While starting a business from scratch sounds exciting, it's risky because it's the most difficult way to get into business. A better option for many entrepreneurs is to buy an established business. Buying a going concern shortens the learning curve, reduces the costs of "on-the-job training" and helps you avoid many of the errors you might make in developing your business from the ground up. In an already existing business, everything is in place, from customers to a credit line at the bank.
Keep in mind that all businesses for sale are for sale for a reason. And it's up to you to discover what that reason is, whether it's financial or personal. Do your homework and investigate thoroughly before you even consider investing. The areas and documents you want to make sure you investigate include:
- Furniture, fixtures, equipment, and building status
- All contracts and legal documents
- Incorporation paperwork
- Tax returns
- Financial statements
- Sales records
- Complete list of liabilities
- Accounts receivable
- Accounts payable
- Debt disclosure
- Merchandise returns
- Customer patterns
- Marketing strategies
- Advertising costs
- Industry and market history
- Location and market area
- The business's reputation
- Seller-customer ties
- List of current employees and an organizational chart
- Occupational Safety and Health Administration (OSHA) requirements
- Product liability
Don't be too anxious when you're looking to buy a business. Take your time and recognize that businesses typically don't sell overnight. And make sure to avoid these practices:
Buying on price. Buyers don't take into account ROI. If you're going to invest $20,000 in a business that returns only a three-percent net, you're better off putting your money in a CD or municipal bond.
Running out of cash. Some buyers use most of their cash for the down payment on the business and don't reserve enough for working capital. This is folly of the worst kind, putting the business' future on the line. Cash is king and needs to be managed thoughtfully. As a rule of thumb, at least 10 percent of your cash should be considered contingency funds and at least three-months worth of operating expenses should be set aside as working capital.
Buying all the receivables. It generally makes good sense to buy the receivables, except when they're 90 days old or older. The older the account, the more difficult it will be to collect. You can protect yourself by having the seller warrant the receivables--what's not collected can be charged back against the purchase price of the business. Receivables beyond 90 days belong to the seller for collection.
Failure to verify all data. Most business buyers accept all the information the seller gives them without doing due diligence (preferably by a CPA who can audit financial statements). Heavy payment schedules. During the first year or so, it makes sense to have smaller payments, graduating to larger payments as the business grows and becomes successful. This can easily be negotiated with a seller.
Buying a business is a complex and highly emotional transaction. To make the best decision and achieve the most favorable terms, be aware of your emotions at all times, as they reveal why you're passionate about a particular business. And don't forget to bounce your thoughts and feelings off your attorney, CPA, and other advisors.