Buying an established business is a great way to save on startup costs and avoid the growing pains associated with new ownership, such as product launches and customer acquisition. It’s not without its risks, however, and closing deals isn’t always easy. Here, we’ll show potential owners how to buy an existing business.
Find a Likely Candidate
How to buy an existing business? Even when you’re working with the best business brokers in Austin, deciding which type of company to buy is the first and most important step. For instance, boutiques and shops are a great fit for those with retail experience.
It can be tough—if not impossible—to succeed in certain industries without passion and experience. Buyers who go in with basic knowledge start at an advantage because they are more likely to understand the industry’s challenges, opportunities, and trends.
Look at the Company’s Reports
Next, potential buyers should determine whether a business is worth its asking price. There are multiple valuation methods based on balance sheets, projections, and earnings, including:
- Asset-based. These valuations involve adding up the market value of the company’s assets, including certain intangible assets, such as patents, and deducting liabilities like lines of credit, mortgages, and other debts. The asset-based valuation method is well-suited for distressed companies, not necessarily those companies that will remain as going-concerns.
- Market. The market valuation approach looks at past sales of other companies in the same industry, setting a price based on those numbers. Market valuation only works if a buyer or broker can find comparable companies that sold recently and made their terms public.
- Income. An income-based valuation requires an estimate of the business’s expected cash flows over a predetermined period, as well as the terminal value of annuity-like cash flows. Income-based valuation strategies are best used when it’s easy to forecast a company’s future earnings.
Some valuators combine multiple methods, such as income- and market-based approaches. In any event, valuing a business is a complex process, and buyers would be well-served to consult a valuation company or a business brokerage that focuses on valuations.
Submit a Letter of Intent
In the business world, letters of intent are non-binding agreements that convey a purchaser’s intention to buy a business. When these letters are submitted, the issuer usually gets refusal rights, which means they get the first chance to buy a company—even if other buyers come along through an exclusivity term. Letters of intent show business owners that buyers are serious, which makes them more likely to share in-depth legal, tax, and financial information.
Perform Due Diligence
As part of the purchase process, buyers should research their targets to ensure that there are no expensive surprises after closing. Known as due diligence, the process gives potential purchasers an opportunity to examine a company’s financials, tax records, operations, and legal records. Before committing, look at the company’s:
- Permits and licenses. Check with state and federal agencies to determine whether the company is in good standing and which types of permits and licenses the government requires.
- Tax and bank records. Ask for copies of recent income, property, payroll, sales, and excise tax returns, along with bank statements. Then, verify whether the seller’s documents match reported banking and tax activity. Finally, ensure that there are no tax liens on the company.
- Environmental and zoning rules. If you’re buying a brick-and-mortar business, ensure that it complies with zoning laws and environmental requirements.
- Status of assets. Review the company’s loan and lease agreements to ensure that it owns all the assets included in the sale, that those assets are valued accurately, and there are no hidden liabilities included.
- Contracts. Read all business contracts to learn how they’ll affect the transition. For instance, if the company’s profit predictions were based on a single vendor or customer contract, is the agreement transferable? If a building is under lease, ensure that the lease’s terms won’t change. It is a good idea to ask the seller to sign a non-compete agreement.
- Organizational structure. A company’s organizational structure outlines workflows, the chain of command, and the ways in which information is passed down through the hierarchy. Do some management team members face excessive reporting requirements? Are some parts of the company overstaffed while others are stretched too thin? Who is responsible for financial reporting, business development, sales, and other crucial functions? Getting the answers to these questions will leave you with an idea of what to expect as the new owner.
Finally, business buyers should consider the legal ramifications of their purchases. When working with a brokerage to close a sale, be sure to investigate any pending or threatened litigation involving the company or its current owner. While this is why most deals are asset purchases, as opposed to stock purchases, being knowledgeable about pending litigation is a must.
Once you’ve found a business to buy and learned all about it, there are several ways to pay for the purchase.
- SBA or Small Business Administration loans. The SBA’s 7(a) lending program allows business buyers to borrow a maximum of $5 million to buy a company, secure working capital, and purchase fixtures, furniture, and equipment. While these loans are backed by the US government, they’re available from approved lenders.
- Term loans. Some financial institutions offer loans to help aspiring entrepreneurs acquire businesses, but qualifying can be a challenge. Term loans are typically only available to business buyers who have great credit, a history of success, and plans to buy companies with sizable holdings. Despite these difficulties, term loans are still a worthwhile option for buyers who want to buy a business with more than $2 million of EBITDA or greater.
- In-house financing. In some cases, a company’s current owner may loan a potential buyer the money to make some of the purchase. Usually this is 0% -30% of the purchase price, but not 80%-90%.
- Partnerships. Do you have the knowledge to run a business, but lack the funding to get started? Consider finding a partner who can make the investment. Partnerships come in various forms. For example, a silent partner will provide funding but stay out of day-to-day decisions, while a private equity sponsor will provide support, guidance, and professional connections.
- Personal funding. If you’ve held onto some money, tap into those savings to cover the purchase.
Many business buyers combine one or more of these funding sources to close deals. For example, it’s possible for buyers to use their own money along with a bank or SBA loan.
An Extra Step: Closing the Deal
After performing due diligence, agreeing to a price, and securing financing, it’s time to close the deal. Most business sales are structured in one of these two ways.
- Asset purchases. Here, the buyer starts a new entity but transfers the DBA, while the buyer gets all the company’s assets, including inventory, intangibles, equipment, customer lists, and patents.
- Stock purchases. In this type of takeover, a buyer acquires a business’ stock, along with its liabilities, contracts, and assets.
Each method has its benefits and disadvantages, and it’s best to discuss your chosen transaction type and its tax, financial, and legal consequences with your legal team before signing a purchase contract. An attorney can help by updating leases, contracts, agreements, and other documents after the sale has been finalized.
The Benefits of Buying an Established Business
While there are a few pitfalls to consider, the benefits of buying a business typically outweigh the risks. Advantages include:
- Simplified customer acquisition. Existing businesses come with established customer bases, so new owners don’t have to spend all their time testing products, trying new services, and generating new leads. Rather, they can focus on retaining the customers they’ve acquired.
- Easier financing. In most instances, buyers of existing businesses find it easier to get financing than they would if they were running a startup, simply because these businesses already have histories.
- A greater chance of survival. Many new companies fail within the first several years. Corporate takeovers, however, come with much higher survival rates than startups.
- A shorter launch. While buying a company comes at a significant upfront cost, it’s easier to turn a fast profit because there’s no need to purchase inventory, find vendors, and hire employees.
- Experienced and trained workers. Like buying existing equipment and inventory, acquiring a trained workforce is an asset to a new business owner, especially if they’re getting into a new industry. These workers will know how the business operates, which will save money and time on hiring and onboarding.
- Cash flow. Because existing businesses have their customer bases, staffing, and processes established, a new owner can generate positive cash flow on the first day. By comparison, a startup owner may take several months—or even years—to see a profit.
- Brand recognition. Another reason to buy an existing company is that it already has a market presence and a brand. This will help a new owner save energy, time, and financial resources that they’d otherwise spend building a brand and putting their products and services in front of customers.
Whether you’re looking to branch out into a new industry or gain ground in an area where you already have experience, buying an existing business is an excellent way to achieve your goals. Count on the team at CGK Business Sales for the advice, expertise, and help needed for a successful purchase. Hopefully this article has been helpful as to how to buy an existing business!