How to Buy an Existing Business: A Comprehensive Guide

Buying a business

Many people dream about owning their own business. However, few convert that dream into a reality. Unfortunately for some, the dream of business ownership turns into a nightmare -- often because they do not fully understand the issues surrounding business ownership.

Here is a comprehensive guide to help you through the process of determining whether you should own a business, and hopefully reduce the probability of having difficulties.

Why do you want to be in business for yourself?

People desire to own a business is because of their own particular reasons. These reasons will influence the type of business they should invest in or whether or not they should own their own business.

Ask yourself the following questions to help identify your reasons:

  • What do you hope to achieve from owning a business?
  • How long do you expect to own the business?
  • Do you have the skills and experience to be successful?

Just because you want a business does not mean you should own one, or possibly not owning one just yet. Do you have the skills, experience and capital to operate this endeavour? Evaluate your personal and business attributes and don’t kid yourself.

Personal attributes to consider:

  • How well do you handle people (customers and staff)?
  • Do you handle pressure?
  • Can you delegate?
  • How many hours a week do you want to work?
  • Are you persistent?
  • Are you creative?
  • Do you follow process and complete tasks?
  • How confident are you in your abilities?
  • How realistic are you?

Business attributes to consider:

  • Have you run a business for someone else?
  • What other business exposure have you had?
  • Have you done a small business course?
  • Can you do or supervise the administration side of the business?
  • How good are you at sales?

Other things to consider:

  • What are your strengths and weaknesses? Discuss these strengths and weaknesses with people who know you well and will give you a straight answer.
  • Do your family or partner fully support your decision go into business?  Really probe this issue as owning a business will have a major time and financial commitment and risks.
  • What skills and experience should you develop before you own a business?

Financing the business

Before you start searching in detail to buy a business, you much first know how much can you afford. Your finance broker will be able to give you an indication of the amount of borrowings that a bank may provide. There is no point looking for a business priced at $500,000 if you can only raise finance of $200,000.

When doing your calculations on how much you can invest, don’t forget about any bonds or guarantees that may be required and the transaction costs (professional fees, bank charges and stamp duty), as well as, the level of working capital (inventory and receivables) that you will need to operate the business.

Type of business

Different types of business are suitable for different types of people. The type of business you choose should match your interests, skills and experience.

Here are some clarifying questions:

  • Do you want to work indoors or outdoors?
  • Are you aiming for many customers or few customers?
  • Are you looking for consumer or business customers?
  • Other demographics to consider – age, gender, ethnicity
  • High customer interaction or lower customer interaction
  • High technical skill or lower technical skills
  • High sales component or moderate sales component
  • Monday to Friday 9 to 5 or weekends and/or nights
  • Many staff or few staff
  • Part time or full time
  • How much money do you want to make?
  • Is the business a family involvement or by yourself?

These questions (and more) will assist you in narrowing down the type of business that meets your objectives. As a business broker, I regularly see people buy different types of business to the one that they approached me to buy.

Buying vs. starting a business

Some people are more suited at starting a business, whilst others are better in purchase an existing business. Starting a business may require fewer funds upfront, but make take time to generate a reasonable profit. An established business may make initial profits; however, you will have to pay for that goodwill and there may be risks about the information that the vendor provided.

Business or franchise

Some people are more comfortable in the structure of a franchise business whilst some people could not see themselves paying any franchise fees. If you are considering a franchise, make sure you do your homework on the fee structure, the performance of the franchisees, and litigation issues -- as not all franchises are viable.

Finding a business

The most common ways of searching for a business to buy is to search the internet for sale listing sites. The leading internet listing sites will allow you to refine your search on different criteria such as the business type, location and price. You should also identify any business brokers who operate in the segments of the market that you are planning to buy. I strongly recommend only approaching business brokers who are members of Australian Institute of Business Brokers (www.aibb.org.au).  

The initial review

When you identify a potential business, typically you may be given some preliminary information and then you will be required to sign a confidentiality agreement for any substantive information is provided. After reviewing the initial information, prepare a list of questions to ask the business broker, including the inevitable question: “Why are they selling the business?”

Then, it's time to visit the business and meet the owner. Again, have your questions prepared ahead of time. If they are not willing or able to answer any reasonable questions, be very cautious in progressing. Do not just go to the premises or talk to the vendor directly, without the business broker.

Unless you are very lucky, the business you buy will not be the first business you see.  If the business is not one for you, use this initial review to help clarify your ideal business and determine the reasons for not being interested.

Evaluating a business

After the initial review, if you decide to proceed further, then you will undertake what is called due diligence. This is checking the information provided and determining the viability and profitability of the business. The extent and nature of due diligence will depend on the particular business. Do an internet search on “Buying a Business Checklist.” For more detail guides, talk with your professional advisers. Here are some of the issues to be checked:

  • Financial performance from accounts and income tax returns
  • Trends in the industry
  • Property lease
  • Franchisee agreements
  • Customer profile
  • Suppliers 
  • Specialist skills of employees
  • Staff roster
  • Role of the owner
  • Location
  • Zoning, licenses and permits
  • Insurances
  • Assets to be acquired
  • Material agreements
  • Level of working capital (inventory and receivables) as well as value and age of inventory

Price

Clearly, you do not want to overpay for a business.  

Most small business are valued on what is a called the Capitalisation of Earnings method. This method involves the multiplication of an Earnings figure by an appropriate Capitalisation Rate. Earnings are the assessed profits that can be derived by the business and excludes any one off items. For example, a business with earnings of $100,000 and a capitalisation rate of 3.0 is valued at $300,000.

Use due diligence and other analysis to determine the level of profitability of the business. Profitability is the biggest single driver in the value of most small businesses.

The next component of the Capitalisation of Earnings is called the capitalisation rate. This is the return that an owner seeks for a business, having regard to its risks and growth potential. A business valuer can assist you with this and review the listing price of other businesses.

Two factors to keep in mind:

  1. Ensure you are talking about the same earning figure, as sometimes they are reported as before owner salaries and other time after owner’s salaries. The differences may have a major impact on value.
  2. Agree on what you get for the price you are paying – does it include all assets necessary to operate the business, other than working capital?

Your accountant can assist you in better understanding valuation concepts.

Many industries have valuation rules of thumb. Be wary of these, as most would assume that all business are the same, have the same profitability, growth potential and risks. They are also often out of date. Be prepared to negotiate on a price and walk away if a suitable deal cannot be achieved.

Negotiating the deal

In addition to agreeing on a price for the business the vendor and you, there are other important issues to be negotiated such as:

  • Assignment of lease or new lease
  • Training period
  • Trial period to confirm turnover
  • Staff retention
  • Restraint area and period
  • Assets under finance
  • Other special conditions, franchisor approval, licenses and permits 

Who should assist you?

Unless you are an expert in buying a business, make sure that you have developed a team of advisers to assist you. This team may include a solicitor, an accountant and a finance broker.  Ensure that they are each experts in business (not just conveyancing and tax).

The solicitor will assist you with the business sale agreement and reviewing the property lease and other material documents, such as franchise agreement. If you have partners in the business, the solicitor should draft a shareholders agreement.

The accountant can assist you in reviewing the results of the business, recommend the appropriate business structure to operate the business (company, trust, partnership or sole trader) and help you set up systems to monitor the performance of the business after acquisition.

The finance broker can assist you in finding the finance to buy the business from a bank or other financier.

The settlement process

The process for selling a business is slightly different in each state, so please consult your legal adviser. The business sale agreement will specify what you are acquiring and what undertaking the vendor is making. A key undertaking is a restraint of trade which prevents to vendor from competing against you for a specified period and area.

At settlement, you should be provided with the assets necessary to operate the business such as equipment, assignment of lease, business names, domain name, and telephone number. Licenses and permits will need to be transferred and arrangements on what to do with any assets under finance.

If the business has inventory, you may jointly conduct a stock take or have an external party perform it for you both.

The handover

Typically, the vendor will assist in some form of handover period. They will show you the ropes on how to run the business and may confirm the level of weekly turnover.  Depending on the business, this handover may include a list of customers and suppliers and introduction to the key parties.

You may like to use a video camera or smartphone to record the initial instructions so you don’t forget them. Use this time to write down the processes for each day and each month, or ideally the vendor will have already done this for you.

The first 90 days

Whilst there is a temptation to immediately change things, use the first 90 days to really understand how the business operates. After all, you purchased it because you thought it had some merits.  Once you are on top of the operation, then you can modify things and put your personal touch on it. Also, use the first 90 days to make sure that the business is not too reliant on you.  Most people want to take some holidays, which is difficult if your business cannot survive without you.

The business plan

Preparing a Business Plan is a good way of assisting in the analysis of a particular business.  The Business Plan should be as brief as possible covering the strengths, weaknesses, opportunities and threats, and an action to plan to address the key points for improvement.

Have fun and good luck with your business!


Peter Wallace

Peter Wallace

Non Executive Director at Endeavour Capital

Managing Director of Endeavour Capital, an independent corporate advisory firm specialising in providing solutions to smaller and middle-market Australian companies Our services include acquisitions, business sales, business valuations and succession and exit planning see www.endeavourcapital.com.au or www.endeavourbb.com.au

Endeavour Capital

Endeavour Capital 1 FOLLOWER

Consulting and strategy


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