Building a small business from the ground up can take years. To cut down your launch time, you could buy an existing small business that’s already making sales. But buying a business is a considerable investment, and it’s a decision you need to plan carefully.
Here’s a rundown of how to buy a business, from a few things you need to consider to several different strategies for buying a business at a fair price.
The Pros and Cons of Buying a Small Business
Buying an existing small business has several major advantages over starting your own, such as:
- An existing customer base. When you buy a business, you’re also buying its reputation and customer base. That means there’s already money coming in to help cover the day-to-day operating expenses.
- Trained staff. An existing business usually has trained employees, so you don’t have to spend time hiring people and teaching them how to do their jobs. You might even be able to learn from the staff’s experience.
- An established supply chain and relationships. The business you buy likely already has relationships with vendors for its inventory, equipment, utilities, and other necessary supplies.
- Easier financing. A brand-new business might have a tougher time qualifying for loans, as there’s no incoming cash flow and the business concept hasn’t been proven viable. When you buy a business, the lender can see that there’s already revenue coming in. There’s less risk, so you’re more likely to get the loan.
- No wait time to launch. It can take months to open a brand-new business; you have to find a location, write a business plan, hire staff, and buy all the necessary inventory. Buying an existing business means you’re ready to go from day one.
But there are also potential drawbacks to consider before you think about how to buy a small business.
- Higher initial cost. Buying a small business could be a lot more expensive than starting one from scratch. You’re paying extra for the previous owner’s hard work. And if the previous owner took on any business debts, you might need to take on those debts as part of the deal.
- Older equipment and inventory. If the business has been around for several years, you’ll be using their equipment rather than buying everything brand-new. You might not have the latest upgrades, and the equipment might already have considerable wear. If you need to replace some old equipment, an equipment financing loan can help fund the purchase.
- Culture and reputation. The existing staff will have established its own company culture and formed their own habits. You’ll need to merge your new ideas with what’s already in place. And if the business had any trouble, such as poor reviews, that reputation sticks, even though you had nothing to do with it.
Finding a Business to Buy
The first step in buying a business is finding one for sale. Reach out to people in your personal and professional networks to see whether they have any leads. A warm introduction from a friendly face can start the negotiations on a strong foot. If no one in your network knows of any opportunities, you could search on websites such as BizBuySell and MergerPlace, which are online clearinghouses of businesses for sale.
If that doesn’t work, you can use a lead service, such as Data Axle USA, to pull a list of all the businesses in your target industry in your area. Then, you could cold-call the businesses to approach their owners about a potential deal. 2020 could be a buyer’s market — buyer confidence is at a record high, and 57% of buyers believe they can receive a better deal now than they could last year, according to BizBuySell.
Setting Your Price
If you’ve found the right small business for you, your next step is to figure out a fair purchase price. There are a few valuation strategies that can help guide your offer.
Income Valuation
One option is to set a value based on the business’s earnings. Ask to see the business owner’s financial statements from the past few years, which will show you the business’s sales and profits. If the business is profitable, you could come up with a price based on a multiple of the profits. It’s common to base this valuation on three to five years’ worth of profits, ExitAdviser says.
On the other hand, if the business is relatively new and hasn’t turned a profit yet, you could base your offer on what you and the owner think the business will earn in the future. You’d want to discount the future earnings, as there’s a chance that they might not materialize. An online discounted cash flow calculator or your financial advisor can run that calculation for you.
Asset-Based Valuation
Another option is to tally the business’s assets and derive a valuation from the total. This includes any physical property, such as equipment, real estate, inventory and machinery; you can estimate their value by calculating what they would be worth on the market today. You should also put a value on the business’s intangible assets, like its reputation, existing customer list and staff. Then subtract any existing debts and liabilities from the assets, and there’s your price.
Comparable Deal Valuation
Another way to set your price is to research similar business sales in your area. Averaging sales prices could be a good way to gauge whether your estimate is in the ballpark.
Negotiation Tips
The valuation techniques can help you determine a fair offer, but that’s just the starting point. You’ll need to negotiate with the seller. Here are some tips for negotiating a reasonable closing price.
- Do your research. Owners are often emotionally connected to their businesses, and that could inflate what they think their businesses are worth. Strong research into a fair valuation and local market trends will explain how you go to your offer.
- Consider deferred payments. If the final price is higher than you’d like, you could try to spread the purchase across multiple payments over time, rather than paying it all at once. Or you could make the payments a condition of future profits so that you aren’t stuck paying out more than you take in.
- Negotiate more than the price. Remember to negotiate other factors that could affect the business, such as whether the previous owner pays off the debts they accrued, whether you could get a partial refund if costly problems develop down the line (like if a key piece of equipment breaks), and whether and how long the previous owner stays on to help with the transition.
- Know the owner’s situation. Learn as much as you can about where the owner is coming from. Are they eager to retire? Do they need some quick cash? Are they busy with another venture? These tidbits can give you a bargaining edge. On the other hand, if you’re dealing with a business owner who’s pretty happy where they are, it’s going to be tougher to negotiate a better price.
- Don’t be afraid to walk away. Your terms set the stage for whether you can make this business successful. If the price is too high to make sense, be willing to walk away. There will be other opportunities, so don’t fall in love with just one.
Who Can Help?
Learning how to buy a business can be overwhelming, but you don’t have to go it alone. Many professionals can help guide you through the process.
- Business brokers. A business broker’s job is literally to help you buy a small business. They can find potential deal opportunities, put you in touch with owners and negotiate final sales.
- Valuation specialists. Valuation specialists examine your target business’s finances to determine an appropriate price. They’re neutral third parties, and they can help set a starting point for negotiations.
- Business lawyers. A business lawyer writes up the terms of your sales agreement and processes the legal paperwork to transfer business ownership.
- Accountants. An accountant advises you on how to best structure the purchase to minimize your tax burden. They could also help you prepare financial statements and get you ready to pay the business taxes when you take over.
- Lenders. Running and growing a business involves expenses beyond the purchase price. Small business loans can help you cover these expenses so that you don’t have to draw even deeper into your reserves. Remember: If you’re buying a business with a track record of profitability and positive cash flow, you’re more like to qualify for a small business loan.
By learning how to buy a small business, working with the right professionals and setting up the necessary financing, you’ll give your deal the best chance of success. Then it’ll be time to get to work.
