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Updated on Tuesday, April 16, 2019
Buying an existing business can be an efficient way for an aspiring entrepreneur to get their foot in the door as a business owner.
More than 10,000 businesses changed hands in the U.S. in 2018. You could take over an operation that already has a proven business model and an established brand. If you’re lucky, the business would already have positive cash flow.
“There’s all kinds of scenarios where you might want to buy an existing business rather than start your own,” said John Bartelme, a SCORE mentor based in Durham, N.C. SCORE is an organization providing business education through mentoring and workshops in partnership with the U.S. Small Business Administration.
An opportunity to buy an existing business may arise if the owners of your current workplace decide to sell. You might consider buying the business if you have already spent a significant amount of time working for the company, learning the ins and outs, Bartelme said. For current business owners, buying another company in your industry would allow you to grow your enterprise, he said.
Another instance when you might buy an existing business would be when one goes up for sale in an industry in which you have interest, like restaurants, Bartelme said. But purchasing a business without any industry experience can be a risky move. You may not necessarily be suited to run a restaurant just because you like dining out, he said.
Before you take over an existing operation, we’ll help you decide whether buying a business is the right choice for you.
How to buy an existing business in 5 steps
To organize the purchase process, consider this as your checklist for buying an existing business.
1. Consider your skill set
To give yourself a better shot at success, consider purchasing a business that matches your existing skills and knowledge, Bartelme said. If you already know the industry, you would be in a position to improve and strengthen the business you’re buying.
On the other hand, when you purchase a franchise, the franchiser would provide guidance and a business plan for you to follow as you learn the ropes, Bartelme said.
“Buying a franchise is a way to go for a lot of people who have no prior experience in that area,” Bartelme said. “The need to be competent in that kind of business is less a factor than it would be in some other businesses where you don’t have that support.”
2. Estimate the value of the business
Before making an offer on an existing business, you need to know what it’s worth. The seller would likely determine the value, but you should make your own estimation, Bartelme said. He suggests hiring an independent, third-party valuation firm to appraise the business. Hiring a valuation firm will be an extra expense, but it could save you from overpaying, he said.
“What a person thinks their business is worth versus what it’s actually valued at can be quite different,” Bartelme said.
There are several methods to determine the value of a business. If you’re experienced in finance and accounting, you may be able to value the business on your own. If not, consider hiring an accountant or valuation firm to appraise your business.
These are a few common valuation approaches:
- Capitalized earning approach: Value is based on the expected return on investment.
- Excess earning method: Similar to capitalized earning approach, but the investment return is separated from other earnings.
- Cash flow method: Value is based on how much cash flow can support any type of financing, like a business loan.
- Tangible assets, or balance sheet, method: Value is based on the business’s tangible assets.
- Intangible assets method: Value is based on the potential worth of specific intangible assets.
3. Do extensive research
You should understand the facets of the industry in which the business operates, as well as all details about the business itself. After expressing an interest in the existing business, you may be able to sign an agreement that gives you access to financial records in exchange for confidentiality. Review all recent tax returns, financial statements and banking records to get an idea of the financial health of the business.
You may want to hire an accountant or analyst to help you pore over documents. They could spot red flags that you might miss. For instance, if the business is relatively cheap, there’s probably a reason why. The brand reputation could be damaged, or the markets may have rejected the business’s products or services.
4. Figure out your financing options
Unless you can pay the price of the business in full, you’ll likely need some form of financing to cover the purchase. You could work out a number of creative financing deals with the seller, Bartelme said, depending on your relationship. For example, the seller may offer you a deal that would allow you to put down a portion of the cost upfront and pay the rest in installments, Bartelme said.
“They might be agreeable to selling it to you over a time frame,” he said. “But you don’t want to begin talking about that until you’ve agreed on a sale price.”
In some cases, the seller might hold on to the title of the land or building where the business is located and lease it to you, he said. You would purchase the business itself, but not the property.
You might have to turn to a small business lender to obtain extra capital. Before borrowing money, make sure the business is able to support loan payments.
Consider starting your financing search with LendingTree, MagnifyMoney’s parent company. On LendingTree’s platform, there are dozens of business lenders there to compete for your business. You simply fill out a short form online and can be matched with offers from up to five lenders based on your creditworthiness.
5. Make an offer
Once you have a clear idea of what the business is worth and how much you can afford to spend, you would present an offer to the seller. This is where an independent valuation would come in handy, Bartelme said. Both parties could negotiate based on that figure.
Sellers are often overly optimistic about what the business is worth, Bartelme said. Expect the seller to try to get the largest amount for their business, especially if it’s a family-owned operation.
“Typically for a family business, this has been their life,” he said. “They’re emotionally connected to it, and rightfully so.”
Including business experts like brokers, accountants, lawyers, certified valuation analysts or advisors in the negotiation process could ensure that you make your best deal. They could also help you shape a plan to operate the business successfully going forward.
Pros and cons of buying an existing business
There are several benefits to buying an existing business, as well as downsides to taking this route into business ownership.
- Opportunity to improve an established company: After completing your research and due diligence, you would be able to see how you could make your mark on the business and grow the company.
- Potential financing from the seller: Rather than borrowing money from a business lender, you could work out a deal with the seller to finance the business. You may be able to pay off the purchase over time without the help of a bank or lending institution.
- Existing position in the market: Instead of starting from scratch, you would be able to rely on the business’s existing customer base and brand awareness. Ideally, the business would already have positive cash flow.
- Could be more expensive than starting a new business: When you purchase an existing business, you have to start spending money immediately to keep it operational. A large business could require a sizable amount of capital. Not only would you need to pay the purchase price, but you may have to hire additional employees, remodel the building or upgrade equipment. You could spend less by starting a small business that you could grow over time.
- Surprises after closing the deal: If you didn’t take enough time to research the business – or even if you did – you could come across problems after the purchase is finalized. You may realize complications within the business when it’s too late. You could find that the previous owners misrepresented financial data or didn’t disclose much-needed repairs to the building. You could also inherit disgruntled employees, outdated equipment or unreliable suppliers.
- Existing structure could be difficult to change: You might have a hard time making changes to products, services or internal processes after buying an existing business. You would be inheriting the structures that your predecessor set up, and it could take time to implement your ideas.
What’s next as the sale wraps up?
The closing process typically takes 30 to 60 days, depending on the complexity of the sale. During this time, you should take a final look at all sales documents and financing agreements. Be sure to check titles and ownership documents for all assets that are transferring as well.
There’s typically a transition period when new ownership takes over a business, Bartelme said. It’s not uncommon for the previous owner to stay on board as a consultant. They may agree to a consulting contract for the first year or two.
“The upside is that you have a smoother transition that is much more transparent to the customers and the clients,” he said.
But the downside is that the previous owner could continue to act as if they still own the business, Bartelme said. It could be a while before they hand over the reins completely.
Once you have full control of the business, prior industry experience would become beneficial, Bartelme said. You could hit the ground running and start earning a profit.
“The less you know about a business, the higher the risk,” he said. “That’s why it’s pretty important that you do know something about that industry.”