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Buying an Existing Business

By | June 27, 2016

If you think that starting a business from scratch is too difficult but still want to have your own small business, you have choices. You should consider either buying an existing business, perhaps from an owner who wants to retire, or buying a franchise.

Buying an existing business has both advantages and disadvantages.

Advantages

  • Immediate operation — Someone else has gotten the company started, and once you take over, you can usually continue the status quo.
  • Quick cash flow — Existing inventory and receivables can generate income from the first day.
  • Existing customers — Customers and suppliers have already been located, and relationships with them have been established.
  • Easier financing — Financing is easier to obtain because the business has a track record.
  • Less competition — Buying a business may eliminate a competitor that you would have had if you had started from scratch.

Disadvantages

  • Cost — Buying a business is sometimes more costly than starting one from scratch.
  • Problems — There may be inherent problems in the business, some of which may not be apparent until after the sale. Be sure to find out why the owner is selling.
  • Personality conflicts — You may clash with existing managers and employees.
  • Obsolete goods — Inventories and equipment may be obsolete.
  • Uncollectable receivables — Receivables listed on the balance sheet may be stale and uncollectable.

Getting started. The steps involved in purchasing a business are similar to those you need to take whenever you make any major purchase. You need to locate some good businesses to buy, and then research your first choice thoroughly before deciding to go ahead with the deal.

Caution should be exercised throughout the whole process, not only because it will help you to find the business that is right for you, but it will also help you to avoid being taken advantage of by unscrupulous sellers. Your attorney and your accountant should be actively involved in your search (and they may know of good companies for sale, too).

If you know what type of business you are looking for, trade publications and associations for that industry may be a good place to start your search. Some other places to look are:

  • Newspapers — Most newspapers, and specialized magazines like Entrepreneur and Home Office Computing,, have a classified ad section in which businesses are listed for sale. Some, such as The Wall Street Journal, even have a specific classified section for business opportunities. Be careful. Publications don't screen their advertisers, and there are scam artists out there.
  • Internet — There are many Internet sites that list businesses for sale, and there are more appearing all the time. You can do a general search for sites that offer businesses for sale, or you can do a specific search for the particular type of business you're interested in.
  • Business brokers — One of the benefits of using a broker is that the broker, at least a good one, will screen businesses that are for sale to determine if there are major problems and to make certain that the business being sold exists. The broker will also guide you through the process of selling and help you deal with snags that may develop along the way. However, the broker's fee will probably result in a higher sales price, even if the seller nominally pays the commission.

And here's a hint: You don't have to limit your search to businesses that have been listed for sale. If you find a business that you would like to own, tell the owner you'd like to buy it and make an offer (subject to your attorney's approval of the contract, of course). The worst that can happen is that the owner will say "no."

Once you've found a business. After finding a business that is for sale and that seems a likely prospect for you to run successfully, you should spend at least a month investigating the business. You should definitely get your lawyer and accountant involved in this process, as well.

By thoroughly investigating the business (doing "due diligence," in business-speak), you increase the chances of making a decision that is right for you. The time spent investigating the business, the industry, and the market will make you confident that your decision to buy (or not to buy) was the right one.

In many cases, the seller will not give you any sensitive information about the business unless you have signed a letter of intent that, essentially, makes a non-binding offer for the business, and unless you have also signed a confidentiality agreement promising that you'll use the information only to make a decision about buying.

Keep in mind that if a business is for sale, there must be a reason why. That reason may be a problem you can solve, such as bad management, or a problem that you can't, such as an obsolete product or a poor local economy. A thorough investigation should reveal the existing problems and enable you to weigh those problems in your purchasing decision.

A business investigation is usually performed before the business is bought, but can continue after the sale. In such a case, some of the sales proceeds will probably be held in escrow until the investigation is completed, or your contract may provide that the seller will reimburse you if certain types of problems turn up.

At a minimum, you should examine the following documents:

  • Organizational documents — documents that show how the business is organized, such as partnership agreements, articles of incorporation, and business certificates, should be examined to determine how the business is structured and capitalized.
  • Contracts and leases — documents such as property and machinery leases, sales contracts, or purchase contracts should be examined to determine the exact obligations the business is subject to.
  • Financial statements — examine the financial statements for the past three years (and longer if available) to determine the financial condition of the business.
  • Tax returns — examine the tax returns for the past three years (and longer if available) to determine the profitability of the business and the whether any tax liability is outstanding.

As a final note of caution, when purchasing a business, don't buy the receivables. If you do, at least structure the purchase so that you are reimbursed for uncollectable receivables. This is generally done by establishing an escrow account with part of the purchase price. The account can be used to reimburse you for certain problems that creep up during the first year of operations; any money remaining at the end of the period will go to the seller.

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