How to buy a business: Follow these 6 simple steps
- Understand your target industry
- Identify your target company
- Do your due diligence
- Establish the business value and price
- Compare lenders and get financing
- Close the deal
Buying an existing business is expensive but can be a rewarding investment if done right. Price alone should not dictate the business you purchase. From your personal expertise to industry conditions and company goodwill, there are several factors to consider when you’re in the market to buy. These six steps will help you get a handle on the basics of what it takes to purchase a business.
1. Understand your target industry
To successfully run a business — and convince a lender to provide the financing to purchase it — you need experience in that particular industry or a similar field. Narrow down your options to those that align with your experiences, skills and passions.
Consider what kind of licensing and regulations will affect your product or service. Is the product or service tangible or intangible? Are you selling locally, nationally or internationally? Is the business in a heavily regulated field, such as energy, finance or medicine?
Location is also an important factor, as it affects not only the taxes and regulations that apply to the business but your lifestyle as a business owner. Do you want to operate a brick and mortar location or work remotely?
Size dictates how your business operates as well. Do you prefer a small business with lots of client interaction or a larger corporate environment where you take more of an advisory role?
2. Identify your target company
Once you have an idea of what sort of business you are interested in, it’s time to start shopping. There are several online marketplaces where business owners list companies for sale, but one of the best ways to find a potential acquisition is through networking. Attend industry conferences and happy hours to meet potential sellers as well as experts associated with the industry who may be able to refer you to sellers.
Oftentimes business owners are not actively advertising their company despite having thought about selling, and a conversation can pique their interest. Don’t be afraid to approach business owners who are not advertising to see if they are willing to sell.
If you don’t want to do the legwork of seeking out businesses, you can hire a business broker. Much like real estate agents, brokers help you identify businesses that match your requirements, assist in the negotiation process and handle some of the sales paperwork. These services can cost roughly 10 percent of the purchase price. It is important to remember that most business brokers work for sellers. Regardless, be sure to work with a professional team that represents your interests in the purchase, a move that is imperative in the next step of the process.
3. Do your due diligence
Arguably the most important part of a business acquisition, once you have identified an attractive business opportunity, you need to conduct a thorough assessment of it. At a minimum, you should hire an acquisition attorney and certified public accountant with experience in business purchases, regardless of whether you hire a business broker. As you will become liable for any issues with the business — past and future — this is not an area in which to skimp.
Your legal and accounting advisors assess all of the business’ tax returns, financial statements, contracts and legal documents. The following questions are a good place to start when evaluating the company:
- Why is the business for sale?
- What is its growth and profitability outlook?
- Are there any outstanding liens, pending litigation and disputes or tax audits?
- How is the business’ credit history?
- Does it have all licenses and permits required to operate? Will renewing them be an issue?
- What special regulations does the business face?
- Who are its local, national and international competitors?
- Is the business dependent on one key client or vendor?
- What kind of reputation and market goodwill does the business have?
Speak to several clients and suppliers to get an understanding of where the business stands in its industry and any challenges they can identify.
4. Establish the business value and price
There is no single rigid way to appraise a business. Common methods include book value or net worth, which is the difference between assets and liabilities; return on investment for the buyer after purchasing the business; and capitalized earnings, which projects future earnings relative to other investments such as stocks and bonds. Ultimately, it is up to you and your accountant to determine an accurate valuation based on the factors important to you.
With that figure in mind, negotiate a fair price with the seller. Try to identify how quickly the seller wants to exit the business and leverage that knowledge to negotiate. When it comes to small businesses in particular, a human connection can be very powerful. Business owners who have spent their lives building their companies most likely want to see their legacy carried on. Demonstrating your intention to continue to grow the business can sway a seller to choose you over another buyer with a less personal touch.
How you plan to finance and structure the transaction can also affect the price. A seller who isn’t willing to budge on price might agree to take monthly payments through seller financing. If the seller is keen to get maximum cash in hand, they may be willing to accept a lower figure if it is paid in a lump sum.
5. Compare lenders and get financing
While purchasing a business is typically less risky than starting your own, lenders nonetheless want to see a company with a history of strong cash flow and creditworthiness. They also evaluate the borrower’s personal experience in business management or the industry in question, and a business plan outlining the transition and years ahead.
Financing a business acquisition typically takes a mix of strategies. Most conventional term loans and U.S. Small Business Administration (SBA) loans require a minimum equity injection of 10 to 30 percent, depending on your credit history, as well as available collateral and the strength of the business.
Oftentimes buyers raise money for the down payment in a few ways, including through seller financing, where the seller acts as a lender on a portion of the business; tapping into retirement funds through a rollover for business startups; or selling non-voting shares of the company to employees.
Compare lenders to see what options are available, but be aware that a formal application will result in a hard credit inquiry, which can hurt your credit score.
6. Close the deal
Once you have agreed on a price and obtained financing, you and the seller need to complete several closing documents, including the sales agreement your lawyer drafted. You may also need to apply for authorizations such as a new business license and federal employer identification number. The SBA has a checklist of documents needed to close a business acquisition. Set aside enough time for your lawyer to review everything in detail before proceeding.