9 Steps On How To Buy A Business
So, you’re in the market and wondering how to buy a business? Great choice! Acquiring an existing business can offer you immediate cash flow, a proven track record, and a faster path to profitability. As a specialist acquisition CPA firm, we’ve seen the benefits for our clients. In this post, we will walk you through the process of how to buy a business, from finding a business to financing, due diligence and more.
Franchising vs. Buying a business
When you’re considering entering the world of business ownership, you’ll likely encounter two main paths: buying an existing business or investing in a franchise. While both options come with their own sets of advantages and challenges, understanding the key differences can help you make an informed decision that aligns with your goals, lifestyle, and skill set.
- Structured Support: Franchises often provide extensive training programs, marketing support, and operational guidance.
- Brand Recognition: You’re buying into an established brand that customers already know and trust.
- Lower Risk: With a proven business model, franchises often present less risk compared to starting a business from scratch.
- Limited Control: Franchisors set the rules, and you’ll need to follow their operational guidelines, which may limit your creative freedom.
- Ongoing Fees: Franchises often require ongoing royalty fees, which can eat into your profits.
- Initial Franchise Fees: Besides the cost of buying the franchise, you’ll often have to pay an initial franchise fee, which can be quite hefty.
Buying an existing business
- Immediate cash flow: When you buy an existing business, you get immediate cash flow.
- Complete Control: You have the freedom to run the business as you see fit, allowing you to implement your vision and strategies.
- No Royalty Fees: Unlike franchises, you keep all the profits, as there are no ongoing fees payable to a franchisor.
- Established Operations: An existing business likely has employees, suppliers, and systems in place, saving you the time and effort needed to build these from scratch.
- High upfront costs: Buying a business requires a significant financial investment upfront. Make sure you’re prepared for this.
- Hidden issues: Every business has its challenges. Whether it’s employee issues or inaccurate financial statements, you’ll want to know about these before you buy.
- Time-Consuming: Taking over an existing business can be a long process, requiring extensive due diligence and potentially complicated financing arrangements.
Whether you’re considering buying a stand alone business or franchise, it’s beneficial to think about some practical aspects first, such as:
- Your Skill Set: Assess your own skills and experiences. If you’re new to business ownership, the support from a franchisor might be invaluable.
- Financial Commitment: Both options require a significant financial investment, but the nature of the costs and on-going financial commitments differs.
- Risk Tolerance: Are you comfortable taking risks and solving unexpected problems, or do you find security in a proven model?
- Long-Term Goals: Consider your long-term business goals. Do you aspire to own multiple locations, or are you content with operating a single unit?
Reasons Behind The Sale Of The Business
Before you make any decisions, it’s crucial to understand why the business you’re interested in is on the market in the first place.
There are many reasons for selling a business. Be wary of owners who are just trying to offload a sinking ship. An owner that does not have a good reason to sell is also more likely to back out of the deal.
To prevent lost time and money you want a seller that is as committed to the sale as you are and has a valid reason for selling. Here are some common high motivation reasons to look out for:
- Health problems
- Disagreements between partners
- Death of the owner
Questions To Ask The Current Owner
A good idea is to spend some time with the current owner and get to know them, how they operate, how they interact with key stakeholders and what they think about the business. You can pick up a few insights into their success by spending time with them in their business.
Ask them questions about the history of the business, current operations and future growth potential. Understand key relationships, potential problems and what skills they believe the new owner needs to have.
9 Steps: How To Buy A Business
Step 1: Self-Assessment
Before you even start looking, you need to ask yourself some questions. What are your skills? What are your goals? Do you have access to financing? What types of businesses could you effectively manage? Doing a self assessment will help you identify the type of business that’s right for you.
Step 2: Market Research
Once you have an idea of what you’re looking for, start researching the market. You will need to check out the competition in that market, take a closer look at customer behavior and what the industry trends are.
Step 3: How To Find A Business To Buy
There are various ways to find a business to buy. You can use business brokers, online marketplaces, or tap into your network.
- Directly from the Owner: One way to find a business to buy is directly from the owner. This often allows for more straightforward negotiations.
- Business Brokers: Business brokers can help you find businesses that match your criteria and budget. They can also assist in negotiations.
- Online Platforms: Websites like BizBuySell offer listings of businesses for sale, sorted by industry, location, and price.
- Networking: Your professional network can be a goldmine for finding businesses for sale. Don’t underestimate the power of word-of-mouth.
Step 5: Due Diligence
This is where you dig deep. Examine the business’s financial records, contracts, and any other relevant documents. You can use our Due Diligence Checklist For Buying a Business to make sure you don’t miss anything. It is important to get this step right. You don’t want to acquire a business that later turns out to be a dead weight.
Here’s a glimpse of what our Due Diligence Checklist covers:
- Financial Documents: A thorough review of tax returns and monthly financial statements to identify discrepancies or red flags.
- Proof of Cash: Verification of reported results through a comparison with bank statements.
- Add-backs: Examination of items added back to net income to arrive at seller discretionary earnings.
- Employee Assessment: A comprehensive look at employee roles, salaries, and benefits to understand the organizational structure.
- Insurance and Software: Evaluation of current insurance policies and software systems to identify any potential future costs.
Step 6: Financial Due Diligence
Financial due diligence is a critical step in the process of buying a business. It involves a thorough examination of the business’s financial records to confirm the information provided by the seller. This step is crucial for assessing the feasibility of your financial projections and making an informed decision.
Here’s what you need to know:
- EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization. This metric gives you a clear view of the business’s operational profitability, excluding external factors like taxes and interest payments.
- SDE: Seller’s Discretionary Earnings. This is an earnings metric used to show the business’s profitability. It includes the owner’s salary and benefits, providing a more accurate picture of the business’s true earning potential.
- NWC: Net Working Capital. This is calculated as current assets minus current liabilities. It gives you an idea of the business’s short-term financial health and its ability to cover its short-term liabilities with its short-term assets.
- QoE: Quality of Earnings. This report assesses the sustainability and quality of a company’s earnings. It helps you understand if the business’s income is recurring or one-time, and whether it’s generated from core operations or other activities. For a deeper understanding, read our blog on QoE.
Financial due diligence aims to identify and explain trends, anomalies, or inconsistencies in the business’s financial performance. It also presents a normalized view of key metrics like EBITDA, SDE, and NWC. This step is not just about number-crunching; it’s about understanding the story those numbers tell about the business you’re considering buying.
Step 7: Business Valuation
Determining the value of a business is probably the most difficult thing to do. There are different methods used, depending on the type of business and its industry. It is a complex process that involves looking at financial statements, assets, liabilities, and cash flow. Midwest CPA can help you with this.
Step 8: Making An Offer
Once you know the business’s value, you can make an offer. This is usually done through a Letter of Intent (LOI), which outlines the basic terms of the deal.
Step 9: Financing
You’ll likely need some sort of financing to buy the business. We’ll cover this in more detail in the section below on “How to get a loan to buy a business”.
Step 10: Closing The Deal
This is where you sign all the paperwork and officially become the owner of the business. Congratulations!
A big part of learning how to buy a business is also knowing what to do post-acquisition. Once you take control of the entity, there are a few key things for you to consider.
The first few months are crucial for setting the tone for your leadership and making any necessary changes. Change is a difficult and unsettling time in any organization. Make sure you have a plan in place for the transition.
A big part of that transition plan will be employees. Will you keep them? Will roles change? How will you manage people? Keeping clear and open communication from the beginning is important.
You should also reach out to key stakeholders, such as your client base and key suppliers to reassure them. Let them know of the change in ownership and any changes that may impact them. They’ll want to be reassured that business will continue as expected with your company.
How To Get A Loan To Buy A Business
Part of learning how to buy a business involves understanding financing options. Banks and financial institutions offer various loan options for buying a business or you could use your own funds. Let’s look at the financing options:
Your Own Piggy Bank
If you’ve got the cash, this is the simplest way to go. But this isn’t an option for the majority of people.
Traditional Bank Loans
Banks offer various types of loans for buying a business. However, they usually require a strong credit score and a solid business plan.
SBA loans have the backing of the Small Business Administration. This makes it easier for you to get the loan and you might even get better loan terms.
How To Buy A Business With No Money
If you think buying a business with no money is not possible, think again. Seller financing and venture capital are options you can explore.
In some cases, the seller will finance part of the purchase price. This can be a good option if you’re unable to secure a traditional loan.
Venture Capital And Angel Investors
If the business has high growth potential, you might be able to attract venture capital or angel investors.
If you already run a business in the same industry and general area of your target acquisition you may be able to use the equity in your own business as a down payment.
Legal Requirements When Buying A Business
You’ll need a Purchase Agreement that outlines every detail of the sale. This should be drafted by a lawyer to ensure that all legal bases are covered.
Licenses And Permits
Make sure you transfer or obtain all the necessary licenses and permits. Failure to do this can result in hefty fines or even the closure of the business.
Remember, buying a business is a big decision, so do your homework, never underestimate the crucial role of financial due diligence in the process of how to buy a business. Book a free consultation with Chris at Midwest CPA today for further advice.
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The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting, or investment advice. You should consult a qualified legal or tax professional regarding your specific situation.