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How to buy a business that’s right for me!

Not knowing how to buy a business that is right for you could wipe you out financially. You are investing both money and time into a new business venture. Don't waste either.

There is a very specific process that you will need to go through. The process is highly successful at weeding out inferior opportunities and identifying winners. I encourage you to read through this article on how to buy a business carefully so that you will be well equipped to make a good decision. If you need more help with the process, please visit my coaching website, My Small Business Mentor.

How do I buy a business that's right for me?

First and most important in considering how to buy a business is to develop a great business idea, find your value proposition, and determine whether it is a fit for you personally. We discussed this in detail in the article on selecting a business idea.

The second step in how to buy a business involves a careful search for businesses for sale that fit your idea. If you are unsure of how to find a business for sale see the article on Looking to Buy a Business. Hopefully your search will turn up multiple opportunities to buy a business.

Evaluating the business opportunity.

When deciding how to buy a business right for you, you must evaluate each opportunity carefully. It must fit with your business idea and your value proposition. If it doesn’t, it's not likely the right opportunity for you.

If the business for sale is a fit, you still need to do a small business evaluation. Is this a quality business that will give you the best opportunity for success? There are many questions to answer when considering whether to buy a business. I encourage you to carefully follow the advice in this article.

There are two major areas of concern. The first will require a thorough review of financial information and is the topic of my article on business valuation. The second requires a thorough review of the company itself, its people, its products and services, and how it is run. Let's see how to do that so we can now how to buy a business that will succeed.

What you need to know BEFORE you buy a business.

Understanding how to buy a business requires you to evaluate the economic environment you will operate in. If the economy of the nation or the region is depressed or going through a difficult time it will obviously effect the success of the business.

Certain businesses do well in down times and other will simply struggle or fail. In 2008 and 2009 we have seen a number of areas hard hit by the economic crisis. Businesses serving markets for necessities did much better than those serving markets for discretionary purchases.

You must know how the proposed business will fare in the economy. It effects both the viability of the business as well as the price you should pay for it. In a booming economy prices for businesses tends to be higher.

Once you have satisfied yourself that your business will work in the current and future economic climate, you must look at the company itself. Here are some factors that I think about when evaluating how to buy a business that will succeed:

How is the company legally organized?

The company will be organized as either a sole proprietorship, partnership, corporation, limited liability company (LLC), or such. It's very important to know the structure. The organizational form has a significant impact on legal liability of the owners. It also impacts how it is taxed and what possible tax benefits there are for the owners.

In addition to knowing how to buy a business, you also need to know who to buy it from. For this you will need to know how the business is organized in order to identify who the actual seller is.

In a sole proprietorship you buy from the individual. With a partnership you will need to reach an agreement with one or more partners depending on the type of partnership and how it is run. A corporation is sold by its shareholders. If you are buying 100% of the corporate business you will likely need most if not all of the shareholders to agree.

If you buy a business that is incorporated, you have the choice of buying the stock of the corporation or simply buying its assets. Sellers like to sell stock as it gives them the best tax result and is a simpler transaction. You as a buyer like to buy the assets instead.

Buying assets gives you a better tax advantage and limits your liability from legal issues. When you buy the stock of a corporation you step into the shoes of the prior owners. You inherit any contingent liabilities or future claims and lawsuits against the business that relate back to the time before you bought the corporation.

So which is better, buying stock or buying the assets of the business? There are many issues and they all will be reflected in the price you pay. A seller selling assets rather than stock will demand a higher price. It comes down to your evaluation of the liability risks of acquiring the stock against the higher price you’ll pay to acquire the assets along with some consideration of tax consequences either way. My best advice is to review the proposed deal with appropriate tax and legal counsel.

What is the history of the company?

The history of the business will tell you where the business came from and how it was built up. It will identify key individuals in the organization. The loss of a key person in the sale of the business will be significant and this isn't how to buy a business that's destined for success.

A history may identify opportunities for future growth that you will want to pursue. The history could also give you valuable information as to the culture of the business, how it interacts with its customers, vendors, and employees.

Have there been any recent sales of the company or changes in ownership?

If there are any prior sales or changes in ownership, they may give an indication as to value. It is useful to know what the business was valued at when the change happened. Prior transactions can also be an indicator as to problems in the business. Why did they sell the business in the first place and why is it now for sale again?

Knowing the reasons why is vital information that will help you know how to buy a business.

Are there any subsidiary or affiliated companies?

If there are subsidiary or affiliated companies they will have a bearing on value and operations. Perhaps the subsidiary provided products or services to the business on favorable terms. Will those favorable terms continue after the sale? Will you need to acquire the subsidiary or affiliate or find another relationship?

How is the business managed?

Try to get a good overview as to the management of the company. You are acquiring a business culture. You will likely change the culture to fit your character and personality. Will the change be difficult for employees?

Many new owners make changes that cause concern for employees and they quit during the transition. Culture changes have to be well thought out and gradually implemented in most cases.

Try to get detailed resumes of the management team so you understand their qualifications. The better qualified and longer they have been around the better for the transition. Customers and vendors don’t like change. Stability in the staffing is a key to success.

Sometimes though, there will be people on the team that need to go and the prior owner didn’t clean it up during their time. You will be getting the good with the bad. Are you up to the task of eliminating the bad and finding new employees?

It’s often a good idea to interview some of the employees. The interview will help you learn about them and give you a chance to sell yourself. They need to have confidence in you or they’ll be out looking for jobs as soon as you step in.

You should also gain an understanding of the staff in general. I look at things like character, experience, and longevity with the company.

High turnover will be a major headache for you as it is difficult to find good employees. High turnover can be the result of many possible issues. High turnover also increases costs to the business as it takes time and money to get people up to speed in your business.

Thus, a company with low turnover can be worth more to you when deciding how to buy a business that will have a high chance of success.

What types of employee benefits are provided?

Understand what the current employee benefits are. You will be taking over the benefit plans and have the associated costs. There is no better way to alienate the employee group you have just acquired than to cut or even change benefits. They will be suspicious of you until you have earned their respect.

Is there any family involvement?

Family involvement in a business is often a good thing. However, when you are buying and family members are involved in the business there are certain issues. Many times a family member is either not paid or is working at discounted rates. Once you take over you may need to replace them at costs far in excess of what shows up on their financial statements.

Therefore, when considering how to buy a business that has significant family involvement, be very careful to evaluate the services each provides and the rate of pay they receive. You will need to replace those individuals and it may cost more to do so.

Do they have high quality books and records?

The better the books and records of the company the better information you will have to make decisions. The quality also reflects the overall management of the company.

Some companies are reluctant to show you their books and records. This is usually because they are hiding something from you, their creditors, or the IRS. If they have “skeletons in their closet,” do you want to inherit them?

If the books and records aren’t available to you, just walk away. There will be no meaningful way to do a small business evaluation of the company without them. Fortunately, the data will usually be available to you.

It bodes well when the company uses a CPA to review their financial information each year. It is also good to see CPA prepared income tax returns. While nothing is ever perfect, having an independent CPA involved does reflect a higher standard.

Are there any significant contracts?

You must understand what significant contracts the business is subject to. You may or may not want to assume those contracts. Review them with your advisors.

Sometimes the contracts are for continuing sales to customers. Many times you will want to assume them. Other times the contracts maybe at very unfavorable terms and you’ll want out. The same issues apply to vendor contracts and leases.

Are there regulatory or environmental issues affecting the business?

Ask the owners, ask your advisors, and think through the possibilities. In your contract to buy you will want warranties as to the existence or nonexistence of these issues. If they are present, be sure you understand your obligations.

If there are environmental issues you MUST review them with your legal counsel. If you skip this on assurances from the seller you will have violated every bit of wisdom on how to buy a business by taking on a risk that could wipe you out.

What do you know about the physical facility?

Is the business location owned or rented? If owned, will the owner be selling the premises with the business and at what cost? If the owner won’t sell the premises you will need to see at what terms you will be able to lease them from the owner or if you need to move the business.

When thinking about how to buy a business, remember moving is usually not a good thing during the transition. You want change to come slowly so as not to cause concern to your employees or to your customer base.

If the premises are currently leased, is the lease assumable by you? What are the terms of that lease and are they reasonable? Any lease should be reviewed by your attorney for issues that may effect you. You may want to discuss with a commercial Realtor or appraiser whether the lease cost is above or below market rates.

In any case you should determine if the facility is sufficient for what you want to do with the business. Consider the space you need now and for the foreseeable future. It is expensive and disruptive to move a business. This information will help you with decisions as to lease term, moving the business and expansion plans.

Look at key sales and marketing issues.

Understand how the current sales and marketing of the products or services is accomplished. How are sales staff compensated, commissions or salary? Changes in compensation structure can be disruptive. How should sales staff be compensated?

Was the owner the one responsible for selling or bidding work? If so, will you be able to take that over or need to hire someone else to do this? How will you facilitate the transition of the customers to a new person?

Do you understand all of the products and services currently provided? How do they fit with your value proposition? You should have ideas as to how you will bring your unique value to the company’s customer base.

Few customers, or many?

If the sales for the company are heavily concentrated in just a handful of customers you will have much higher risk in buying the company. The loss of just one or two of these key customers could destroy the business.

It's much better to have a broad base of customers. The risks are far less. When I consider how to buy a business that will succeed, I always look for those with a broad base of customers.

Always understand the concentration of customers and how you will maintain and improve relationships. It often takes 2-3 years or more for customers to gain confidence in you.

Who is the competition?

There is always competition. Sometimes direct competition, sometimes indirect through substitute products or services. Do you know who the competition is? Is the competition well established and well funded?

Why should the current customers continue with you rather than seeking out a competitor after the owner sells? Your value proposition should help you to answer some of these questions.

How is pricing set?

You need to understand how the business prices its products and services. You will hopefully bring additional value above what the prior owner did through your value proposition. Additional value can bring increased prices with additional profits and more satisfied customers.

You don’t want to be in a business where you don’t bring additional value otherwise you will only be able to compete based on low price. And that's not how to buy a business that will be a winner.

In the long run, if you have to be the lowest price, your margins will get so small you will go out of business. Customers want a value added product or service, give it to them.

What is the market size and this company’s share of it?

A very small market with some well established competition could be difficult to succeed in. A larger market with fewer well established competitors could give you the opportunity to be a market leader with your value proposition. Know the market and know why you will succeed in it. If you aren’t sure then your value proposition is insufficient.

Where is the industry going?

You must understand where industry of this business is going. If the industry is growing and gathering strength it will sweep you along with it. If the industry is in decline it will pull you down too.

Is there new innovation in the industry that will require significant changes in how you do business? What are the trends? A new innovation on the horizon may point to further growth or make you obsolete.

You need to research this industry and know what to expect in order to best understand how to buy a business that will succeed. You can't change the industry so you must understand if there is opportunity for you within it.

A last bit of advice on how to buy a business.

You must evaluate each business for sale to see if it’s right for you. It must fit with your business idea and your value proposition. Your review of the company, its people, its products and services, and its management must be thorough.

After you have satisfied yourself that you know all you can about the business for sale and that it seems like a winner, you must still review the financial information and determine a proper value.

No discussion about how to buy a business would be complete without looking at how to determine actual value. This article will help you with how to value a business.

When you are deciding how to buy a business you need to know it will generate enough cash flow to warrant the price you pay and the time you devote to it. Never buy a business or settle on a price without doing a thorough analysis of the financial statements and the risks inherent in the business.

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The advice given here is not intended to be legal or tax advice.
Contact your attorney or CPA should need such advice.