Buying an Existing Business

Buying a business that is already operating is an excellent way to get started and has many advantages. But, as with any business decision, your purchase takes careful thought and research.

The first step is to determine what type of business to buy. This could depend on your personal interests, previous work experience, life style, or a number of other criteria. Make sure that your prospective business fits your needs.

After deciding on the business type, you need to locate a business for sale. You can contact businesses yourself, look in newspaper advertisements, ask friends or acquaintances for suggestions, or get professional help from a real estate broker or consultant.

When you find a business you are interested in, plan to do some serious research and analysis. You need to study the records, ask questions of customers and neighbors, do market research, and learn all that you can about the business. Professionals will be very helpful at this time, especially an accountant and lawyer. Some of the areas to evaluate include:

• Location
• Physical assets such as equipment, fixtures, inventory
• Personnel
• Client base and customer loyalty
• Financial condition
• Products or services offered
• Warranty liabilities
• Business relationships with suppliers, distributors, etc.

How much is the business worth? There is really no simple answer to this question. The fair market value comes down to what the buyer is willing to pay and the seller is willing to accept. A dollar value for a business can be derived in several ways. One is to look at replacement cost; what it would cost to start the business from scratch. Some parts of a business are easy to calculate: inventory, equipment, fixtures, etc. But others are more difficult to put a dollar value on such as customer base, name recognition, and goodwill. Another approach looks at the return on investment. For example, if you expect a 25 percent annual return from your business, you can look at the net cash flow of the prospective business and calculate what it is worth. Many business brokers use an income multiplier, that is, an accepted industry factor which is multiplied by the annual gross income of the business. Another easy approach is to compare with other similar businesses on the market. Professional appraisers may be able to provide a dollar value for businesses.

Now it's time to prepare a purchase offer. This is an opportunity to work with the seller to negotiate the best solutions for both of you. Some common types of business transactions are:

• Outright purchase. The disadvantage of this is that it leaves the seller with little incentive to be concerned with your success as a new owner. If you find a problem, you may have difficulty recovering any money.
• Phased-in purchase. The buyer acquires the business over a period of time, usually three to five years.
• Lease management. The business is leased from the owner for a period of time with the option to purchase at a later date for a specified price and terms.
• Marketing agreement. This is a long-term contract that gives you exclusive rights to market a product within a particular area without buying the entire company.
• Licensing contract. An alternative to purchase in which your product is manufactured and distributed by an existing company.
• Management contract. You manage the business for a fee with the option to buy if the business meets your expectations. As with all business transactions, the terms need to be carefully spelled out.

There are many ways to finance a business purchase. Each has its own benefits and risks. Creativity can be exercised to come up with the best solution for both buyer and seller.

Preparing the purchase offer and closing the sale should be handled with the assistance of your lawyer. Be familiar with the terms of the agreements and the legal documents involved.

Other sites of interest:

• Buying or Selling a Business
• Buying Fundamentals
• Buying a Business Due Diligence Workbook
• Buying a Business
• Buying and Selling a Business
• Business Acquisition Protocol and Valuation Matrix
• Don't Let Anyone Know It's For Sale...But Sell It Quickly

This document was prepared by the San Joaquin Delta College Small Business Development Center. Send comments to: Gillian Murphy

Acknowledgements, disclaimers, etc.