If you’re thinking about buying an existing small business, it could be a fantastic decision – if you do it right. It’s still a tough economy out there. As a result, you may be able to buy an existing business much cheaper – and with much less risk – than setting up a small business from scratch. It’s also easier to get working capital and start-up capital for an existing business.
But you could also get caught holding a lemon. It’s going to ruin your entire day if you spend good money and end up with a company that has lousy staff, little cash flow and stale inventory. Don’t let that happen to you.
Here’s how to spot smart business ideas.
1. Remember what you’re trying to do.
By buying an existing business, you want to avoid the pitfalls of opening your own shop. Look for a business with a strong customer base, growing sales, good staff, established procedures and (most important) positive cash flow.
Neal’s Notes: If you are considering buying an existing business, compare that to buying a franchise. That might be a safer move.
2. Is it a fit?
You have experience and strengths. Buy a business that gives you a chance to leverage those skills. Make a list of what you bring to the table. Are you a good manager? Sales person? Organizer? Do you have specialized technical knowledge in a certain area? What do you enjoy doing? What do you dislike? Keep an open mind and list everything. Spend a good chunk of time thinking about the types of businesses you think would fit.
Go talk to three successful people you trust and respect – and who know you. Bounce your ideas off of them. For the price of a cup of coffee you’ll get invaluable insights. This is just one of many great ways to make sure your business concept is sound.
3. Announce it to the world.
Besides keeping an eye out in the paper and on Craigslist for “Businesses for Sale,” run your own ad. Network everywhere you go. Let people know what you are looking for.
4. Put your team together.
You’ll need an attorney, banker, accountant and possibly a business broker. (And remember, there are plenty of family business consulting services you can get for free.)
A broker could be a good idea. She’ll filter out lots of businesses that don’t make the grade. She’ll also help negotiate the price. But be careful. The broker only gets paid when you buy a business, so it’s in her interest to get you to sign on the bottom line. Choose carefully.
Whoever is on your team, they’ll help you check out the various options. This is called “due diligence.”
5. Ask questions.
Here is a partial list of questions you need answers for.
a. Why is this business for sale?
b. What is the outlook for the future? Why?
c. How has the business changed over time? Different products? Services? Clients?
d. How does the business obtain customers? What is the marketing plan?
e. How long have the employees been there? Are there any key employees who would be hard to replace? Why or why not?
Don’t even think about buying a business unless you talk to its customers and suppliers. Get them to tell you as much as possible about their experiences doing business with this firm. It’s also really important to check with the Better Business Bureau and to get a credit report on the owner individually and the business. These are musts.
6. Review financial statements.
This is the point when your CPA really earns his keep. Get the business owner to supply historical financial statements and projected future financial statements. Those are called “pro forma” statements. With these, your CPA and entire team can start thinking about the value of the company and what it’s worth.
7. Get down to the brass tacks.
Time to dig down and see what’s under the hood.
If the business sells products, you’re going to pay for everything that’s on the shelf and in the back room. That’s what inventory is. As long as you’re paying for it, you might as well make sure it’s all there. Don’t take the seller’s word for anything.
You and the owner will go and examine the inventory to make sure it’s all there and to make sure it’s in good condition and able to be sold. Just because the owner says it’s worth one thing doesn’t mean you have to go along. You can negotiate the value of it, and you’ll be better able to do so if you get professional help in evaluating what the inventory is worth.
Furniture and Fixtures
Make sure you don’t pay the owner what she paid for this. Remember, you’re getting used furnishings, so don’t pay new prices. That goes for equipment too.
Review the legal documents and contracts. That includes articles of incorporation, leases and tax returns for the last five years. Make sure your lawyer and CPA go over these with a fine-tooth comb. They will make sure that contracts are valid and the income projections are reasonable.
While you’re at it, make sure the owner gives you sales records for the last three years. They should be broken down by product or service. This will tell you which direction the business is heading in (hopefully it will be “up”).
Get a detailed list of all liabilities too. Has the owner borrowed money against any of the assets? Have they made use of cheap sources to fund the business? Are there any pending lawsuits? Are there any employee benefit claims to be settled in the foreseeable future? Your attorney and CPA can help establish this.
Are the accounts receivable good? How long have those receivables been on the books? The longer they are held, the less likely it will be that you’ll be able to collect. For example, if someone was supposed to pay the company in 30 days but hasn’t paid in 90 days, there is a problem. What is the quality of those receivables? The same thing goes with accounts payable. Make sure the business owner is able to pay her bills on time. If she pays her bills late, it might mean the business doesn’t have a healthy cash flow. Look at the price list. Has the owner been able to increase prices over time? Have prices fallen because of a dwindling demand? What gives?
You probably don’t need me to tell you this but location is critical. If you rely on retail sales, is the location one that will continue to attract traffic? Why? Let’s say you buy a donut shop next door to Starbucks. You depend on Starbucks to bring you the traffic. How long has Starbucks been there? How are they doing? How long is their lease? These are all things you need to know.
Are you trying to buy an existing business now? Have you bought a business in the past? What was the process like? What do you wish you had done differently?
Awesome read! Does this checklist apply to buying online businesses as well?
Neal Frankle, CFP ® says
Good question. I think it could be helpful for any business. What are your thoughts?
Checklist of some of the basic things to lookout for when buying a business! When buying a small business, do ensure that the business is not too reliant on the presence of the business owner (the guy who’s selling you the firm). Do your due diligence! You don’t want to end up with an empty shell of a company do you?
Pat Jennings says
I think it is important to clarify one point on item #4. Yes, brokers will negotiate the selling price, but if you contact a broker they will only show you businesses that are in their inventory. When they negotiate the price they are working for the seller. The broker gets paid a percentage of the actual selling price so it is in their interest to keep the price as high as possible. I’m not saying don’t use a broker – if they have a business that is perfect for you, by all means work with them. But just remember that they work for, and are paid by, the seller. If negotiations or business valuation are not your strong suits, you should have an experienced person – perhaps your CPA or attorney negotiating for you. In my experience, buyers hiring a broker and paying them a fee to negotiate a deal is extremely rare. Brokers would much rather spend their time working for sellers and earning a 10% commission than to work for the buyer for a flat fee.
Neal@Wealth Pilgrim says
I’m with you e-fables.
I started my business on a folding table 25 years ago. Still going strong (and I still have the table but I don’t use it in my business!)
Not a huge fan of investing tons of dough into infrastructure. Let it grow organically.
Your detailed article about opening a business offline reminds me of the similar hassles of opening a business online. There are so many things to prepare for to initiate a business and sustain it but it seems that many people take these initial preparations lightly. I have known people who would open 3 restaurants in a row and failed, so they have plenty to say about how to fail in business. I think it’s as good to learn how they fail to avoid repeating those mistakes as to study how people succeed to mimic them. I prefer business with low-start up cost and low maintenance cost with reasonable profit. High-risk-high-rewards mentality doesn’t fit me since I might lose my mentality before I reap that so-called high rewards.