Buying a small business, even a profitable one, comes with surprises in almost all situations. It could be machinery that is currently operating nicely, but only because the owner knows how to fix and repair it and that skill leaves when their contractual term is done. If you haven’t talked to suppliers and vendors to fully learn about the logistics and supply chain demands, there could be favorable terms based on relationships that impact cash flows and won’t be available under new ownership.
These are things that show up in the books, but understanding the “why” the numbers look good only comes from asking the right questions, digging into the details, and learning how the cash flow stabilizes and where new expenses will show up once the current owner exits in full.
Each small business is going to have different surprises and challenges. A small business where the owner is part of the branding and is the face of the company, like family restaurants and trusted service providers, will need to transfer that brand trust to the new owners for a smooth transition. Franchises will have rules and restrictions that privately owned businesses will not face as the privately owned business controls their own operating details, assuming there’s no investors or debt like small business loans or mezzanine financing where collateral could be guaranteed to the financier until the debts are paid off.
Here are 11 things you’ll want to know before you decide to buy an existing small business so you can be prepared and feel confident the purchase is one that makes sense for you.
The Time From Offer to Closing
A privately owned business with no debts and where the owner is ready to exit will close faster than a business whose owners have trade credits, business loans, and investors because there are less third parties that need to approve the sale. If you have a pre-existing relationship with the business owner and have done your due diligence, you could close as quickly as three months, including taking an acquisition loan to cover the costs.
Franchise resales can take anywhere from 4 to 8 months. You’ll want to do your due diligence and study all financials, meet the team, and complete other review steps. Then, you need to get an approval from the franchising company, apply for financing, go through training, and finally do the legal and closing paperwork to take ownership.
For a small business with debts that have collateral like a business loan, investors or stakeholders, you should expect the process to take between 6-12 months. After the due diligence step, you’ll likely be required to sign an NDA, then review the Profit and Loss statements (P&L), find any assets pledged to third parties, get a sign off from investors and stakeholders, and see how many outstanding obligations, such as merchant cash advances, which may need to be settled before the sale
Maintaining Brand Trust
The restaurant or HVAC company you’re buying can have amazing food or a fantastic reputation for showing up on time and late at night, which is why it’s always busy. But this could be the current owner’s family recipes or their interactions with customers, or because the current owner has a trustworthy face and is known in the community, so residents trust them in their homes.
Once the face of the company is no longer there, you’ll need to build that same level of trust and brand with the community. Talk to customers and get honest reactions to the owner selling, see if your style can match the original owners to keep them coming back once their “friendly neighbor” has exited, and create a plan to replace the inevitable churn.
You’ll also want to make sure there is an advertising budget where you can run ads about “new ownership, same great service” or “the quality you love.” Then, begin looking at how you can build on it based on their feedback, so the customer base knows things are about to get even better for them.
Pro-tip: Make sure there is a clause that keeps the current owner engaged long enough to help customers trust you as the new owner. Usually 1 to 3 years is a good ballpark, but many can clear in under 2 years’ time.
Gather All Financial Documents
One of the most vital types of information you’ll need from any business in order to make an informed decision is financial data. Thoroughly examining and understanding the documents included in this list will take time and effort, but is one of the most important steps to help prevent some of the unexpected surprises that come after buying small businesses.
- Financial accounts including bank statements, checking, savings, credit cards, and investments
- Annual reports
- Cash flow statements
- Debt disclosures
- Tax returns
Clear Leases, Liens, and Loans
In most cases, you’re going to need to clear leases, liens, and loans before you can buy the small business if the current owner has likely put up assets for collateral or made personal guarantees that you’ll need to cover. This is a bit more complex in practice, so make sure you’re prepared for this step by researching what is owed and to whom first, then how to clear them.
For a business loan, you can do a loan assumption where the balance due transfers to the new owner, the existing collateral remains the same, and is controlled by a lender. The obstacle you may run into is matching their current personal guarantee if you don’t have the same assets or collateral available the lender will want.
If there are equity investors, you’ll need to convince them that you can run the business equally well or better so that their investment will be put to good use and they’ll get an equal or a greater return.
Check the Books and Ask Questions
Hire a bookkeeper and a licensed CPA (these are two very different jobs) to review the financials and create a detailed list of questions and items that need cleared up to help you know what your financial risks are, and where cash flow is. Licensed, trained, and experienced professionals can find these where someone who isn’t involved in finance day in and day out will likely miss them. Then question the current owner and get a definitive answer to each.
Once the previous owner is gone, you’re stuck with the finances they left behind. It is always better to know the full story before you buy their business rather than find surprises after.
Pro-tip: Hire a licensed business attorney to review the documents, findings, and all of the tiny details in your contract to help ensure you’re covered if things are misrepresented. This helps you have options to recoup losses in a worst-case scenario.
Vendor and Supplier Relationships
Talk to every vital vendor and supplier to see if they provide trade credit or other types of lending. Your goal here is to learn if the current business owner had cash flow gaps and relied on trust from suppliers, and if they’ll be willing to do the same with you once you own the business.
You may also learn about seasonal trends where things get tight and how quickly they clear. By knowing this, you can create a better operations plan to make these periods smoother or a non-issue by spending differently. You may also discover price breaks and deals based on the friendly relationship with the previous owner that may disappear once the owner exits.
Make sure to find backup suppliers and vendors just in case the current ones are not going to provide you with the same options, or if they’re close to selling or closing and won’t be available. This way you can continue to operate without disruption. If there are no alternatives and a vendor goes under, you’ll either need to change your products and services or possibly take over their business too.
Learn the “Real Earnings” Before Signing
Find out what is being run through the business that is actually a personal expense such as personal vehicle costs or family expenses billed to the business. These may not show up on the P&L and will impact profit and revenue.
Ask the accountant and bookkeeper about the Seller’s Discretionary Earnings (SDE), a figure that adds back the owner’s compensation and personal expenses to net profit to show the true total benefit the business provides its owner.”
Buildings, Inventory, and Assets
The business owner may have been using personal assets for part of the operations which can include physical assets like their personal van to do deliveries. If you only have a car and cannot do the deliveries, you’re about to take on more expenses with loans or leases when buying or leasing a van. This is why knowing what is actually owned by the company you are buying and what is used to operate it will help prevent surprise expenses.
Get a full list of assets including:
- Leases and Rental Agreements
- Locations owned and property
- Equipment owned and leased
- Inventory
- Furniture
- Supplies
- Hardware
- Software
- Investment accounts
Pro-tip: Don’t forget to look up insurance policies, warranties, and other protective plans that you’ll want to have covering the business once you take ownership.
Licenses, Permits, Certifications, and Zoning
Businesses may need licenses and permits in some areas where others don’t require them. The same goes for certifications, and zoning laws can change where the business is vs. where you operated in a previous company you owned or worked at.
Once you purchase, you may also need to have them updated with your name, or to get certified to help keep your business in good standing. These might be able to transfer from the current owner, and if they cannot, you’ll want to apply for and get approved before making the purchase.
Pro-tip: Make sure to check Federal, State, and Local requirements.
Employees
If employees are not open to change, they could be disgruntled and impact operations post purchase. There could also be necessary team members that are close to retiring and if they exit with the owner, there will be a gap that is hard to fill.
Spend time bonding with the team and building a relationship before you make a decision. Let them know you’re interested in purchasing the business and gauge their reactions. Get feedback on what could be improved and what works, and you’ll likely find ways to cut costs and increase efficiencies.
Keeping team members that make the business work is key, and if they’re going to leave, you’ll need to invest in hiring, training, and finding ways to keep things running until the new talent starts. This can be one of the most stressful and costly parts of buying an existing small business.
Create a Forecast
Take everything you learned above and create a one-, two-, and five-year financial forecast and then turn this into a business plan. If you are not able to forecast and create an actionable plan, this may not be the best decision, or you may not have gathered everything needed.
If you’re missing information, go back to the current owner and get it. You’re investing your income and future on this purchase. There is zero room for guesswork when it comes to creating projections and a plan. While things will not always go as planned, having them mapped out and a contingency plan in place each step of the way may help to reduce issues as they arise.
If you’ve done your homework and are ready to go to the next step, here’s our guide on how to buy an existing small business so you will know the steps in the process and what to expect. Congrats on considering buying an existing small business, and if you’re ready to finance it, click here and let us help.
National Funding does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
