From the Nolo eCommerce Center
Thinking about purchasing an existing business? Here are some things you should know before you take the plunge.
How can you tell if your business idea will be profitable? The honest answer is, you can’t. But this uncertainty shouldn’t keep you from researching the financial soundness of your idea. Preparing what’s known as a “break-even analysis,” as well as several other financial projections, can help you determine whether or not your business will succeed.
What a Break-Even Analysis Tells You
For some people, buying an existing business is a better option than starting from scratch. Why? Because someone else has done much of the legwork for you, such as establishing a customer base, hiring employees and negotiating a lease. But if you want to buy a business, you’ll need to do some thorough research to make sure that what you see is what you’re going to get.
What Type of Business Should You Buy?
The kind of business you should buy depends on the types of work you’ve done in your life, classes you’ve taken or perhaps special skills you’ve developed through a hobby. It’s almost always a mistake to buy a business you know little about, no matter how good it looks. Not only will you have to struggle up a big learning curve after you buy it, but you might not know enough about the industry to determine whether a particular company is a good value.
In addition to buying a business in an industry that you know, try to choose one that you love. It’s less difficult – and a lot more fun – to succeed in business when you enjoy the work you’re doing.
Finding the Right Business
After you’ve decided what type of business you want to buy, you’re ready to begin your hunt for the perfect company. Consider starting your search close to home. For instance, if you’re currently employed by a small business you like, find out about the present owner’s circumstances and whether she would consider selling the company. Or, ask business associates and friends for leads on similar businesses that may be on the market; many of the best business opportunities surface by word of mouth – and are snapped up before their owners ever list them for sale.
Other avenues to explore include newspaper ads, trade associations, real estate brokers and business suppliers. Finally, there are business brokers – people who earn a commission from business owners who need help finding buyers. It’s fine to use a broker to help locate a business opportunity, but it’s foolish to rely on a broker – who doesn’t make a commission unless he makes a sale – for advice about the quality of a business or the fairness of its selling price.
Research the Business’s History and Finances
Before you seriously consider buying a particular business, find out as much as you can about it: thoroughly review copies of the business’s certified financial records, including cash flow statements, balance sheets and accounts payable and receivable, employee files, including benefits and any employee contracts, and major contracts and leases, as well as any past lawsuits and other relevant information.
This review (lawyers call it doing “due diligence”) will tell you a lot about the company you’re buying and will alert you to any potential problems. For instance, if a major contract doesn’t allow the current owner to assign it to you without the other party’s permission, you should enlist the owner to help you obtain the other party’s consent.
Don’t be shy about asking for information about the business. Here are some other details you should determine before you commit yourself to buying a particular business:
- who holds title to company assets
- whether there is any potential or ongoing litigation
- whether there have been any workers’ compensation claims or unemployment claims made by company employees
- whether the company has consistently paid its taxes, and any potential tax liabilities
- whether any commercial leases and major contracts can be assigned to the new owner
- whether the company has given any warranties and guarantees to its customers
- whether the company owns trade secrets, and how it protects them
- whether the company owns patents and copyrights
- whether the company holds registered trademarks
- whether business licenses or tax registration certificates are transferable
- whether the business is in compliance with local zoning laws
- whether there are any toxic waste or environmental problems, and
- if the business is a franchise, what it will take to get the necessary franchisor approval.
This isn’t an exhaustive list; you should review any business records that will provide you with information to help you decide whether the business is a smart purchase. If the seller refuses to supply any of this information, or if you find any misinformation, this may be a sign that you should look elsewhere for the right business to buy.
Closing the Deal
If you’ve thoroughly investigated a company and wish to go ahead with a purchase, there are a few more steps you’ll have to take. First, you and the owner will have to agree on a fair purchase price. A good way to do this is to hire an experienced appraiser who can estimate the company’s fair market value.
If all goes well, you and the business owner will agree on a fair price as well as other aspects of the purchase, such as which assets you will buy and the terms of payment – most often, businesses are purchased on an installment plan with a sizable down payment.
After you have outlined the terms on which you and the seller agree, you’ll need to create a written sales agreement and possibly have a lawyer review it before you sign on the dotted line. One good resource is Buying a Business: Legal & Practical Steps, by Attorney Fred S. Steingold (Nolo.com), which contains a fill-in-the-blank sales agreement.