Purchasing an existing business can present a huge opportunity, but it can also be challenging. Due diligence is vital in order for you to avoid common pitfalls and ensure future success. Here are some things to keep in mind if you are considering purchasing an established business.
1. Determine the type of business you want to buy. Franchises can be appealing to those looking to purchase their own business. They often have a proven system, strong brand recognition, pooled advertising, and leadership from the franchisor. However, you are likely to have less control with a franchise than you would with your own standalone business. No matter what kind of business you’re considering buying, it’s important to ensure that your skillset matches the business. For example, if you have no experience in the food industry, buying a restaurant may not be a wise move. The more knowledgeable you are with the industry and business model, the more likely you are to be successful.
2. Find out why the business is for sale. This is where that sage advice: "If it seems too good to be true..." comes in. Don’t let a seemingly good deal shade your ability to see a bad investment. Uncovering the truth about why a business owner is selling can help you better understand the obstacles you may face once the business is under your own management. This isn't to say that you can’t turn around a failing business with the right expertise, but it’s important to consider what it will take to do so. You may want to think twice if a business is for sale for any of these reasons:
• Excessive debt
• Crushing contract obligations
• Too far behind competitors
• Location issues
• Poor brand reputation
• Small or limited market
• Inventory issues
• Zoning or environmental issues
If you do decide to purchase a business that has suffered from any of these issues, you should ensure they’re considered when valuing the business, and you should use them to negotiate a fair purchase price.
3. Get an accurate value of the business. When buying a business, you don’t want to end up paying more than its worth. Remember that an asking price doesn’t necessarily reflect the true value of a business. There are several approaches for calculating the value of a business, many of which rely on reviewing the business’s financials to understand its assets, earnings potential, and market value. You may also consider hiring a business valuation professional to help you accurately estimate the business’s worth. The American Society of Appraisers and National Association of Certified Valuation Analysts can help you find an accredited business appraiser.
4. Understand the full financial picture. Each business is different. It's important to look beyond the business value by reviewing the following documentation from the business:
• Organizational docs and licenses
• Past 3 years of tax returns
• Current financial statements
• Debt and contract obligations
• Inventory quantity and condition
• Building, technology, vehicle, and equipment condition
• Intellectual property (e.g., patents)
• Intangible assets (e.g., goodwill, social media engagement)
5. Evaluate your funding options. Once you’ve decided to purchase a business, you need to determine how you’re going to pay for it. If you don’t have cash on hand, you’ll need to evaluate financing options. This might include loans from family and friends, or more traditional funding sources such as:
• Secured personal loans
• Small business loans
• SBA loans
• Crowdfunding
6. Set yourself up for a smooth transition. If you ultimately do decide to purchase an existing business, you’ll want to make the transition as smooth as possible. As you near final closing, see if you can gain access to the business’s:
• Customer lists
• Branding and marketing materials, e-commerce accounts, and social media profiles
• Employee files
• Operational procedures
• Technologies and accounts
• Vendor information
Buying a business is not a decision that should be taken lightly. It’s important to have a clear understanding of the business you are taking over, and a plan in place to ensure you’ll have the experience, funding, and resources needed to make the business a success. If you are considering buying an existing business in Massachusetts or Rhode Island, BankFive may be able to help. Contact us today to talk through potential financing options, buy/sell agreements, and more.