How to Buy a Business in 8 Steps (+ Due Diligence Checklist)
There are several paths to becoming a business owner. The most popular one is building a business from scratch. It is also one of the hardest routes to owning a business.
You have to come up with a product or service from scratch, conduct market research, find the right employees, attract customers, build cash flow, and so on.
If you don’t want to go through all this, an easier and less risky option is to buy an already existing business.
An existing business already has existing products or services, existing customers, employees who are knowledgeable about the company and its products, existing cash flow, and so on.
It’s good to note, however, that buying a business is not as simple as finding a business that’s on sale and paying the asking price. There are several things you have to keep in mind if you don’t want to end up making the wrong decision.
Below, let’s check out the 8 step process of buying an existing business.
Table Of Contents
How To Buy An Existing Business Checklist
Step 1: Decide What Type Of Business You Want To Buy
If you go to BizBuySell and search for all businesses that are on sale, you’ll find thousands of businesses from a wide range of industries.
For instance, if you search for on-sale businesses in California, there are over 1,500 businesses that you can buy. The first three results show how varied the businesses are – the first business is in the tax preparation industry, the second in the food industry, and the third in the cannabis industry.
It is very unlikely that these three businesses across very different industries would all be suitable for you.
Therefore, before you begin searching for an existing business to buy, you have to start by thinking about the kind of business that you want to buy, one that would be suitable for your unique needs, characteristics and financial goals.
Some of the things you need to look at when deciding what type of business you should buy include…
Most businesses operate within a specific location, and therefore, when buying a business, this is something you need to think about. Ideally, it is a good idea to look for a business that is within your locality.
If you are looking to buy a business in a different geographical location from where you live, this could require you to move, so it’s something you should be ready to do.
Apart from the convenience of being able to closely monitor your new business, the location of a business also affects other things such as taxes, labor costs, the cost of leasing rental premises, and so on.
All these have an impact on the business’s performance, so it is important to consider them before deciding to buy a business.
It’s good to note that if you’re looking to buy a business that operates online, location will not be such a huge factor to consider, since you can operate the business from anywhere.
2. Your Passion, Skills, Talent, And Experience
When buying a business, it is always a good idea to go for something that is well aligned with your passion, as well as your skills and experience. This is because these factors affect your ability to properly run the business and keep it profitable.
For instance, let’s say you have always worked as a marketing executive in a marketing agency, and have always dreamt of owning your own digital marketing agency.
If you go ahead and buy an existing digital marketing agency, you have enough skills and experience in the industry to successfully run the marketing agency you just bought.
Now, imagine that with your experience in the marketing industry, you go and instead buy a business that deals in mountain biking gear.
You have never ridden a mountain bike all your life, you have no idea which gear is popular among mountain bikers, you have no mountain biker in your network.
Without the experience, skills, and passion in the industry, it would be very difficult for you to keep the business profitable, even if the business was making money before you acquired it.
Note that this doesn’t mean that it is impossible to achieve success with a business in an industry you have no prior experience with. However, the more knowledgeable you are about the industry, the more likely you are to be successful.
3. Market Outlook
Just because an industry is performing well today, this doesn’t mean that it will do the same in future. And just because an industry is not doing well today, this doesn’t mean that it won’t do well in future.
Therefore, before making the decision to buy a certain type of business, take the time to do some market research and consider the long term forecast for the industry. Is there potential for growth within the industry?
Another important thing to think about is the size of the business you are interested in buying. Are you looking for a small business that you can run by yourself? Do you want a large company with dozens of employees and revenue that runs into the millions?
Being a business owner is more than a job; it is a lifestyle. This is because running a business is a demanding venture that will have a huge impact on your lifestyle.
Before you decide to buy a business, therefore, you have to consider how it will affect your life, and if you are ready for such changes.
For example, if you are a solitary person who likes spending their time alone and doesn’t enjoy interacting with strangers in person, it would be advisable to buy a business that allows you to make money online, without the need to interact with customers in person.
Similarly, if you buy a business that will involve lots of travel, yet you do not like traveling, this could take a toll on your lifestyle, making it difficult for you to keep the business running successfully.
With this in mind, we recommend choosing a business that is well aligned with the kind of life you’d want to lead.
Finally, before you start looking for a business to buy, you have to consider how much you are willing to spend on purchasing the business.
You could find a well-performing business in an industry you are passionate about, a business that is well aligned with your lifestyle, and in a location that is convenient for you, but if it costs more than you can afford, you’ll have no other choice but to let it go.
You should keep in mind, however, that you don’t need to have all the money in cash in order to buy a business. You can still afford a business through other innovative financing options, such as seller-financing, debt financing, and so on.
Step 2: Search For Businesses That Are For Sale
Once you have determined the kind of business you want to buy, you can now start looking for businesses that are available for sale and that meet your criteria.
At this point, you want to identify as many businesses as possible that fall within what you are looking for, so you should look in as many places as possible. Some of the places and methods you can use to search for on-sale businesses include…
1. Online Platforms
The easiest way to find businesses that are for sale is to use the internet. There are several websites that list businesses that are for sale. The beauty of using online platforms is that they allow you to quickly identify thousands of businesses that you can buy.
Many of these platforms also allow you to filter available businesses by criteria such as location, industry, price, cash flow, gross revenue, how long the business has been in operation, and so on.
Another advantage of using online platforms is that they allow you to set up email alerts. This way, if a business that meets your search criteria is listed, you get notified. This is a lot easier than having to come back to the listings website to search for businesses every few days.
One of the best online platforms for finding businesses that are for sale is BizBuySell. With over 100,000 for sale businesses listed at any one time, you have a very high chance of finding a business that is perfect for you.
Other online platforms and websites where you can search for on-sale businesses include…
- BizQuest.com: Best for finding small businesses and local business brokers.
- BusinessBroker.net: Over 30,000 listings at a time, and offers finance and loan options.
- BusinessMart.com: Best for finding business using advanced search and filtering options.
- BusinessForSale.com: Over 70,000 listings from across the world.
- DealStream.com: Has a database offering over 40,000 businesses and investment options at a time.
2. Reach Out To Local Businesses
Very often, business owners that are selling their businesses don’t put up signs on their door advertising that the business is for sale, since this can easily push away employees and customers.
So, how do you tell that such a business is up for sale? By talking to actual business owners.
To use this method, start by identifying suitable local businesses in your preferred industry that you’d be interested in buying, then reach out to the owners and let them know that you are looking to buy a business in that industry.
If you are lucky, you’ll get in touch with a business owner who is looking to sell their business. Even if they are not selling, however, they probably know another business owner who would be interested in selling their business.
With this method, you’re basically tapping into the network of business owners within your locality and using it to identify businesses that could be looking for a buyer.
One thing to keep in mind when using this method is that you are not looking for an immediate yes or no answer. If the person you are talking to doesn’t know anyone who is selling their business, ask them to be on the lookout and notify you if they happen to hear about a business that is for sale.
3. Hire A Business Broker
Hiring a business broker is one of the most effective ways of finding a business that you can buy. Business brokers are always in contact with business owners looking to sell their business, and therefore, it is very easy for them to find a business that meets your needs.
It’s good to note that brokers will charge you a commission to help you find a suitable business. However, this commission is usually paid if you find a business you like. Working with a broker can also provide you with several other benefits, including…
- Screening the business for you: Any broker worth their salt will usually screen a business before recommending it to their clients. Many will check to make sure that things like the business’s financials and price are okay before recommending the business to you.
- Paperwork assistance: If you have no prior experience buying a business, a business broker can help you with the required paperwork and ensure that you are compliant with all necessary laws and regulations.
- Negotiation: A good broker also knows the ideal price range for different kinds of businesses and can help you negotiate a good deal.
- Help you avoid pitfalls: Good business brokers know what kinds of businesses you should avoid and the mistakes to watch out for when buying a business, and can help steer you from buying a business you’d later come to regret.
4. Watch Out For Advertisements
Business owners looking to sell their business will sometimes put up advertisements in local newspapers, industry journals, publications and newsletters, and even classifieds sites like Craigslist. By keeping an eye out for such ads, you might find a business that fits the bill of what you are looking for.
You can also take matters into your own hands by putting out your own ads letting business owners know that you are looking for a business to buy.
Someone who is looking to sell their business but doesn’t know how to find a buyer could spot your ad and reach out to you with just the right kind of opportunity you were looking for.
5. Talk To Professionals That Work With Business Owners
Another way to identify businesses that are up for sale is to talk to professionals that work with business owners, such as lawyers, insolvency guys, M&A firms, auditors, and so on.
These guys will often know if a business owner is looking to sell their business, and by asking them for leads, you can easily identify business buying opportunities that you’d not have known about otherwise.
Step 3: Shortlist The Companies You Would Want To Own
The aim of the previous step was to identify all businesses that fit the criteria of the kind of business you are looking for. However, all the businesses you identified in that step will not be suitable for your needs, and after all, you cannot buy them all.
What you need to do next is to take a more detailed look at the businesses you identified in step 2 and come up with a shortlist of 2 or 3 businesses that are best aligned with your goals, your budget, and your resources.
When shortlisting the most suitable businesses, here are some of the factors you need to look at.
When identifying businesses that fit your criteria in Step 2, you looked at the cost and your ability to afford them. Now, it’s time to take a second look at each of the businesses you identified and determine which ones are comfortably within your budget.
Here, you should look not just at the initial cost of purchasing the business, but also the working capital needed to keep the business running once you take over. You don’t want to buy a business and then run it to the ground simply because you spent all the money on the purchase and don’t have the money to keep the operations going.
As part of evaluating how much you’ll need to keep the business running, you have to think about what you intend to change about the business, and how that will affect operation costs.
For instance, if you intend to focus on new marketing channels to help you grow the business, confirm whether your budget allows you to do this, in addition to paying the purchase price.
2. Expected Return On Investment
Take a look at things like the products or services offered by each of the businesses you identified, their customer base, and their annual revenue to help you estimate how much returns you can expect once you take over the business. Generally, the higher the expected return from the business, the more suitable it is.
3. Think About The Required Time Investment
All the different businesses you identified will require different levels of time investment. For instance, if one of the businesses is in an industry you don’t have a lot of experience in, you’ll need to spend a lot of time learning about the industry and the market.
An online business in an industry you are experienced in, on the other hand, might not require such a huge time investment from you, especially if it is a business that you can easily automate.
What you need to do here, therefore, is to go through the list of businesses you identified and determine the kind of time investment you’ll need to put into each business, compared to the time that you can actually put in realistically. The less time you need to invest in order to make the business successful, the better.
4. Understand Why The Owner Is Selling
A lot of times, business owners sell their businesses for very valid reasons. They could be relocating to a different place, they might be looking to retire, or they might have undergone a lifestyle change, making it impossible for them to continue running the business.
All the above reasons have something to do with the owner, rather than the business, and therefore, you can easily take over the business and continue running it successfully.
Sometimes, however, people will put up their businesses for sale because there is something wrong with the business. This is a huge red flag, since it will affect your ability to earn returns from the business once you take it over.
Some of the negative reasons why someone could be selling their business include…
- Poor business concept
- Declining market
- Business debts
- A product or service that does not have any market
- Poor business location
- Negative brand reputation
- Outdated, costly equipment
- Excessive competition
If the owner is selling the business for some of these reasons, they’re just trying to dump it on some unsuspecting investor. Note, however, that the seller won’t tell you this is why they are selling, so you need to do your homework to identify the owner’s motivations for selling.
If you feel that the business owner is being untruthful about their reasons for selling the business, strike it off your list.
5. Steady Income Stream
Just because a business has been operational, this doesn’t necessarily mean that the business has been making any profit, or even sustaining itself.
Therefore, it is important to check whether the business has been providing enough cash flow to pay for its expenses, and whether it has been making any profit for the owner.
Go through each business in your list and strike off any business that has been in existence for a significant amount of time but has not been generating sufficient income to keep things running smoothly.
Such businesses could end up being a money pit for you without delivering any returns, even in the long run.
6. Potential For Improvement
Sometimes, a business that is up for sale might not be performing optimally. However, upon closer inspection, you realize that there are some opportunities you can potentially exploit to significantly improve its performance.
Such businesses are some of the best that you can buy. Due to the sub-optimal performance, you will be able to negotiate for a significantly low price. Once you take over the business, you can then exploit the opportunities you spotted and rake huge returns from the business.
When evaluating a business, always try to see if there’s anything that can be done to improve the business. If there is no potential for improvement, strike it off your list.
Finally, make an evaluation of the market each business is operating in and the level of competition it is facing. What percentage of market share does the business control? Who are its biggest competitors? What do the competitors excel in? Does the business have any edge over the competition?
Generally, the less the competition a business is facing, and the greater the advantage it has over the competition, the more suitable it is.
By the end of step 3, you should have narrowed down your list to about 2 or 3 businesses that present the best opportunity for you.
Step 4: Complete Your Due Diligence
Now that you have 2 or 3 businesses you are really interested in owning, it’s time to conduct proper due diligence into each of these companies. This allows you to determine whether the assumptions you have so far about the business are accurate, and whether the business presents a good opportunity for you.
To do this, you need in-depth access to the company’s information, so you’ll first need to sign a letter of intent.
The letter of intent is drafted after you have spoken to the business owner and expressed your interest in purchasing their business.
The letter of intent defines your proposed buying price (subject to valuation), the tentative list of assets and liabilities that you intend to purchase as part of the acquisition, and the terms and conditions that will govern the sale.
The letter of intent is a demonstration to the seller that you are serious about your interest in purchasing their business, and that if everything meets the conditions agreed upon, you’ll go ahead with the deal.
Once you’ve signed the letter of intent, the seller can now allow you to access any legal or financial information that you need in order to perform a thorough analysis of the business. It is advisable to go through these documents with the help of an accountant to help make sure everything is in order.
During the due diligence stage, some of the things you need to look at include…
1. Financial Statements
These give you a detailed look into the business’s finances. How much money is flowing into and out of the business every month? Is the business generating enough money to keep itself running, or is it spending more money than it is making? How do the company’s assets compare to its liabilities?
Checking the financial statements will allow you to determine the financial health of the company and decide whether it is a worthy purchase.
The financial statements will also help you identify any opportunities that can be exploited to grow the business. For instance, you might identify expenses that can be reduced to generate more profits, or revenue opportunities that the business is not taking full advantage of.
2. Sales Records
Even though the financial statements have a record of the sales, you should still go through the sales figures individually. If possible, check the monthly sales figures for the last three years or more.
When evaluating the sales, check which products generate the most sales, whether most of the sales are made in cash or credit, whether most of the sales come from a single client or multiple clients, and so on.
This will give you a good idea of current business activity and help you make more accurate projections of what to expect once you take over the business.
3. Business Structure
How is the business legally structured? Is it a sole proprietorship, a partnership, or a corporation? This information is important because it will affect things like taxes, as well as your liabilities once you take over the business.
4. Brand Recognition
Branding is a very important factor in business. When a lot of customers know about the business you are interested in purchasing, you can easily achieve results without having to invest so much into marketing. It is also easier to benefit from things like word of mouth marketing.
It’s good to note that brand recognition can sometimes be negative, which is something you want to avoid. You are better off trying to build a little known brand than trying to do damage control for a brand with a negative reputation.
You can evaluate the kind of reputation a business has by checking feedback from past customers on the company’s social profiles, BBB ratings, and other online reviews.
5. Business Operations
These are the processes that the business undertakes every day in order to deliver products and services to customers. How are products manufactured? How does the business facilitate sales? What distribution channels does it use?
The point of evaluating business operations is to help you determine whether you’ll be able to keep these operations up once you take over the business, and identify any opportunities to make the business more efficient once you acquire it.
6. Marketing Strategies
How does the business promote its products and services to customers? What kind of image does the business project to customers? Are these marketing strategies working?
Taking a look at the marketing strategies the business is applying and their effectiveness will help you determine if you can grow the business by improving how it markets itself.
If the business deals with physical products or supplies, check the level of inventory that the business is holding at the moment.
Find out the condition of the inventory, where they are stored (and whether you’ll have access to the storage area following the purchase), the company’s inventory management processes, and whether you’ll get the inventory as part of the purchase.
8. Existing Contracts
Since the business is already in operation, there is a high chance that it already has some existing contracts with clients, partners, suppliers and vendors, and so on.
Go through these contracts and determine how they will affect business operations once you take over the business.
For instance, some contracts could prevent you from bringing in new vendors, which means you won’t be able to lower some expenses.
If the business has existing contracts with clients, on the other hand, this is a good sign, because it means you’ll have clients even after you take over the business.
9. Employee Details
A business is as good as the employees working for it. Therefore, before purchasing a business, take the time to dig into the existing team. How skilled and qualified are they? How productive are they? Are there employees who are redundant?
If the business has a good team in place, it will be easier for you to take over the business without any significant impact on business operations.
Similarly, if you find that the business has some redundant roles, you can reduce costs by letting go of the employees in these roles.
In the shortlisting stage, you only looked at the general location in which the business is located and how that affects your ability to run the business. During the due diligence stage, you need to look at the specific location of the business and how it affects the performance of the business.
For instance, if you are interested in buying a restaurant business, look at the specific area where it is located and ask yourself questions like,
- “Is there enough foot traffic to sustain the business?”
- “Are there other restaurants around the area?” “
- “What kind of people frequent this area?”
In addition to helping you determine how the location affects revenue, you should also consider the costs that come with maintaining a business in that location.
For instance, if the business you want to buy is a manufacturing business that doesn’t rely on foot traffic, you can reduce expenses by moving the business to a cheaper location.
Does the business own any assets, such as buildings, property, equipment, furnishings, vehicles, and so on? Will these be sold together with the business, or does the owner intend to retain ownership of some of these?
Generally, purchasing a business together with its assets will be costlier, but it could still be beneficial, especially when these assets are crucial to business operations. However, take the time to evaluate the condition of some of these assets, such as equipment and furniture.
With the help of an accountant, go through the list of all liabilities owed by the business and determine how they affect the business.
For instance, if the business owner has used some of the business assets to secure loans, this is something you’ll want to know.
Similarly, if there are any unrecorded liabilities, such as out of court settlements that the business is paying off, or employee benefit claims, you’ll want to be aware of them, since they could be transferred over to you once you purchase the business.
13. Customer Patterns
If the business has been keeping track of customer data, go through this data to gain a better understanding about customer patterns.
Here, you want to answer questions like:
- “Do most sales come from existing customers or first time buyers?”
- “What is the customer churn rate?”
- “Which seasons attract the highest number of first time or repeat buyers?”
- “Which products are the most popular with customers?”
The more you understand about the business’ customers, the easier it will be for you to give them what they want and grow the business.
14. Seller-Customer Ties
Sometimes, you’ll find that there is some special tie between the business owner and some customers. In such situations, the exit of the business owner could result in the loss of such customers.
To avoid finding yourself in a situation where the business loses major customers following your purchase, try to identify any relationships between the seller and customers.
Who are the biggest customers? How long have they been customers of this business? Do they have some special agreements with the business? Do you have any reason to believe that these customers could leave once you take over the business?
Step 5: Brainstorm On What Marketing, Product, And Organizational Changes Could Increase Your Enterprise Value
While it is important to consider the past performance of a business before acquiring it, greater attention should be paid to its potential performance in future.
Now that you have done your due diligence and have a good idea of where the business you want to buy stands, both in terms of finances, legal and organizational structure, and business operations, it is time to brainstorm on ideas that you can use to grow the enterprise and increase its value.
The more ideas you can come up with on how to grow the business once you own it, the more suitable that business is, and the higher chances you have of achieving success after you buy the business.
Below are some marketing, product and organizational changes that you can make to grow the value of the business once you own it.
1. Create Additional Income Streams
If you have noticed some opportunities for earning the business new income streams that the current owner has not been taking advantage of, implementing them can be a great way to grow the business following the acquisition.
For instance, let’s say the business you want to buy is an online sports store. During the due diligence stage, you noticed that the business’s only source of revenue is selling sporting equipment.
However, based on your experience in the industry, you feel that the company is sitting on an opportunity to make money selling digital workout programs that your customers can do using your sporting equipment.
By implementing such new income streams, you can grow the company’s revenue without any significant increase in recurring expenses, leading to increased profitability.
2. Get Rid Of Unprofitable Products And Services
Sometimes, a company could be generating good revenue, but then a huge chunk of this revenue goes to producing and maintaining products and services that are not profitable.
By getting rid of such products, you can quickly increase the company’s profitability, while at the same time freeing up your employees to work on more productive tasks that contribute to the company’s bottom line.
Steve Jobs provides a great example of how this works. In 1996, Apple was producing dozens of products, but the company was on the brink of bankruptcy, with over $1 billion in losses in 1996.
When Steve Jobs came back to the company in 1997, he realized that the company was supporting too many products that were not making any profit.
When Jobs took over as the new CEO, he got rid of 70% of Apple’s existing products at the time, and only retained four of the company’s most profitable products. By the end of 1998, Apple had made over $300 million in profits.
Just like Jobs, if you notice that a business is spending resources producing and maintaining unprofitable products and services, you can increase the company’s profitability by simply getting rid of these products and services.
3. Improve Product Quality
Another easy way to grow a business after acquisition is to improve the quality of its products and services.
For instance, if you are buying a restaurant, and you think that the reason it has not been maximizing its revenue is because the food was average, you can hire a skilled chef after acquisition to improve the quality of the food, which will lead to more clients patronizing the restaurant.
4. Invest In Better Marketing
After doing your due diligence, you might have noticed that the business has great products at a great price point, but is still not making enough sales. In such a situation, the problem could be the marketing strategy.
5. Review The Current Pricing Structure
A business’s pricing strategy has a huge impact on its ability to make profits. While raising prices immediately after acquiring a business can be a risky move, it can still make a huge impact on the company’s profits, especially if the price increase is accompanied by an increase in quality.
6. Increase Operational Efficiency
Very often, businesses are unable to achieve peak performance not because they don’t have the right resources, but because they are not using these resources in the most efficient manner.
For instance, unnecessary red tape and departments that operate in siloes can easily lead to increased delivery times and loss of productivity.
If you identified such inefficiencies during the due diligence stage, you can make a significant impact on the organization’s bottom line by reducing the inefficiencies.
Some of the things that you could do to improve operational efficiency include getting rid of policies and workplace procedures that introduce bottlenecks, breaking down siloes between teams and departments, and ensuring that all teams are aligned with the needs of the business.
7. Reduce Expenses
Another low hanging fruit for anyone looking to improve a company’s bottom line following an acquisition is reduction of expenses. By reducing business expenses, you can achieve an immediate increase in profitability without implementing any other strategy.
Some of the things you can do to reduce expenses include shifting to low cost production processes, finding cheaper vendors and suppliers or negotiating for discounts, letting go of redundant employees, moving the business to new premises with lower rent costs, digitizing processes to reduce paper and stationery costs, and so on.
You can easily identify excessive expenses that present the opportunity for reduction during the due diligence stage by looking at documents like the cash flow statement.
8. Take Advantage Of Technology
Adopting new technology is another very effective way of increasing the value of an enterprise after acquiring it and making an impact on the bottom line.
For instance, by taking advantage of artificial intelligence software and tools, you can automate various business processes and increase productivity without the need to increase your staff.
Aside from increasing productivity, adoption of new technology after you take over the business can also help you increase the quality of your products or services and give you a competitive edge over the competition.
Step 6: Evaluate The Price Of The Business
Having done your due diligence on the business, and with a clear idea of the changes you’ll make to improve the business and grow its value, it’s now time to evaluate the current value of the business, which will help you determine a reasonable price for the business.
In most cases, the seller will often try to get as much as possible for the business, and will sometimes use unconventional valuation methods that give them the greatest advantage. This is why it is very important to conduct your own valuation.
You can evaluate the price of the business by yourself or hire a professional to do it for you. Whatever option you opt for, below are some of the most common methods used to determine the price of a business that is on sale.
1. Using Multipliers
This is a simple way of evaluating the price of a business, where you take a certain business value, such as after tax profits, seller discretionary earnings (SDE), or monthly gross sales, and apply a predetermined multiplier to this value.
For instance, let’s say you are using monthly gross sales as the basis of your valuation. The business you want to purchase registered average monthly gross sales of $100,000 over the last 12 months, and the industry multiplier for this type of business is x3.
In this case, the price of the business would be:
$100,000 x 3 = $300,000
While using multipliers is often the simplest way of determining the price of a business, it has one major weakness – multipliers are subjective.
Multipliers will often vary depending on factors like the industry the business is operating in, the level of competition in the industry, how diversified the business is, post-closing expenditure, how well-established the business is, how closely related the business is to the owner, whether the business owns any intellectual property, and so on.
With all these, deciding which multiplier to use can be confusing, and there’s a chance that the seller will prefer using a different multiplier that gives them the greatest advantage.
That said, using multipliers can still give you a quick estimate of what you should pay for the business.
2. Assets Approach
This is one of the most accurate ways of evaluating the value of a business. With this method, you determine the price of the business by subtracting its liabilities from its assets, then multiplying the difference by a predetermined number, usually one or two.
You can easily determine the difference between assets and liabilities by checking the company’s balance sheet.
The assets to consider when using this method include any property owned by the business, equipment, furniture, fixtures, leasehold improvements, unsold inventory, supplies, accounts receivables, trademarks, patents, and so on.
Liabilities include tall unpaid debts, bad investments, liens, uncollected taxes, lawsuits and judgments, and anything else that can potentially take money away from the business.
Asset based pricing evaluation is the best approach when you are purchasing a business that is capital intensive, as well as those that have not started making profit.
3. Discounted Cash Flow
This method allows you to estimate the current value of a business by looking at its projected cash flows in future.
In other words, the DCF method tries to determine the current value of a business based on the return on investment you will receive from the business in future, adjusted for the time value of money.
The DCF method assumes that the value of a dollar today is higher than the value of the same dollar tomorrow, because today’s dollar can be invested to yield more money tomorrow.
When using this method to value a business, you need to calculate the projected cash flows from the business for a certain period of time, then use a discounted rate to calculate the present value of those earnings.
While the DCF method is a great way to evaluate the appropriate price of a business based on your expected returns, it has one major weakness. The accuracy of your valuation depends on the accuracy of your predictions. If you come up with inaccurate cash flow projections, you’ll end up with an inaccurate valuation.
When evaluating the price of a business, it is always advisable to work with a professional who is well conversant with valuing businesses, otherwise you can easily end up paying more than the business is worth.
Step 7: Secure The Required Funding To Finance The Purchase
After valuing the business, you now know how much money you need in order to complete the purchase. If the seller is in agreement with your valuation and has agreed on the amount you are offering, it’s now time to put together the money you need to acquire the business.
It’s good to note that buying a business can be a costly affair, so you need to have given some thought to your source of funding even before you start looking for businesses to buy.
Fortunately, you have several options when it comes to raising funds to finance a business acquisition. Let’s check out some of them below.
1. Personal Funds
This is the simplest way of funding a business purchase. Here, you are basically using your own money to cover the cost of purchasing the business.
The problem with this financing option is that you need to have a lot of money saved up, which often makes it a not viable option, especially when you want to acquire a large business.
However, you can easily use personal funds to finance the purchase of a small business that has a relatively low price tag.
2. Debt Financing
This is one of the most common ways of financing the purchase of a business. With debt financing, you are purchasing the business with money borrowed from a bank or other lending institution.
The beauty of debt financing is that you can then use proceeds from the business to clear the loan over the agreed period of time.
What makes debt financing such an attractive option for financing the purchase of an existing business is the fact that the existing business provides you with tangible proof of the ability of the business to pay back the loan.
By providing the lender with documents like cash flow statements, the company’s tax returns, financial histories, valuations of the company’s equipment and inventory, employee records, and so on, you give lenders the confidence that they are not funding something that could end up being an expensive gamble.
If you decide to use debt financing, some of your options include…
- Traditional bank loans: This involves approaching a bank for a loan. The bank gives you money that has to be repaid plus interest within a certain time, usually ranging from 1 to 5 years. Bank loans work best when you are purchasing a business with substantial assets. You also need to have an exceptional credit score.
- Online loans: This involves financing the business acquisition using funds borrowed from online lenders. They are similar to bank loans, but they usually have lower qualification requirements compared to traditional bank loans. However, these loans often charge higher interest since they are usually unsecured. Some examples of good online lenders that you can borrow from include Fundera, Lendio, Fundbox, Funding Circle, BlueVine, and OnDeck.
- SBA Loans: This is one of the best options for borrowing money to purchase a business. SBA loans are guaranteed by the U.S Small Business Administration, which makes SBA loans easily accessible and very affordable, with very low interest rates.
3. Seller Financing
This is a unique way of financing the acquisition of a business by borrowing money from the seller.
In simpler terms, you pay the seller an initial sum of money, take control of the business, then continue paying them over time until the whole purchase amount has been cleared. In most cases, you pay off the seller using money generated from the business.
It’s good to note that finding a seller who’s open to this option can be very difficult, since most sellers want to get their money and hand over the business entirely. However, there is no harm in asking, you might come across a seller who is comfortable with this option.
4. Asset Based Financing
Also known as a leveraged buy-out, this is where you use the assets owned by the business you are buying as collateral to secure a loan, and then use this loan to fund the acquisition of the business.
Some of the business assets that you can use to secure funding include the company’s property, equipment and machinery, inventory, and unpaid invoices.
It’s good to note that with this kind of financing, you won’t be able to raise the whole amount required to purchase the business. Therefore, this option is typically used with another financing option, such as use of personal funds or seller financing.
5. Find A Partner
If you are unable to raise the funds to purchase the business on your own, another suitable option is to find a partner to help you purchase the business.
With this option, you have two options. The first one is to find a co-owner. In this case, you own the business together, and each one of you will be involved in the day to day running of the business.
If you opt for the co-owner route, it is advisable to find someone who has some skill set or experience that is beneficial to the business.
If you don’t have someone who’d be interested in partnering with you in mind, ask the business owner to give you a list of any other people who had expressed interest in purchasing the business but couldn’t afford the purchase price.
You can then approach these people and propose a partnership deal. Remember to always prepare a partnership agreement with the help of your lawyer before bringing on board a partner.
The second option is to find a venture capitalist or an angel investor. In this case, the investor is not involved in the day to day running of the business. Instead, they only give you the money and get a share of the profits until they recoup their investment plus interest.
6. Selling Stock To Employees
Another innovative way to finance the purchase of a business is to sell stock to the company’s employees.
With this route, you pay a percentage of the purchase price, while the employees raise the remaining percentage, which gives them some ownership of the company.
If you opt for this route, it is advisable to sell non-voting stock. This way, you get to retain total control over how the business is run. The employees only get a share of the business profits in the form of dividends.
7. Decline Receivables Or Assume Liabilities
You can also lower the initial purchase price of the business by declining the company’s receivables or assuming its liabilities.
When you decline the receivables, any money owed to the business before you took over will be paid to the seller. This means that you can deduct this amount from the purchase price.
When you assume the business’ liabilities, you are agreeing to pay off the debts that the business owed before you acquired it.
Note that while this will reduce the initial purchase price, you’ll still have to spend money to cover the debts. The only difference is that you will not be required to spend this money immediately, and can therefore pay off the debts using money generated by the company after you take it over.
Step 8: Close The Deal With The Right Documents
If everything is in order, and you have secured the funds you need to finance the purchase, it’s now time to do the final thing in the process – closing the deal and taking ownership of the business.
Closing the deal is a complicated process that sometimes involves various legal and financial traps, so you should always go into this step with the guidance of your lawyer.
Your lawyer will ensure that you meet all your contractual rights and obligations, and help you scrutinize all the necessary documents.
Below is a list of the documents that need to be present before you can finalize the deal, pay the seller, and officially take ownership of the business.
1. Confidentiality Agreement
During the sale of a business, a lot of confidential information is exchanged – details about business assets, debts, and finances, details about how the business runs its operations, details about you (the buyer) and how you intend to finance the purchase, and so on.
All these are very sensitive details that both you and the seller might want to keep away from the public – whether the deal goes through or not. To prevent such details from leaking to the public, it is a good idea to always have a confidentiality agreement.
2. Bill Of Sale
This is a very important document that proves that the sale occurred and that the business, as well as its assets have been transferred from the seller to the buyer.
3. Adjusted Purchase Price
This document gives the final purchase price of the business, and takes into account the cost of everything that contributed to the final purchase price – including the cost of things like assets, inventory, goodwill, and so on.
4. Acquisition Agreement
This is a legal document that covers all the terms that govern the purchase. It defines all the details of everything that the seller and the buyer have agreed upon, including the price of the acquisition, the assets and liabilities that are to be transferred as part of the purchase, and the time frame within which the acquisition needs to be completed.
The acquisition agreement also anticipates and describes what needs to be done in case things do not go as planned – for instance, if the buyer discovers that the seller misrepresented some information. The aim of this is to protect you (the buyer) and ensure you get what you are paying for.
5. Asset Purchase Agreement
If you are assuming ownership of the business’s assets as part of the purchase, you will need an asset purchase agreement. This document describes, in detail, the exact assets that you are purchasing, and those that you are not purchasing.
The information in the asset purchase agreement is usually covered by the IRS form 8594, which you must complete before acquiring a business.
The asset purchase agreement typically covers the following:
- Inventory: A list and value of all inventory currently held by the business.
- Plant and machinery: a list and value of the plant and machinery owned by the business, as well as the lease or purchase agreements for these assets.
- Goodwill: This gives the value of intangible assets like customer base, brand and reputation, and intellectual property.
- Creditors/debtors: Unless you have agreed to decline receivables or assume liabilities, the seller will be responsible for paying creditors and collecting debtor payments until the transfer is officially completed.
- Employees: This describes whether the employees will be automatically transferred with the purchase of the business. This is usually governed by the TUPE regulations, and usually applies when the business is being transferred as a ‘going concern.’
- Contracts: Any current contracts will be listed here. You might want to review the contracts and protect yourself from potential liabilities by adding some clauses to these contracts.
- Assignment deeds: In the event that you are taking over lease or hire purchase contracts, you have to get the consent of the lessor or the hire purchase company before the contracts are transferred to you.
- Property transfer documents: If you are acquiring the business premises as part of the transfer, you’ll need to fill and sign the formal transfer documents.
- Landlord consents: In situations where the business has leased the business premises, you’ll need to get the consent of the landlord to have the lease transferred to you. As part of getting the landlord’s consent, you might be required to provide some personal guarantee.
- Vehicle transfer documents: If the business owns any vehicles that you are purchasing as part of the business acquisition, you’ll need to get the proper forms and have the ownership of the vehicles transferred with the local DMV.
6. Intellectual Property Transfer Documents
If the business you are purchasing owns any copyrights, trademarks, and patents, make sure that these are transferred to you before you take over the business.
7. Non-Compete Agreement
Imagine a situation where someone sells their business to you, then sets up a similar business next door. By doing so, they take away the customer base, as well as any goodwill they had built in the business they just sold to you.
To avoid such situations, it is always recommended that you ask the seller to sign a non-compete agreement.
The non-compete agreement restricts the seller from setting up a business, or from being employed or consulting for a business that would be a competitor to your business within a given radius from your business premises.
A good non-compete agreement will also have a clause to restrict the seller from engaging in similar business with the customers of the business for a given time frame following the purchase.
The non-compete agreement should also restrict the seller from encouraging the employees of the business to quit from their positions in your business and take up employment in a competing business.
8. Employment/Consultation Agreement
In the event that you intend to have the seller remain in the business, either as an employee or a consultant, you’ll need to create this document to define the terms of this agreement.
9. Bulk Sale Laws
Bulk sale laws are laws that were created with the aim of protecting creditors of a business by giving them a notice whenever a company that owes them is selling most or all of its assets. This way, business owners cannot sell their businesses with the aim of escaping their liabilities to creditors.
Before closing the deal, you’ll need to notify the local tax office about your intention to purchase the business.
If all the above documents are in order, you can now go ahead to make the payment to the seller and assume control of the business.
Quick Due Diligence List For Buying A Business
Collecting as much information as you can about a business before you decide to acquire it, which is also known as due diligence, is a very important part of the process of buying a business.
If you don’t do it right, you could potentially find yourself in various financial or legal problems shortly after taking ownership of a business.
To help you avoid finding yourself in such problems, here is a quick list of everything you need to look at when doing your due diligence before buying a business. You should go through everything in this list with the help of your lawyer and accountant.
1. Organization And Good Standing
Here, the aim is to determine the legal structure of the business and find out whether it is in good standing with state authorities.
Some of the documents and paperwork you need to look at here include:
- The articles of incorporation for the company, and any amendments that have been made since incorporation.
- All company bylaws, as well as amendments of the same
- Copies of the company’s minutes for the duration it has been in operation
- A list of shareholders showing how much shares each shareholder holds
- Certificate of good standing
- A list of all states and countries where the business is legally authorized to do business, as well as states and countries where the business does business, has employees, and holds or leases property.
- The company’s annual reports for the last 3 years
2. Financial Information
A company’s financial information plays a key role in helping you determine whether a business is worth buying, as well as how to value the business. When evaluating a company’s financials, some of the documents you need to look at include…
- The business’s audited financial statements for at least 3 years
- The company’s most recent unaudited statements
- Auditor’s reports, letters, and replies for at least 3 years
- Sales records for the last 3 years
- A schedule of accounts receivable and accounts payable
- The company’s capital budgets, projections, and strategic plans
- The company’s analyst reports
- The company’s credit report
- The company’s general ledger
- An analysis of the company’s gross margins, if available
- An analysis of the company’s expenses, both fixed and variable
- A schedule of the business’s advertising costs
3. Inventory, Equipment, And Other Assets
The assets owned by a business you want to purchase will have a direct impact on the amount you are going to pay for the business, so it is important to know what they are, their actual value, and their condition, as well as whether you’ll actually need them once you take over the business.
Some of the documents to ask for here include…
- Copies of purchase documents on equipment owned by the business
- All leases on equipment not owned by the business
- A schedule of the business’ fixed assets and where they are located
- A schedule of all major capital equipment purchased or sold by the business in the last three years
- A schedule of all inventory held by the business
- All U.C.C filings
4. Real Estate
If the business owns some property, you need to know about the property, and whether it will be part of the transfer or not. If the business owns real estate, you’ll need to ask for the following documents…
- A schedule of all business locations maintained by the company
- Copies of all deeds, title policies, mortgages, leases, variances, surveys, and use permits
5. Intellectual Property
Where the business you are interested in holds some intellectual property rights, copyrights, and trademarks, you should ask to see the following documents…
- A schedule of copyrights
- A schedule of trade names and trademarks
- A schedule of all patents held, both domestic and foreign, as well as any pending patent applications
- Any “work for hire” agreements
- A description of how the business protects its know-how and trade secrets
- A description of all technical know-how held by the business
- Copies of consulting agreements the business has with third parties
- A list of all intellectual property claims or threatened by or against the business
6. Employees And Employee Benefits
When purchasing a business that employs staff, it is important to know the number of staff under employment and how much they get paid, especially if you intend to retain the employees after acquiring the business.
Here are the employee-related documents you’ll want to check as part of your due diligence…
- A detailed list of all staff, including their positions and roles, their salaries and benefits, how long they’ve been working for the company, and all salaries and benefits paid out for at least 3 years.
- All agreements between the business and its employees, including employment, consulting, non-competition, non-solicitation, and non-disclosure agreements.
- The company’s employee handbook and schedules of all employee policies
- Resumes of key employees
- Copies of any existing collective bargaining opportunities
- Copies of all stock purchase plans and stock options available to employees
- A description of existing employee health and welfare insurance policies and the benefits accorded under these policies
- A list and description of all labor disputes the business has faced within the last 3 years – whether settled or pending
7. Business Permits And Licenses
It is also important to know whether the business you want to purchase has all the permits and licenses it needs to operate, and that it is not in violation of any state or city laws. The permits required will depend on the nature of the business and the industry it operates in.
8. Environmental Regulations
Imagine buying a business, only to discover that it is facing fines and penalties because it has been illegally disposing of hazardous chemicals into a nearby river? To avoid such situations, you need to make sure that the business is in compliance with all environmental laws.
Some of the documents to ask for here include…
- Any available environmental audits for all properties leased or owned by the business
- A list of the business’s environmental licenses and permits
- A list of all hazardous substances the business uses in its operations, as well as how they are disposed
- Copies of all correspondence between the business and any environmental regulatory agency
- A list of all environmental disputes, investigations, or litigations the business has been involved in
9. Zoning Laws
Next, you need to check whether the business you intend to buy is in compliance with any zoning restrictions.
In some cities, you might find that certain businesses, such as bars, nightclubs, and manufacturing businesses, are not allowed in certain neighborhoods. You don’t want to buy a business that could end up being closed for violating zoning laws.
Has the business you are interested in buying been diligently filing its taxes, and is it compliant with all tax laws and regulations? Here, ask to see the following documents…
- All sales and income tax returns filed for the last 3 years
- All employment tax filings for the last 3 years
- All recent tax settlement documents
- Any tax liens
11. Contracts And Leases
It is important to find out all the contracts and leases held by a business before you acquire it. This way, you can determine whether to maintain the contracts and leases or whether to negotiate new ones, as well as how canceling any of these contracts will affect the sale.
When reviewing contracts and leases, you’ll need to look at the following:
- Contracts and agreements between the business and its vendors and suppliers
- Contracts and agreements between the business and its customers
- Any lease agreements for properties occupied by the business or equipment
- All installment sale agreements
- All loan or credit agreements to which the business is a party
- All non-competition and non-disclosure agreements the business has signed with other parties
- Any other contracts and agreements that apply to the business
12. Product And Service Lines
Ask for a list of all products and services currently offered by the business, as well as those that are under development. If there are any evaluations, studies, tests, surveys, or customer complaints regarding the products or services, get a copy of these as well.
13. Customer Information
Your due diligence would be complete without information about the company’s customers. When reviewing customer information, ask for the following…
- A list of the company’s biggest customers for the last 3 years
- Any existing supply or service contracts between the business and customers
- A description of any credit agreements between the business and its customers
- A list of all pending customer orders
- A list of all key customers lost over the last 3 years, and the reasons behind the loss
- A description of the business’ current marketing strategies
- A list and description of the business’s main competitors
If you purchase a business that is facing legal disputes, you could easily end up assuming liability for these disputes.
To avoid this, you need to make sure that the business is under no legal threat. To do this, ask to see a list of all pending and threatened litigations, as well as documents relating to any settlements, consent decrees, or injunctions to which the business is a party.
If the business has engaged any professionals over the last 3 years – such as consultants, external accountants, and law firms – ask for a list of these professionals, as well as their contact information.
16. Articles And Publicity
Finally, ask for copies of all of the business’s press releases, articles, or any other form of publicity that the business has been featured in over the last 3 years. This can help you evaluate the company’s brand and reputation.
Pros Of Buying A Business
Now that you are conversant with the step by step process of buying a business, is it better to buy an existing business or build your own business from scratch? Let’s go over some of the advantages of buying a business that is already in existence.
1. Market Tested Concept And Products
When starting a new business from scratch, you are taking a very big gamble. You don’t know whether your business concept will work, or whether there is a ready market for your products and services.
Things like creating a business plan and conducting market research will help you reduce the risk, but you’ll ultimately know whether there’s demand for your products once they hit the market.
With an existing business, the risk is less, because you can check how the business has been performing to determine whether the business concept is working, and whether there is demand for the products and services.
2. Reduced Startup Time
Getting a new business off the ground takes a significant amount of time and effort, because there are lots of things to be done.
You have to find office space or business premises, purchase equipment and inventory, find the right employees and train them, come up with management policies and processes, build relationships with vendors and suppliers, develop a distribution network, and so on.
With all these activities that need to be done, it could be a while before you actually open your doors to the public and start selling.
When buying an existing business, most of this work has been done for you. You can literally finalize the purchase today and open shop tomorrow.
However, this is not to say that there’ll be no work on your part. You also have to put in work to improve the business and take it where you want it to be.
3. Established Brand And Customer Base
Building a brand is no small task, especially if you are starting a business in a crowded industry. It could take a few years to get people to know about your brand and your products and services, and a few more to build a loyal customer base.
With an already existing business, the brand is already established, and the business already has an existing customer base, thus making things a lot easier for you.
4. Securing Business Funding Is Easier
Raising funds to start a new business is not an easy thing to do. This is because you are borrowing money against an idea that is only in your head.
This presents a huge risk for investors and lenders, because the only tangible thing is your business plan, and there is no guarantee that you will be able to successfully implement the business plan.
With an existing business, securing funding is a lot easier because you are not borrowing against projections that may never materialize. Lenders and investors can look at revenue figures, profit margins, and the company’s assets and lend you money against something tangible.
This is not to say that it is impossible for an existing business to fail. However, financing an existing business presents a lower level of risk to lenders and investors compared to financing a new venture.
5. Intellectual Property
Sometimes, the business you are buying could have copyrighted slogans, patents, trademarks, and other intellectual property.
Once you acquire the business, this intellectual property could be transferred over to you, and could give you a competitive edge that you would not have had by starting your business from scratch. Note, however, that you may be required to pay for this intellectual property as part of the purchase.
Cons Of Buying A Business
Despite having all the above advantages, buying an existing business is not all smooth sailing. Some of the drawbacks of buying an existing business include…
1. Higher Upfront Costs
With a new business, you can acquire various assets gradually as the company grows, which allows you to keep the cost of starting the business manageable. When buying an existing business, however, you’ll be expected to pay for these assets all at once.
In addition, when acquiring an existing business, you’ll also be paying for other intangible assets, such as the brand and reputation of the business, the customer base, intellectual property, business policies and procedures, income streams, and so on.
While all these are negotiable, having to pay for them at once can push the cost of acquiring an existing business way higher than the cost of starting a new business and growing it gradually.
2. Risk Of Unidentified Problems
Sometimes, business owners will decide to sell their business because there’s an issue with the business that could affect its long term success. However, many of them will try to hide this information from potential buyers.
While an intensive due diligence process can help you identify such red flags before you commit your money to buy the business, it is possible to miss an issue or two, or underestimate an issue that seems insignificant.
Once you have bought the business, there’s no going back. If you discover any red flags at this point, the only thing you can do is try as much as possible to rectify the issue, though this might not be possible in some cases.
For instance, if you just bought a business in a market that is declining, there’s not much you can do to revive the market.
3. Unfamiliarity With The Business
When you build a business from scratch, you’ll have an extensive knowledge of how that business works, how it makes its profits, and the inner workings and processes that make the business successful.
When you buy a business that was built by someone else, you don’t enjoy the privilege of such knowledge, even if you have experience in the industry. This means that you’ll have to go through a steep learning curve in order to continue running the business successfully.
Sometimes, someone who bought an existing business might be unable to discover the unique thing that made the business successful under the previous owner, and faces the risk of running the business into the ground.
4. Making The Business “Your Own” Can Be A Huge Challenge
When someone starts a business, they have a goal and vision for that business. When you buy the business, you’re essentially stepping into the founder’s vision.
Since you don’t have the same vision as the founder, you have to work on developing your own vision for the business, which calls for changes to the business.
For instance, you might want to introduce new products and services, or change the business model. However, instituting such changes to the business can be detrimental to its performance, and can sometimes lead to loss of customers or key employees.
Ready To Buy A Business And Start Your Entrepreneurial Journey?
If you want to become a business owner, but don’t want to go through the challenging process of building a business from scratch, you can start your entrepreneurial journey by choosing to buy an existing business instead.
While buying a business can be a complicated process that requires its own specialized knowledge, we’ve furnished you with all the required information and broken the process into 8 easy to follow steps.
Here’s a recap of the steps:
- Step 1: Decide what type of business you want to buy
- Step 2: Search for businesses that are for sale
- Step 3: Shortlist the companies you would want to own
- Step 4: Complete your due diligence
- Step 5: Brainstorm on what marketing, product, and organizational changes could increase your enterprise value
- Step 6: Evaluate the price of the business
- Step 7: Secure the required funding to finance the purchase
- Step 8: Close the deal with the right documents
While these steps break down buying a business into a simple process, buying a business is still an involved process that requires a lot of time investment and a lot of caution. We always recommend working with the right professionals to avoid any legal or financial problems down the road.
It is also advisable to keep in touch with the previous owner, because you might need their help or advice somewhere down the road.
All said and done, if you follow the process and recommendations shared in this guide, you’ll be able to successfully start your entrepreneurial journey without the pressure of building a business from the ground up.If you prefer starting your own business, rather than buying an existing business, check out our guides on how to start a blogging business, how to start a podcast, how to start a consulting business, and how to start an online store.