Buying an Existing Business

Related Terms: Discounted Cash Flow; Business Appraisers; Franchising; Selling a Company

Most businesses are purchased by companies as a means of diversification or expansion. In these situations several of the ingredients of success are usually present: the business has good reasons for the acquisition, it has experience in the industry to be entered through long contact, it has skilled people to evaluate acquisition candidates, it has the means to make the purchase in cash or through contact with funding sources, and it has the ability to run the purchased business. Nevertheless, many acquisitions flounder. Similarly, the prospective buyer may be a wealthy individual with many years of business experience but presently no corporate base. Such an individual is functionally equivalent to a company in means and in experience. Buying an existing business is also, finally, one of the alternatives available to the would-be entrepreneur. He or she faces the same decision manufacturers call the "make or buy" decision: Should we tool up to make this product or buy it from someone else? To make some-thing from scratch usually takes longer but offers opportunities to shape the product exactly as the builder intends it to function. To buy the product usually gets the buyer to the starting line much faster but limits his or her choice to a preexisting design.

The individual entering business must keep in mind that buying a business is not a way to avoid initial fund-raising chores. In its summary of the issue, for example, the U.S. Small Business Administration (on its site titled "Buying a Business") makes the following somewhat erroneous statement: "Many find the idea of running a small business appealing, but lose their motivation after dealing with business plans, investors, and legal issues associated with new start-ups. For those disheartened by such risky undertakings, buying an existing business is often a simpler and safer alternative." The reason entrepreneurs worry over business plans and talk to investors is because they want to raise money they don't have. A person lacking funds but wishing to buy an existing business must also project the business into the future, have a plan, and undergo the process of raising funds. Books exist that boldly promise to teach the entrepreneur how to buy a business with not a penny down—but few people actually have the persuasive powers or profiles of experience to make that sort of thing happen. Buying rather than building a business is a decision to be reached after the funding effort has at least been started and looks reasonably promising.

KEY ELEMENTS

Once the funding issues are resolved sufficiently to turn the entrepreneur into an actual buyer, meaning that at least a portion of the down payment is in hand, the key elements of buying a business are 1) formulation of clear objectives (homework), 2) search and contact, 3) evaluation of the target (sometimes called due-diligence), and 4) negotiation and purchase.

These elements are very frequently iterated in an actual acquisition program, meaning that failure to close deals and the learning that has taken place while getting to an unsatisfactory result will cause the entrepreneur to rethink the process, sometimes from the beginning. Initial homework consists of exploring the industry or specialty that looks most suitable to the talents and experience of the buyer. A part of that homework is to learn the going price for different types of enterprises. That, in turn, may cause changes—and even require additional fundraising efforts. A search for candidates may reveal that not too many businesses are available or available in the right locations, that prices may be high or most candidates in trouble. Evaluation of businesses after contact may generate wrong assumptions about the real returns possible. Negotiations may fail. Buying a company is almost always a learning process unless the buyer is very experienced, (perhaps even working in the business already) the business to be purchased and its ownership are well known (possibly in the extended family), and everything is easily negotiated because of previous relationships.

Objectives

A buyer's earlier experience (business or avocational) usually sets the stage for formulating goals. Buyers rarely set out to buy into altogether unknown industries, but they may not know the business at its highest levels. For example, a person may know a business from an operational but not from a marketing point of view—or the reverse. Some kind of homework is usually involved.

Search

Sellers of businesses will advertise themselves or engage the services of a business broker. Finding candidates is thus similar to recruiting employees. Sources of leads are newspaper ads, the Internet, or brokers who also advertise themselves. Well-developed Internet resources usually enable a buyer to locate businesses within a state or zip code zone further subdivided by type of business and even asset-size categories. Brokers specializing in different regions or nationally are relatively easy to find. Substantial searching around is, of course, implied—but provides a great deal of information on what is available, what asking prices are, and where the nearest targets are located. Searching can be handed to a broker who will then call or e-mail the buyer with suggestions. Examples of sites, including one that advertises businesses for sale directly (cityfeetBiz) and of brokers (United Business Brokers, serving cities in Utah, Nevada, California, and Idaho), are provided in the references; there are many more.

Evaluation

Once contact has been established with a candidate, a process of mutual exploration begins, usually with a visit to the candidate's place of business where, following a tour of the place, preliminary discussions begin. The motivations of buyers and sellers are essentially the same. Each wishes to establish the qualifications of the other—and the buyer must therefore be prepared to give as much as he/she gets, namely to display his or her abilities to buy the business. If the buyer has no business identity, the seller will usually ask for references and not make financial disclosures beyond those advertised until the buyer's status and net worth have been carefully checked. In the normal course of events several contacts will take place before the buyer can obtain information sufficient to study the targeted business closely. That process is described further later in this entry. Evaluation of a business is central to price negotiations later and must be carried out with care and diligence in order to avoid legal and financial problems later.

Negotiations and Purchase

Assuming that the evaluation has produced satisfactory results, negotiations may become necessary to resolve remaining open issues. These can take many forms and may deal with just about any aspect of the business, from the handling of certain liabilities to employment contracts for key employees or executives. Eventually a purchase agreement will be drawn up, usually involving legal professionals, and the purchase finalized with signatures and transfers of funds.

EVALUATION OF A BUSINESSES

The evaluation of a business can be divided into four clusters: the seller's history and motivations, legal matters affecting the operation, the financial status of the business, and the condition and prospects of the business in its market (its products, services, and future).

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