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By Odee Ingersol, Nebraska Business Development Center
This is part 3 of a three-part series on business transition. Check out Part 1: Transitioning a business to a family member and Part 2: Selling your business to a non-family member.
For many entrepreneurs, the dream of small business ownership centers on building something from the ground up. While that certainly is one route, it often comes with risk, uncertainty, and untold hours of hard work. The good news is that if small business ownership is something you feel pulled toward, the option to purchase an established business is also on the table.
Advantages of buying an established business
Buying an established business allows you to jump directly into the work of running the business, shortcutting many of the steps required to build the business. When you buy a business, you’re also acquiring an established customer base, existing operational processes and systems, branding, and word-of-mouth advertising. The business is likely already making money, so you have the potential for immediate cash flow.
The startup risks are drastically lower than for someone starting from scratch because you get to skip the riskiest period: the beginning. The business has already been built and is already functioning. Additionally, you have the advantage of studying the business’s performance history. You can look back at the data and view the successes and challenges, and since you’re likely less emotionally invested than the founder, you can objectively evaluate them.
Finding a business to purchase
The first step toward buying a business is deciding which type of business to purchase. If there is an industry you are familiar with or have a passion for, you should allow that to guide your search. Prior experience within the industry isn’t mandatory, but it will greatly increase your odds of success.
There are a few ways to go about finding a business to purchase. We recommend starting with your personal contacts. Do you know a business owner who might consider selling? Perhaps they’re nearing retirement age and have begun to entertain the idea of moving on from their business, but they haven’t formally begun the process of selling. You could also talk with accountants, attorneys, or lenders. They’ll check with their clients privately and may get back to you if there is interest. Your community’s Chamber of Commerce professionals also may know about possible sellers. If you’re unable to find a seller through your personal connections, you could consider looking at online listing sites like BizBuySell.com or broker sites.
Seek professional guidance
A transaction as large as a business purchase requires a team of professionals to ensure that everything is above board. First, you’ll want to find a business broker who can help you identify potential sales and guide you through the purchasing process. You’ll also need to get your lawyer and accountant involved. These three professionals will serve as your advisers as you move through the transaction process.
Negotiating the deal
After you’ve found the business you wish to purchase, you’ll work to negotiate a deal that is agreeable to you and the seller. Broker listings are often above fair market value. If the buyer has been planning to sell the business, they’ve likely already had a business valuation. Eighty percent of sellers over-value their businesses, so it's important that you also get a valuation.
Each business sale is unique to the buyer and seller, and there may be specific terms and conditions. A successful negotiation will include all of the things the business will require to be successful. This includes key employees and brands. It’s also smart to have a non-compete agreement in place.
Considerations to make before buying an established business
The best thing you can do to ensure your success is to thoroughly research the business you plan to buy. Look for a solid history of success and upward-trending revenue and profits. As tempting as a Cinderella story may be, it’s risky to buy a turn-around project if you don’t have a history of turning businesses around.
Keep in mind that you’re buying their historical performance, not your future performance. You’ll want to look for businesses with year-over-year upward trends of revenue and profits. If a business is showing downward annual trends, can you change them? Are those trends due to factors you can control? If not, you should proceed with caution. Don’t buy during a downward economic or industry cycle unless it’s a bargain.
Ask the seller about recently lost clients or accounts. Are these indicators of things to come? Check out the business’s website, social media accounts, and online comments. What does the facility look like? Is it in need of some curb appeal? It’s not uncommon for these areas of a business to become stagnant, which might mean putting some money toward a refresh.
Research the industry
It’s important to perform a thorough industry and market analysis. Have you examined the market trends and growth potential? Who are the business’s competitors? A solid overview of the industry will help you move forward with confidence.
Financial and legal due diligence
Before deciding to purchase a business, you’ll want to get a good grasp of its financial status. Pay close attention to annual profits, and keep in mind that you’ll need to account for salaries, benefits, principal, and interest. Reviewing financial statements and evaluating profitability and potential risks will paint a fairly clear picture of what kind of financial responsibility you may be taking on. If the business’s financial health isn’t optimal, do you have the resources to turn it around? Are you willing to take on the risk?
It’s also important to review any existing contracts and agreements the business has and consider whether you’re willing and able to uphold them, as they will become your responsibility as the new business owner. Be sure to have your lawyer look through all legal documents, contracts, and agreements to identify potential legal issues.
Assess day to day operations
Often, existing staff and management come with the purchase of a business. Before taking the plunge, it’s a good idea to talk with the staff and get a feel for workplace culture. As an outsider, you can look at business processes and staff objectively. Are the current processes working? Is the business staffed sufficiently?
An experienced staff can make a business transition nearly seamless, keeping operations steady and assuring loyal customers that the service they’ve become accustomed to won’t be interrupted. Long-time employees may have reservations about reporting to a new owner and there may be fears about their job security under new ownership. These are all things to be aware of as you’re interacting with the staff. Remember, great employees can make or break a business, so it’s important to have a strong team on your side.
Financing options to consider
At the lowest level, buyers must be able to contribute about 20% cash equity to the deal and finance about 80% if they’re working through the Small Business Administration, or 40% to 60% if they’re using a traditional bank loan. A successful buyer will have a FICO score of 650 or higher, no felonies or serious misdemeanors, and no bankruptcies. The same must be true for all partners or investors of 20% or more of the purchase.
These are some of the many factors to consider as you think about purchasing an established business. The Center for Rural Affairs is here to help small business owners in all aspects of their business, including succession planning. Additional resources are available through the Nebraska Business Development Center.
