If I want to buy an existing business, how do I determine its value and what other factors should I consider in my decision making?
Buying a business requires the performance of certain specific actions:
- Determining whether business ownership is right for you including evaluating your personal characteristics and matching your skills and experience to the business.
- Evaluating buying a business vs. starting from scratch as well as determining the kind of business (retail, manufacturing, etc.).
- Enlisting the aid of advisors
- Establishing search criteria and obtaining and evaluating leads.
- Valuing the potential business and negotiating the price.
- Ensuring that all legal documents are in place whether buyer or seller generated
- Performance of “Due Diligence”.
- Obtaining financing.
Assuming you have determined that business ownership is the right course for you (See FAQ On “Getting Started”) you must establish criteria for buying a business. These criteria should include:
- Type of business ( retail, service, manufacturing, wholesale, franchise)
- Size, in terms of sales
- The desired longevity of the business (how long in business?)
- The minimum and maximum number of employees, daily hours of operation and number of days per week
- Maximum purchase price and minimum down payment
- Annual sales growth potential and desired gross profit margin
- The extent of lienable assets.
You may wish to add other criteria to this list.
Sources for finding businesses which might meet your criteria include, business brokers, classified advertising, trade magazines, placing your own ad in newspapers and trade journals, networking with bankers, lawyers, accountants, family, friends, acquaintances and, of course, the internet ( Google “businesses for sale” or “business franchises”). As indicated in FAQ, “Getting Started”, select a business in which you have first hand operating knowledge.
Franchises offer some advantages, chief among which is that the rate of failure is less than other business acquisition categories. They also have their disadvantages, e.g. you are at the mercy of the franchiser in the on-going operation of your business. Franchises can be pursued in a number of ways. Google “business franchises” on the internet or, go to the franchiser of interest web site, e.g. www.mcdonalds.com.
Valuing a business can be accomplished through a variety of methods almost all of which require a working knowledge of accounting. While it is desirable for every business owner to have some knowledge of accounting, you may need help from an accountant in order to value the prospective business. Here are a few of those methods and while we will not elaborate here on the calculations involved, your SCORE Counselor will have this information available:
- Cash Flow Based
- Adjusted Book Value
- Excess Earnings
- Revenue Based
- Capitalization of Earnings
- Comparable Sales
- Ability to Pay
- Rules of Thumb
Each of these has its proponents but they are best used in combination.
Your new business, even though it is an established business, still needs a business plan. You need it as a roadmap and, if financing is involved, lenders will insist upon it. The good news is that you at least have the business’ history as a foundation for the numbers you are presenting. (See the “Business Plan” FAQ for more information.)
As a buyer, you will want to ensure that there are basic documents in place such as:
Letter of Intent, Sales (Purchase) Agreement including the Parties involved, the Purchase Price and Terms, the Allocation of the Price to accounts receivable, inventory, fixed assets, land, buildings, goodwill, etc., “As Is” Sale, Expenses of Sale, Seller’s Covenant Not To Compete, Contingencies (Conditions Precedent), Prorated Items, etc. A “Consulting Agreement” will be necessary if the seller is going to continue to work for you.
Before completing the purchase, you must perform “due diligence” which is the process of making sure that all representations of the seller about the business are accurate. This involves close inspection of all appropriate records. Documents that you may wish to inspect include:
- All financial statements and tax returns from the past five years including interim financial statements, the results of any tax related audits and all supporting footnotes, disclosures and supporting tables relating to financial statements
- All sales tax reports for the past three years as well as, proof that payroll tax deposits have been made in a timely and accurate manner
- Corporate bylaws, articles of incorporation, board minutes, franchise agreements, property and lease agreements, etc.
- Seller’s disclosure form for real and business property
- Contracts with employees, customers, suppliers and maintenance and security companies
- Copies of loan agreements or other debt obligations
- Appraisals, deeds including any independent appraisal of the business value
- Most recent business plan
- Complete list of furniture, fixtures and equipment and any associated liens
Negotiating has been the subject of many books and you should read at least one of these. Among other aspects, it is important for you to know the technique of incremental negotiation. It can save you thousands on the purchase price. You will also have an advantage if you have based your offer on one or more of the valuation methods mentioned earlier because the seller’s price will probably be an off the cuff number not supported by calculations.
Financing of the purchase can be had from a variety of sources. Debt financing may be obtained from commercial banks and non-bank lenders such as Heller First Capital Corp and CIT Small Business Lending Corp. Equity financing means that a portion of the business is sold in exchange for money needed to purchase the business. This may be obtained through partners, venture capital firms or “Angels” (try “investment angels” on the internet). The U.S. Small Business Administration (SBA) is a major player in the financing of small businesses through its various loan guarantee programs. Go to www.sba.gov on the internet. (See the “Grants and Loans” FAQ.) Don’t discount “Seller Financing” in either the debt or equity categories.
The major source for the information related above is a work entitled, “Buying and Selling Businesses” prepared by Dennis Jones of SCORE Chapter 61, Springfield, MO. and available through your SCORE Counselor. Other sources include various web sites including, www.score.org,