You'd Better Shop Around

The Process

So how do you go about buying an existing business? First you need to find the business that's right for you, which could take some digging.

Businesses for sale are advertised in local newspapers and trade publications, as well as on the Web. You can also contact a local business broker--a person who tracks down buyers for sellers. (For a referral in your area, call the International Business Broker's Association at 703-437-4377.)

Keep in mind that, in most cases, the broker's loyalty lies with the seller. "A broker has to be honest and deal fairly with a buyer, but he or she is really working for the seller," says West. "Because of this, businesses for sale by brokers can be overpriced. What a broker can offer you, however, is a variety of choices and information."

Another way to find a business is to locate a company you're interested in and simply make the owner an offer. "If you find a business that looks successful, and the owner is in his or her 50s or 60s and doesn't appear to have any children working for the company, he or she might be considering selling the business," West says. "Write a letter, or in some way approach the owner and ask."

Once you've found the business you want and the owner is amenable, it's time to thoroughly check things out. This includes putting a value on the company and deciding on a purchase price. Generally, before looking into the inner workings of the company, you need to sign a confidentiality agreement with the seller, which promises you won't divulge anything you learn during the investigation. At the same time, the seller often requires you to provide detailed financial information about yourself to help prove you can run the business successfully and thus will be able to finish paying the seller.

This is also time to pick the proper advisors well-versed in business acquisition, such as an accountant, attorney and banker.

"Initially, you shouldn't worry about the asking price of a business," says Brown. "Base your counteroffer on the business's ability to generate the income and cash flow you're looking for. In general, during the first year, buyers should net about the same amount of money they're investing."

To determine the company's earning ability, it's important to look at a re-cast net cash flow, says John Collins, president and managing broker for Pioneer Business Corp., a business brokerage firm in Huntington Beach, California. This is a computation of how much the business nets after such things as the owner's expenses and one-time charges are removed. "It shows a true picture of what the business makes," Collins explains.

Also check on the financial history of the company, says CPA Bonnie Morris of Columbus, Ohio. "Are the payables current? Have payroll taxes been paid on time? Are there any judgments or liens on the business or owner? Does the business have a line of credit with the bank that can be used for expansion in the future? Does the company have a good reputation with the local chamber of commerce?"

You may also want an asset evaluation of the company, says Morris. "There are two ways to value a business, by assets or by five year's net income," she says. "When you buy a small business, you're buying the assets, including any real estate, equipment, even the telephone lines. Depending on the situation, you may want to hire an accountant or real estate appraiser, who can determine the value of any real estate and equipment."

And be sure to investigate the financing terms available. How much of a down payment does the seller require, and how long will he or she carry the balance? What will the interest rate be?

Just knowing the business's financial situation isn't enough, though. "It's important to investigate all the details about that business to understand what makes it tick," says Collins, who suggests you find out the answers to the following questions:

1. Is the location leased? If there's less than three years left on the lease, look into getting a new term or a guaranteed extension from the landlord. A good location means nothing if you have to move out in a year when the lease expires.

2. Will the employees stay? A key employee's departure could profoundly affect the business's future operations and earnings. Also, is there an employee who can run the company in your absence?

3. Who are the customers? Do any of the clients account for more than 10 percent of the business's gross sales? Does the company have a binding contract with these customers?

4. What about training? Is the owner willing to stay for a specified period of time to train you or at least be available for phone consultations? Is there a key employee who can train you?

5. Who's your competition? Check the surrounding area and industry records. If you're planning to buy a doughnut shop and another one is due to open down the street, the company may not be such a good investment.

6. Who are the suppliers? Are they in good shape financially and able to continue providing you with necessary supplies? Does the business have lines of credit with them?

7. Are there any licenses or patents due to expire soon?

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 terms of those agreements and when do they expire? If property is involved, what kind of shape is it in?

10. Is there anything occurring in the industry that has long-range implications for the business? If, for instance, it's an import/export business and a new law will prohibit the sale of your product to certain countries, this could negatively affect earnings. Or worse, the product or service could be in danger of becoming obsolete. Locate such critical information from trade journals and trade associations, or consult a broker or business consultant who specializes in that industry.

11. Are there any judgments or lawsuits lurking? Has an employee filed a discrimination or sexual harassment complaint? If so, you need a contract that holds you harmless from future actions.

While digging this deep may seem excessive, it's definitely a good idea to do your homework, says Jim Nakashima, co-owner of The Crab House Restaurant in Camarillo, California, who bought the business with his partner, Mike Lagomarsino, 31, in 1998.

"Although the purchase went well and I'm glad we decided to buy, we didn't check the restaurant's background enough," says Nakashima, 41. "The previous owners didn't disclose the restaurant had been shut down due to health violations in the past. This came as a big shock when the newspaper did a story covering local restaurants that had been shut down. We had to do a lot of advertising and assure customers the place was under new ownership."

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This article was originally published in the August 1999 print edition of Entrepreneur with the headline: You'd Better Shop Around.

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