Buying an Existing Business: Tips and Strategies

Buying an existing business can be an attractive option for entrepreneurs who want to skip the initial stages of starting a new business or don't have a startup idea of their own. By purchasing an existing business, the entrepreneur can take over an established operation with a proven track record, existing customer base, and trained employees. Investing in a deal can also be smart for those looking to diversify their personal portfolios or seeking alternative asset classes, as IRRs and investment terms differ from most other investments.

However, buying an existing business is not without its risks. These are, at the end of the day, small businesses. Many are run by owners who lack extensive business experience or education, and benefit from their company flying under the radar, if you will. This is part of the beauty of small business. It is important to conduct thorough due diligence to ensure that the business is financially viable and has no legal or operational issues. The entrepreneur should also have a clear understanding of the industry and market trends to ensure that the business has growth potential. It's not always necesary to have direct experience in said industry or business model, but there should be a quick learning curve. It is also crucial to negotiate a fair price for the business based on generally accepted market terms.

Overall, buying an existing business can be a smart move for entrepreneurs and investors who are willing to do their research and take calculated risks. It can provide an alternative route to entrepreneurship and a way to enter the market with an existing competitive advantage. However, it is important to approach the process with a clear understanding of the  associated risks and rewards.

Evaluating Business Potential

When considering buying an existing business, it is crucial to evaluate the future potential of the business to ensure that it is a sound investment. There are many variables involved in choosing the right small business to acquire, but to keep it simple this section will cover three key areas to evaluate when assessing the potential of a business: financial health, market position, and operational strength. 

Assessing Financial Health

One of the first things to consider when evaluating a business is its financial health. This involves analyzing the financial statements of the business, including its balance sheet, income statement, and cash flow statement (if they exist). The balance sheet will provide information on the assets, liabilities, and equity of the business, while the income statement will show the revenue and expenses of the business. The cash flow statement will show the cash inflows and outflows of the business.

It is important to assess the financial health of the business to ensure that it is generating sufficient cash flow to cover its expenses, service debt, and pay off investors (and the entrepreneur). If the business is not generating enough cash flow, it may struggle to stay afloat and may require additional capital to keep it running.

When evaluating a business, it is highly recommended to engage a Quality of Earnings professional for assistance with financial due diligence once a letter of intent is signed. Check out The SMB Center's list of QofE providers in the Resources page.

Understanding Market Position

Another important factor to consider when evaluating a business is its market position. This involves analyzing the industry in which the business operates, as well as its competitors and customer base. In many cases, the company's main competitors will be local, or at least regional. It is important to understand the competitive landscape of the industry and the positioning of the business within that landscape before you acquire the business.

Evaluating the customer base of the business is also important to determine the potential for growth and expansion. If the business has a loyal customer base, it may be easier to retain those customers and attract new ones. However, be weary of customer concentration. a good rule of thumb is to avoid businesses where one customer represents 15% of revenue or more, or two customers representing 25% or more. Additionally, be sure to understand the relationship between the customers and the existing owner. The more disconnected and hands-off the owner, the better foundation for a new acquirer.

Evaluating Operational Strength

The operational strength of the business is also an important factor to consider when evaluating its potential. This involves analyzing the processes and procedures of the business to determine their efficiency and effectiveness. An ideal business operates with systems and processes instead of an overrealiance on people, especially the owner. If a company does not have these implemented currently, asses the opportunity to develop and implement them post-acquisition.

In addition, it is important to evaluate the management team and employees of the business to ensure that they have the necessary skills and experience to run the business successfully. Management, if any exist, will be an important factor in determining whether the business is successful or not post-acquisition.

Overall, evaluating the potential of a business involves assessing its financial health, market position, and operational strength. By conducting a thorough evaluation of these key areas, searchers can make informed decisions about whether to acquire an existing business.

Due Diligence Process

Before finalizing the purchase of an existing business, it is crucial to conduct a thorough due diligence process. This process will help the buyer ensure that they are making an informed decision and avoid any potential legal or financial issues that may arise after the purchase.

Reviewing Legal and Tax Documents

One of the most critical aspects of the due diligence process is reviewing the legal and tax documents of the business. This includes analyzing tax returns, contracts, permits, and licenses. The buyer should also examine any liabilities or debt that the business may have and ensure that all environmental regulations are being followed. Always engage an attorney to do legal due diligence - ideally one with mergers and acquisitions experience. .

Inspecting Assets and Inventory

Inspecting the assets and inventory of the business is also an essential part of the due diligence process for asset intensive businesses. The buyer should ensure that all assets are in good condition and that there are no outstanding liens or encumbrances on them. Additionally, the buyer should review the inventory to ensure that it is accurately recorded and valued.

In conclusion, the due diligence process is a critical step in buying an existing business. By reviewing legal and tax documents, analyzing current operations, and inspecting assets and inventory, the buyer can make an informed decision and avoid any potential legal or financial issues.

To be successful at this stage of the acquisition, a solid deal team is needed. A deal team generally consists of an attorney, quality of earnings specialist, lender, accountant, and more. Acquiring an existing business without a deal team significantly increases risk. 

Check out The SMB Center's Resources page for deal team recommendations.

Financing the Purchase

When buying an existing business, financing the purchase can be a major hurdle. There are various options available, each with its own advantages and disadvantages. In this section, we will explore the different financing options, including seller financing, bank loans, and investment.

Exploring Financing Options

Before making a decision on financing, it is important to explore all the available options. Consider reaching out to financial institutions, such as banks, to inquire about their loan programs. 

Understanding Seller Financing

Seller financing is a financing option in which the seller of the business provides a loan to the buyer. This can be an attractive option for buyers who may not qualify for traditional bank loans or who want to avoid the lengthy application process. In this case, the buyer makes payments to the seller over a set period of time, usually with interest.

In most cases, seller financing is couple with and subbirdinate to a bank loan. In fact, many acquirers will refuse to acquire a business without some portion of seller financing, as they seek an impactful way for the seller to still have "skin in the game."

Negotiating Terms with Financial Institutions

Overall, financing the purchase of an existing business requires careful consideration of all available options. By exploring financing options, understanding seller financing, and negotiating terms with financial institutions, buyers can increase their chances of securing the necessary funds to purchase their desired business.

The Role of Professionals

When buying an existing business, it is essential to work with professionals to ensure a smooth and successful transaction. The following are the key professionals that can help buyers in the process:

Working with Business Brokers

A business broker is a professional who specializes in buying and selling businesses. They help buyers find the right business to purchase and guide them through the process. Business brokers have expertise in valuing businesses, negotiating deals, and handling the paperwork. They also have access to a network of potential buyers and sellers, which can help buyers find the right business more quickly.

Working with a business broker can be beneficial for buyers as they can help them find businesses that are not listed on the open market. Business brokers also help buyers evaluate the business's financials, operations, and market position to ensure that the purchase is a sound investment. Business brokers typically charge a commission for their services, which is usually a percentage of the sale price.

Legal Considerations with an Attorney

An attorney is a professional who can provide legal advice and guidance throughout the buying process. They can help buyers navigate the legal aspects of the transaction, such as drafting and reviewing contracts, negotiating terms, and ensuring compliance with state and federal laws. Attorneys can also help buyers understand the potential legal risks and liabilities associated with the purchase.

Working with an attorney can help buyers avoid legal pitfalls and ensure that the transaction is legally sound. Attorneys typically charge an hourly rate or a flat fee for their services.

Accounting Advice for Financial Clarity

An accountant is a professional who can provide financial advice and guidance throughout the buying process. They can help buyers evaluate the business's financials, including its income, expenses, assets, and liabilities. Accountants can also help buyers understand the tax implications of the purchase and develop a financial plan for the business.

Working with an accountant can help buyers make informed financial decisions and ensure that the business is financially viable. Accountants typically charge an hourly rate for their services.

In conclusion, working with professionals such as business brokers, attorneys, and accountants can help buyers navigate the complexities of buying an existing business. These professionals can provide expertise, guidance, and advice to ensure that the transaction is successful and financially sound.

Closing the Deal

Once the buyer and seller have agreed on the terms of the sale, it's time to close the deal. This involves finalizing the sales agreement, setting up the ownership transition, and planning for future operations.

Finalizing the Purchase Agreement

The purchase agreement is a legally binding contract that outlines the terms of the sale. It typically includes details such as the purchase price, payment terms, and any contingencies. It's important to have a lawyer review the agreement to ensure that it's based in market terms and protects both parties' interests.

Setting Up Ownership Transition

After the sales agreement is signed, the buyer and seller need to set up the ownership transition. This involves transferring ownership of the business and its assets, as well as notifying employees, customers, and vendors of the change in ownership. The buyer may choose to retain existing employees or bring in new staff members, as needed. Clear communication and transparency are key during this process.

Planning for Future Operations

Once the ownership transition is complete, the buyer needs to plan for future operations. This includes developing a business plan, setting goals, and establishing a management structure. The buyer should also evaluate the existing operations and make any necessary changes to improve efficiency and profitability.

In summary, closing the deal involves finalizing the sales agreement, setting up the ownership transition, and planning for future operations. It's important to have a lawyer review the sales agreement, communicate clearly during the ownership transition, and develop a solid plan for future operations.