, look for opportunities to better manage the financials once you take over to increase the value of your investment.

Stakeholders

Those with a stake in the business include employees, a customer base, suppliers, landlords, financiers, etc. Look at employee files including contracts, benefits, and compensation. Talk to employees to learn more about the business and identify issues. Talk to suppliers and assess if they are reliable.

Most importantly, look at the customer base of the small business. This will be your bread and butter, what pays your bills. Is the customer base growing or declining? What are customers saying on social media? What kind of reviews do they give?

Legal

Make sure to investigate if the business has had any lawsuits. In addition, for any major contracts, you might want to have a lawyer review them to make sure they are sound. For example, if the business has a lease that forbids someone else from taking it over without the landlord’s permission, you won’t want to sign a sale agreement until you have that permission in writing and with terms you can accept.

Required seller disclosures

Speaking of sellers not disclosing information, there are Federal laws that mandate certain disclosures by sellers. It’s a good idea to familiarize yourself with these. This video by the Federal Trade Commission explains the requirements of the “Business Opportunity Rule” which mandates business sellers to provide a one-page disclosure document with specific information to buyers, for example, to support any earnings claims about the business.

Other important information to investigate

The more you dig, the more questions you ask, the more parts of the business you research, the more educated you’ll be about the next two steps, and about running a business in general. So here are some other factors to nail down in your due diligence:

Feeling like you might need a checklist at this point? SCORE, a national organization that provides free mentoring to small business owners, has a downloadable checklist for what to investigate when buying a business. You can download it here.

Tip: If at any point in your due diligence the seller cannot provide you with definitive information and answers or does not want to do so, that’s a good sign that you should move on in your business search. Remember there’s a 50% chance that the seller is not disclosing something you should know!

Step 4: Determine a Value for the Business

After you’ve taken sometime poking around under the hood of the business, you’ll have a much better idea of what’s there and what it might be worth. You should also have a better idea of what you’re willing to pay. You’re going to use this information to decide on your offer price.

How to evaluate a business to buy

Determining a fair value or price at which to buy a small business is, like budgets, a bit of art and science. It’s important to understand how to value a business because chances are the owner may not have done any official valuation of the business, although they most certainly will have a sale price in mind.

For an in-depth guide to evaluating a business, we recommend you read our comprehensive guide here. In this guide, we outline the potential challenges of valuing a small business, and describe several different valuation methods, weighing the pros and cons of each. We also provide an example to use as a reference.

Asset-based method – This is what it sounds like. The value is determined by adding up the value of all company assets. Asset value minus liabilities equals company value.
Revenue Method – This method of valuation simply relies on taking the top-line revenue or gross sales and applying a multiplier to determine the maximum value of a small business. The multiplier can be less than one, or up to 2x typically. It will depend on the industry, economic environment, and business performance.
Discounted Cash Flow (DCF) – DCF is one of the most heavily used methods to value a business. This method takes the business’s projected future cash flow and the time value of money to determine the current value. The concept of DCG is best expressed by Aswath Damodaran, author of the book The Little Book of Valuation:

Income Stream Valuation – This method of valuation differs from DCF in that it looks at cash flows over a specific period of time (rather than projecting them out into the future). Alternatively, it uses other income streams such as net profit, earnings before taxes, operating profit, or earnings from a specific period only. These are then discounted at a rate reflecting the business risk.
Range of Values – This method combines each of the previous methodologies and tries to derive an agreed-upon valuation through triangulation. With this method, the business owner or buyer can add other factors that affect business value. For example, if an owner knows that a small business has been lacking, he/she can indicate in the final value that with better management, the company could be making more and hence increase the value.

Authorship:

https://www.thebalancesmb.com/how-to-buy-a-business-2947037
https://www.upflip.com/learn/how-to-buy-a-business
https://www.nerdwallet.com/article/small-business/buying-an-existing-business