Sometimes people who are planning to start their own business consider the option of buying an existing business. This can have advantages if the business is well-established and successful.
But this does not mean you don’t need to do your research and develop your own business plan before moving forward. Starting a business requires a lot of planning and hard work, and so does successfully taking over an existing one.
You may see a business for sale that you believe has a lot of potential. However, you should consider whether that type of business is the right fit for you.
Choose a business that fits your interests, talents and strengths. A successful auto repair business might not be best for you if your background and interests involve the food and hospitality industry.
Take some time to thoroughly analyze the strengths and weaknesses of the business. Look at its financial statements and tax returns for the past three to five years. Be sure you understand where the numbers came from and what they mean.
Look for trends in income and expenses. In today’s economy, there may have been significant recent changes in income and profitability. Be sure you look at both profitability and cash flow. Discuss the numbers with the owner and with your accountant to clear up any questions you may have about its financial situation.
Acquire information about employees, customers, suppliers, leases and contracts. Be sure that you have accurate and up-to-date information on equipment, inventory and receivables.
Many times when owners are trying to sell a business, they overestimate its true value. The selling price may be based more on “getting their money back” from the business than on what it is actually worth.
Don’t expect to pay whatever the owner is asking or make an offer based on what you think they might take. Determine what the business is worth and negotiate from there.
Use an accountant to help determine the value of the business. The current market value of the tangible assets of the business, such as inventory, equipment and supplies, must be determined.
In addition, there may be value placed on the earnings potential of the business based on an analysis of its financial performance.
When evaluating the price, you are paying for the business as it is at the time of the purchase. Some of my clients look at potential cash flow based on an expected sales increase from improvements they plan to make. Because they expect sales to increase after they take over, they are willing to pay more for the business than it is currently worth.
But when you buy a business, you are not paying for what you plan to do to improve the business. You are paying for the business as it is now. Your evaluation of potential cash flow should be based on the current performance of the business.
Also consider that if you are borrowing money to purchase the business, it must generate enough cash to cover the loan. If you pay too much for the business, you won’t be able to make your payments.
Even if the business is doing well, you must develop your own business plan detailing how you will operate and your plans for the future. Issues such as target market, competition, marketing efforts, personnel management and day-to day-operation should be covered.
Also consider how critical the current owner is to the success of the business. In a consulting business, when the current owner leaves, the business may lose the main driver of the revenue.
You need to consider what aspects of the operation you would like to change and the possible impact of these changes on future cash flow and cash needs. Your plans may involve negotiating for the owner to stay on for a few weeks or even months to help with the transition.
The fact that a business is already established and can demonstrate sufficient cash flow makes funding your plans more attractive to a lender than starting a brand-new business. However, lenders will still closely examine the situation to see whether the business’s cash flow can support the loan.
They will want to look at the past financial performance of the business and your business plan with projections. They will also evaluate credit and collateral issues. A lender may look more favorably on your request if the seller is willing to finance some of the purchase.
Be sure that you consider potential liability issues. Have an attorney involved in the purchase process to be sure you are protected.
Buying an existing business can be very rewarding and can be less risky than starting a new business, but you still have to do extensive research and planning to improve your chances for success.
Connie Edwards is a business consultant with the University of Georgia’s Small Business Development Center. Contact her at 651-3200.