You'd Better Shop Around Buying an existing business? Smart idea. But before you sign on the dotted line, make sure the business is all it's cracked up to be.
Opinions expressed by BIZ Experiences contributors are their own.
After spending 18 years working for a Fortune 500 corporation,and moving and traveling continually, Ian Mitchell put away hissuitcases in 1997 and went into business for himself. "My wifeand I had been thinking about it for a long time. Our daughter wasin high school, and we decided she needed some stability,"says Mitchell, 53, who bought The Mary Curtis Shop in Concord,Massachusetts, a bustling gift store, decoy shop, printingbusiness, and coffee shop.
Mitchell decided to buy an existing business rather than startone from scratch because he wanted to try something new. "Tostart a business, you need expertise in that field, and Ididn't want to go into the same career," says Mitchell. Hechose the business because it was well-established, showed a goodprofit, and had an experienced staff and an impeccablereputation.
Buying an existing business is an excellent option oftenoverlooked by BIZ Experiencess, according to Russell Brown, author ofStrategies for Successfully Buying or Selling a Business(Business Book Press). Often, the perceptions that deterentrepreneurs from considering buying a business are simply untrue.Many BIZ Experiencess, for example, think buying a business is tooexpensive, or they don't understand the process and areintimidated by the idea of more experienced businesspeople.
Brown urges all prospective business owners to at least lookinto the option of purchasing. "There are so many advantagesto buying a business," he explains. "From day one, youhave existing customers and an immediate income. You also have allthe necessary supplies and equipment, and trained, qualifiedemployees. In many cases, you can use existing suppliers and creditlines, and the necessary licenses and permits are already in place.Add to this free training and consultation from the seller."What could be better?
Buying a business is also usually less risky than starting up onyour own. "You have access to the company's earningshistory, which gives you a good idea of what the business willmake," says Brown. "An existing business has a proventrack record, and most established organizations tend to stay inbusiness and keep making money. When people buy a business, theyalmost always increase sales and profits the first few yearsbecause of the new energy and ideas they bring to it."
And, contrary to popular belief, buying a business is often lessexpensive than starting the same business from scratch. "Anestimated 80 percent of small-business sales are financed by theseller," says Brown. "Generally the buyer has to come upwith 30 to 40 percent in cash, and then owe the seller theremainder."
Of the estimated 6.5 million businesses sold annually, many aresmall, very affordable businesses or firms, according to Tom West,a former business broker and founder of the International BusinessBrokerage Association. West edited The 1999 Business ReferenceGuide (Business Brokerage Press), which gives information onpricing businesses, sample contracts and trade associationinformation, for researching various industries.
According to Brown, "When you buy a strong business thathas a good reputation in the community, as opposed to starting anew one, it's easier to solicit loans from family and friends,or get them involved in a Subchapter S corporation, which allowsthem to become investors."
The Process
So how do you go about buying an existing business? First youneed to find the business that's right for you, which couldtake some digging.
Businesses for sale are advertised in local newspapers and tradepublications, as well as on the Web. You can also contact a localbusiness broker--a person who tracks down buyers for sellers. (Fora referral in your area, call the International BusinessBroker's Association at 703-437-4377.)
Keep in mind that, in most cases, the broker's loyalty lieswith the seller. "A broker has to be honest and deal fairlywith a buyer, but he or she is really working for the seller,"says West. "Because of this, businesses for sale by brokerscan be overpriced. What a broker can offer you, however, is avariety of choices and information."
Another way to find a business is to locate a company you'reinterested in and simply make the owner an offer. "If you finda business that looks successful, and the owner is in his or her50s or 60s and doesn't appear to have any children working forthe company, he or she might be considering selling thebusiness," West says. "Write a letter, or in some wayapproach the owner and ask."
Once you've found the business you want and the owner isamenable, it's time to thoroughly check things out. Thisincludes putting a value on the company and deciding on a purchaseprice. Generally, before looking into the inner workings of thecompany, you need to sign a confidentiality agreement with theseller, which promises you won't divulge anything you learnduring the investigation. At the same time, the seller oftenrequires you to provide detailed financial information aboutyourself to help prove you can run the business successfully andthus will be able to finish paying the seller.
This is also time to pick the proper advisors well-versed inbusiness acquisition, such as an accountant, attorney andbanker.
"Initially, you shouldn't worry about the asking priceof a business," says Brown. "Base your counteroffer onthe business's ability to generate the income and cash flowyou're looking for. In general, during the first year, buyersshould net about the same amount of money they'reinvesting."
To determine the company's earning ability, it'simportant to look at a re-cast net cash flow, says John Collins,president and managing broker for Pioneer Business Corp., abusiness brokerage firm in Huntington Beach, California. This is acomputation of how much the business nets after such things as theowner's expenses and one-time charges are removed. "Itshows a true picture of what the business makes," Collinsexplains.
Also check on the financial history of the company, says CPABonnie Morris of Columbus, Ohio. "Are the payables current?Have payroll taxes been paid on time? Are there any judgments orliens on the business or owner? Does the business have a line ofcredit with the bank that can be used for expansion in the future?Does the company have a good reputation with the local chamber ofcommerce?"
You may also want an asset evaluation of the company, saysMorris. "There are two ways to value a business, by assets orby five year's net income," she says. "When you buy asmall business, you're buying the assets, including any realestate, equipment, even the telephone lines. Depending on thesituation, you may want to hire an accountant or real estateappraiser, who can determine the value of any real estate andequipment."
And be sure to investigate the financing terms available. Howmuch of a down payment does the seller require, and how long willhe or she carry the balance? What will the interest rate be?
Just knowing the business's financial situation isn'tenough, though. "It's important to investigate all thedetails about that business to understand what makes it tick,"says Collins, who suggests you find out the answers to thefollowing questions:
1. Is the location leased? If there's less than threeyears left on the lease, look into getting a new term or aguaranteed extension from the landlord. A good location meansnothing if you have to move out in a year when the leaseexpires.
2. Will the employees stay? A key employee'sdeparture could profoundly affect the business's futureoperations and earnings. Also, is there an employee who can run thecompany in your absence?
3. Who are the customers? Do any of the clients accountfor more than 10 percent of the business's gross sales? Doesthe company have a binding contract with these customers?
4. What about training? Is the owner willing to stay fora specified period of time to train you or at least be availablefor phone consultations? Is there a key employee who can trainyou?
5. Who's your competition? Check the surrounding areaand industry records. If you're planning to buy a doughnut shopand another one is due to open down the street, the company may notbe such a good investment.
6. Who are the suppliers? Are they in good shapefinancially and able to continue providing you with necessarysupplies? Does the business have lines of credit with them?
7. Are there any licenses or patents due to expiresoon?
8. Is the company adequately insured?
9. Is the equipment in good working order? How old is it,and are there warranties or service agreements? What are the termsof those agreements and when do they expire? If property isinvolved, what kind of shape is it in?
10. Is there anything occurring in the industry that haslong-range implications for the business? If, for instance,it's an import/export business and a new law will prohibit thesale of your product to certain countries, this could negativelyaffect earnings. Or worse, the product or service could be indanger of becoming obsolete. Locate such critical information fromtrade journals and trade associations, or consult a broker orbusiness consultant who specializes in that industry.
11. Are there any judgments or lawsuits lurking? Has anemployee filed a discrimination or sexual harassment complaint? Ifso, you need a contract that holds you harmless from futureactions.
While digging this deep may seem excessive, it's definitelya good idea to do your homework, says Jim Nakashima, co-owner ofThe Crab House Restaurant in Camarillo, California, who bought thebusiness with his partner, Mike Lagomarsino, 31, in 1998.
"Although the purchase went well and I'm glad wedecided to buy, we didn't check the restaurant's backgroundenough," says Nakashima, 41. "The previous ownersdidn't disclose the restaurant had been shut down due to healthviolations in the past. This came as a big shock when the newspaperdid a story covering local restaurants that had been shut down. Wehad to do a lot of advertising and assure customers the place wasunder new ownership."
Basic Instincts
No matter how thoroughly you look in to the background of acompany, there comes a point when you must simply trust yourinstincts. "If something doesn't seem right, don'tbuy, but otherwise, be willing to make that leap of faith, becausethere's no such thing as a sure thing," says West.
When it came to purchasing The Crab House, Nakashima relied onhis instincts. "After looking at the numbers, it didn'tmake sense to buy the restaurant, but I had a feeling it wasn'tbeing managed properly and that my partner and I could turn itaround," he says. "Fortunately, I was right. The firstmonth we showed a profit, and we've been increasing sales eversince. We bought the business for $235,000 when it was making$600,000 a year, and in the first 10 months of operation, we mademore than $900,000. This year we're looking at $1.2 million,and we just signed a lease for another location."
Certainly you should do as much research as possible. But, saysMorris, "[You should also] listen to your intuition. If youfind a company that isn't doing well, but you think you canturn it around, buy it and try."
What do sellers look for?
Okay, so you know what you want in a business. But what aresellers seeking in a buyer?
"While sellers want to sell, they also want a new owner whocan make the business successful because in most cases, you'llowe them money," says Tom West, founder of the InternationalBusiness Brokerage Association.
Here are a few things that sellers look for in a buyer:
- Financial ability to pay the down payment and futurepayments.
- Knowledge, or at least a good understanding, of how tosuccessfully run a business.
- A willingness to learn whatever it takes to make thatparticular business a success.
- A realistic understanding of how much income can be generatedfrom the business each year.
The Search Is On . . .
There are businesses for sale everywhere. Check out these Websites:
Julie Bawden Davis is a writer in Orange, California, whospecializes in small- and homebased business issues. She frequentlywrites for the Los Angeles Times, the San FranciscoChronicle and Business Start-Ups.
Contact Sources
The Crab House, 350 N. Lantana, Camarillo, CA 93010,(805) 987-4979
The Mary Curtis Shop, 33 Main St., Concord, MA 02043,(978) 369-2237
Bonnie Morris, (614) 863-5730, fax: (614) 863-1812
Pioneer Business Corp., 9042 Garfield Ave., #312,Huntington Beach, CA 92646, (714) 964-7600
RDS Associates Consulting Firm, (800) 363-8867, http://www.businessbookpress.com
