This article is one of a series that offers insight and guidance into the process of buying selling or valuing a business. Whether you want to buy, sell, or appraise the valuation of a going-concern business, these articles provide specific guidance and references to help you accomplish your goal.
Getting Into Business: Don't Start It! Buy It!!
Russell L. Brown
Many of us have felt the entrepreneurial pull
of running our own business at one time or another. The allure of
being your own boss can be really strong, and no wonder. Small business
ownership and its operation has proven to be one of the most financially
rewarding and intellectually stimulating pursuits that you can follow
in your working life. And, you have the opportunity to be a master
of your own financial destiny.
But, it can also be very frightening for those
of you just starting out! We have all heard about the high mortality
rates for new business ownership; 50% do not make it through the
first three years and 70% will be gone after only five years. There
are many reasons for this including; insufficient operating capital,
poor management, an unworkable business concept, inability to develop
a strong customer base, and just plain old bad luck. It would be
great if these potential problems could be eliminated or at least
minimized for you as a new business operator Well, they can!
Buy an existing profitable business instead of trying to start one from scratch! There are several key advantages to this:
Existing successful businesses have a proven track
record of profits that will most likely continue long after the
business sale. Now you get to apply your new ideas, expertise, and
renewed energy to take the business to even higher profitability.
You will have established customers for immediate
cash flow. No suffering through a long start-up period where you
struggle to attract customers to your business. Use these customers
as a building block for future business growth.
Typically, you will be able to use a business
seller's financing of a large portion of the purchase price to maximize
your buying potential. You will get more bang for your investment
Although I do not know of any solid statistics that exist anywhere that I can quote, it has been my experience and that of my many business broker colleagues, that the vast majority of profitable businesses that are purchased continue to operate successfully for many years to come. There is no question in my mind that the success rate for new business owners that buy an existing business is much higher than for those who start a newly formed business. This makes good sense. An existing profitable business has already proven that it is successful. As long as you continue to follow the basic business approach, you too should be able to operate the business successfully.
However, the actual process of purchasing an operating business can be a challenging and complicated undertaking and you will want to be as fully prepared as you can. You need to gather as much information as possible which will help you to; find a suitable operating business for sale, properly value the business, arrange your purchase financing, successfully conduct negotiations, and finally, to actually close the deal, buy the business and transfer ownership. The good news is that tens of thousands of small business sales occur every year with little or no real problems and the new owners and the sellers both realize their goals. But, you must be fully prepared and knowledgeable for this success to occur! In this article, I will provide you with an overview of each aspect of successfully buying an existing profitable business.
The first step in this
process is to find out if you are truly fully motivated to operate
a small business (whether you start it or buy it). Ask yourself
- Do you know what kind of business you want
- Are you "technically" qualified and
experienced enough to run the business?
- Do you have the temperament to deal with fickle
customers, demanding creditors, and difficult employees?
- Do you have the attention-to-detail that most
- Can you deal with the bookkeeping requirements
of the business?
- Are you prepared to devote a great deal of
time to the business ?
- Can you deal with adversity without losing
- Can you deal with uncertainty without losing
- Are you a good people-person who can successfully
deal with both customers and employees?
- Can you accept the potential significant financial
loss that investing in a business exposes you to?
Next, you need to determine
what your key reason is for buying and operating a business (in
addition to the obvious reason of making money):
- Buying a job to earn a living.
- Acquiring an attractive lease or other real
- Buying prestige (many business owners are respected
- Eliminating competition if you already have
- Buying a hobby or retirement occupation.
- Seeking self-fulfillment and control of your
- Seeking an opportunity for a child or other
Now ask yourself, what
is it that I really like to do, and what is it that I am really
good at? If you have determined that you are a truly motivated buyer
and you know the reasons that you want to own and operate a business,
then you should begin searching only for those businesses that match
what you like to do and ones that match your skills, capabilities
There are many sources
of businesses for sale and quite a few businesses can be relocated,
but to maximize your opportunity of finding the right business for
yourself, you should be prepared to relocate to the business's location
if at all possible. Some good sources of information about businesses
for sale include:
- Newspaper classified advertising under Business
- Newsletters of various kinds (in-house brokerage
publications, regional and national independent publications,
- Business Brokers (most reputable ones are listed
in the telephone yellow pages and can be checked out through the
national professional associations).
- Word of mouth through friends, family, and
colleagues from all walks of life.
- Magazines and other periodical publications.
- The Internet (but usually not under Business Opportunities, but rather, Businesses for Sale).
Now that you know what
your motivations are for buying a business and where to find a good
company for sale, you will need to have some idea about how to apply
a realistic value to the company that you are considering buying.
This is no easy task! Remember, the seller will want as much as
they can get, and you will want to pay as little as possible. The
key is to strike a fair deal for both of you. Remember that buying
a business is fundamentally a financial investment for most of you
and consequently the business is worth only as much as its ability
to generate profits. If you are going to work in the business as
most people do, then the business should also pay you a fair wage
in addition to the profits. The best way to determine a business
value is to work backwards from the available profits that a seller
For example, let us say that a business has a
total of $100,000 pre-tax profits (proven by IRS tax returns for
the latest full year of operation), before allowing for an owner/manager
wage. You plan to work full time in the business (and believe me,
you probably will!), and a fair wage for the work if you were to
hire someone to do it, is $40,000. That leaves $60,000 of available
profit to work with, but don't forget to deduct the income taxes
that you will have to pay. They will probably be about $18,000 depending
on the state and city the business is in, plus other personal factors
(figure at least 30%). That gets you down to about $42,000 of profits
left to be able to either pay off the debt you incur to buy the
business or to provide you with a reasonable return on your cash
There are many ways to work with this $42,000,
but most lenders of money to buy a business, whether they are the
sellers themselves or others, want to see a relatively short payoff
term (about 5 years) and a fair interest rate on the money (say
10%). When you do the math to determine the value of $42,000 in
yearly payments for 5 years at 10% interest, the amount turns out
to be about $165,000. This is the approximate total value of the
business and a good starting point for negotiations. I say approximate
because if the business has inventory, and/or real estate, and/or
accounts receivable (or other current cash assets) that are to be
transferred as part of the sale, their value will be added to the
overall calculated value of the business. The actual sale price
will then be negotiated between the buyer and the seller.
This is of necessity a simplistic example of a
fairly complicated process. There are many other issues associated
with valuing a business and a prospective buyer is well advised
to read as much information on this topic as possible. And of course
before you actually proceed with a purchase you should seek the
advice and guidance of competent legal and accounting professionals.
Next, you will need to start thinking about how
you will pay for this business. This also becomes an integral part
of the negotiation process to arrive at a selling price for the
business. One of the most crucial steps in the purchase of a small
business is to establish the financing necessary to accomplish the
transaction. This issue is of equal importance to both the buyer
and seller. The buyer needs to find the capital necessary to purchase
the business from the seller under acceptable repayment terms. The
seller needs to ensure that the buyer has established a realistic
financing arrangement such that they will receive the agreed upon
funds from the buyer. Since many business sales involve some form
of seller financing and the seller is likely to be required to take
a secondary security position to any other lender, both parties
have a strong interest in the types and conditions of the financing.
There are actually many
sources of financing available to the purchaser of a business and
frequently the buyer will use not just one of these sources, but
a combination of several. The most frequently used sources of funding
- Buyer's Personal Capital
- Business Seller Financing
- U.S. Small Business Administration (SBA) Guaranteed
- Commercial Bank Loan
By far, the most frequently
used funding sources for the purchase of a small business are a
combination of a buyers personal capital and the business sellers
financing. However, many transactions are also financed through
the SBA Loan Guarantee program. To a lesser extent, the other sources
of funding are also used and they could be an important part of
your business purchase financing plan and should not be overlooked
for consideration. Some of the most successful approaches to finding
the financing for the purchase of a small business use a combination
of funding sources, both conventional and unconventional.
In most sales of small businesses, there is usually
some amount of seller financing of the purchase price. This amount
can range dramatically depending on circumstances, but frequently
falls in the 50% to 75% range of the total purchase price. In most
situations, a seller wants to receive as much money up-front as
they can, while a buyer will want to pay out as little as possible.
The reasons for this are varied, but basically the seller will need
a significant amount of cash to pay the IRS capital gains taxes
that will be due upon the sale of the business, as well as business
transfer expenses, and personal funds needs. The buyer, on the other
hand, will want to minimize the cash outlay to lessen the risk in
the business. What if the business is not as good as represented
by the seller? The buyer will also want to conserve as much ready
cash as possible to operate the newly acquired business.
The Promissory Note to
the seller from the buyer is a form of deferred compensation for
the seller. As already mentioned, in most cases sellers will need
to accept a Promissory Note from the buyer in order to complete
the sale. There are several variables that need to be considered
from both the buyers and the sellers perspectives:
- Amount of the Promissory Note
- Interest rate and period over which it is to
- Security for the Promissory Note
The principal amount of
the Promissory Note (the amount of money owed) is usually not as
flexible and able to be changed as is the interest rate and period
of time over which payments are to be made. If the business has
been fairly valued, there should be enough cash flow from the business
operations to cover the payments the buyer must make to the seller.
The business must be able to pay itself off through the business's
cash flow over a reasonable length of time. The seller will want
to ensure that the amount of the Note does not exceed the fair market
value of the assets in the business that are being used as security
for the Note. Sometimes a buyer will need to provide more cash down
(20% to 50% of the purchase price is customary) to lower the amount
of money owed, and therefore, lower the amount of the payments.
The interest rate and time
period of the Note are key factors in determining whether the business
can afford to pay for itself. Interest rates charged by the seller
are usually pegged to the prevailing best bank loan rates or even
somewhat lower. The seller has to be careful about setting the interest
rate too far below bank rates because the IRS has the ability to
impute a fair market interest rate if they determine that the interest
rate being charged is too low (impute means that they will tax a
seller as if the rate was 8% rather than, say, the 4% rate actually
being charged). However, there is usually a wide latitude for negotiation
here as the best bank rate (prime rate) is about 7% at the time
of this writing, and many commercial loans are being written at
rates up to 12%. To give you an idea of the difference that the
spread of interest rates can make in an amount amortized over ten
years, consider the following:
- $500,000 for 10 years @ 4% is $5,062 monthly
- $500,000 for 10 years @ 7% is $5,805 monthly
- $500,000 for 10 years @ 10% is $6,608 monthly
The time period of the
Note is also a key factor when considering the financing of a business
sale. The seller and buyer will both usually want the note paid
off as soon as possible for different reasons. The seller will want
to collect the money for the business to cash-out as soon as possible
to minimize the risk that the money will not be paid. The sellers
biggest fear in accepting a Note for the business is that the buyer
will run the business into the ground, effectively making the business
assets worthless, and then won't pay the Promissory Note. The seller
would then recover a business with little or no value and have received
only a portion of the business's original worth. The buyer wants
to pay off the Note as soon as possible within the constraints of
the business's cash flow so that the maximum financial benefits
can be realized. For these reasons, most business sale Promissory
Notes have a time frame in the 5 to 10 year range. To see the effect
that the different time frames have on payments at a particular
interest rate, the following calculations are offered. I picked
10% as a representative interest rate for illustration purposes:
- $500,000 @ 10% for 10 years is $ 6,608 monthly
- $500,000 @ 10% for 8 years is $ 7,587 monthly
- $500,000 @ 10% for 6 years is $ 9,263 monthly
- $500,000 @ 10% for 4 years is $12,681 monthly
As you can see from the
data presented above, the interest rate and time frame of a Promissory
Note can have widely different effects on the business's ability
to pay the note off. Herein lies fertile ground for negotiations
between the buyer and seller and can make the difference between
a successful business purchase and sale, or a potential failure.
Once you have completed negotiating the selling
price for the business, the next step is to finalize the sale, take
possession of the business, and begin operations yourself. Closing
the deal is the hardest to accomplish, but usually the shortest
part of buying or selling an operating business. After all, the
valuations, due-diligence investigations, and negotiations are complete
and now it is a matter of getting everything into writing in a form
that satisfies everyone so that the transfer of ownership of the
business can take place.
The best situation for
all parties is to follow an orderly buying and selling process that
will move things along in a business-like manner. The major elements
of the business purchase and sale process are:
- Binder and Earnest Money Agreement
- Purchase and Sale Agreement
- Closing (at which actual title and ownership
At the Closing, the actual
legal instruments of transfer are signed and filed, money and/or
promissory notes are exchanged, and the buyer becomes the new owner
of the business. The Closing date and place are set to everyone's
convenience and all of the pre-closing tasks are assigned to the
various parties for completion.
Once the Purchase and Sale
Agreement has been signed by both the seller and buyer, there is
an excellent chance that the sale will actually take place. The
buyer's and/or the their attorney's responsibilities will include:
- Finalizing financial arrangements.
- Reviewing/signing any necessary leases.
- Applying for licenses and permits.
- Complying with the bulk sales law.
- Preparing any additional legal documentation
- Taking inventory of finished goods and work
- Final inspection of the business assets.
The seller's and/or the
business's attorney's responsibilities will include:
- Preparing the real estate lease.
- Preparing the promissory note.
- Complying with the bulk sales law.
- Settling all liabilities and liens.
- Providing for an inspection of the business
and an inventory count by buyer.
- Preparing any additional legal documentation
- Complying with any other provisions in the
Purchase and Sale Agreement.
The business broker's responsibilities
- Ensuring buyer/seller responsibilities are
- Arranging for third-party leases.
- Acting as a go-between.
- Handling buyer/seller anxiety.
- Participating in the closing.
It may seem obvious, but
I'll state it anyway because there may be more to it than you think.
The first thing the buyer does after the closing is to take possession
of the business! This may include the following considerations:
- Change the locks on the business property.
- Formally notify the employees.
- Notify the suppliers.
- Notify the customers (if appropriate to the
type of business).
- File all new legal paperwork with the proper
authorities (titles, licenses, liens, etc.).
Well, that's a snapshot
of what it takes to buy an existing business. As involved as it
may seem, it is far less trouble than starting a new business, and
certainly less risky. If you have an entrepreneurial mind-set and
would like to consider getting into business for yourself, even
if it is only a home-based business to start, I strongly urge you
to consider buying an existing profitable business. There are tens
of thousands of them out there right now just looking for the right
If you're considering buying, selling, or determining the value of a business, please take a look at some of the excellent books, reports, and software we have at Business Book Press to help you achieve success. For example:
The Business Reference and Pricing Guide is the bible of the business brokerage world. If you're a shrewd business buyer or seller, you will want this book to learn what just what the business broker knows. It will pay you big dividends throughout every aspect of the purchase and sale process. Learn more about it...
BizPricer Business Valuation Software is an accurate and inexpensive resource for prospective business buyers and sellers (and business brokers) who want to know the fair market value of a business. No financial expertise or specialized knowledge is needed. Save hundreds to thousands of dollars over hiring an appraiser to provide you with a similar result. Learn more about it...
Preparing A Business for Sale provides business owners with an understanding of the process they need to know to sell their business for the most money. Contains hundreds of little known tips, ideas and strategies to maximize the selling price of a business. Learn more about it...
Strategies for Successfully Buying or Selling a Business is our bestselling book. It has been recommended by Kiplingers Personal Finance Magazine, the BottomLine Personal Newsletter, and has been awarded the Best Business Book of the Year Award from the North American Bookdealers Exchange (NABE). Learn more about it...
Anatomy of a Business Purchase Offer provides you with all of the practical hands-on knowledge you need to make a successful purchase offer to buy a business. The author uses an actual Purchase Offer form to show you exactly what needs to be written and why! He details all of his recommendations in a line-by-line format for each and every aspect of the purchase offer. Learn more about it...
The Business Buyer's How-to Kit: We've assembled a specially-priced Kit with all of the key information you'll need to know to successfully buy a business.
The Business Seller's How-to Kit: We've assembled a specially-priced Kit with all of the key information you'll need to know to successfully sell a business.