How to Negotiate When Buying a Business
"Negotiating is an entrepreneur's most important skill," says Jessica Mah, the 20-year-old founder of the start-up InDinero. Before one buys a business, he or she will need to have a proper negotiation strategy in place in order to get the best outcome from the deal. Indeed, the process is different depending on what type of business you plan to buy, if you intend to purchase the rights to the name of an existing business, whether or not you wish to acquire the contents of the business, or if you want to only purchase a businesses' assets.
For small business owners, it is wise to educate yourself about all of the potential pitfalls of your purchase long before you get the ball rolling and certainly before you attempt to place your John Hancock on any official document. Negotiations to contracts existing and implied should be completed before you sign anything, and documents regarding such should be reviewed by your legal counsel for best results. The following will guide you though the proper process of negotiating one of the most life-changing endeavors that you can undertake for better or worse - buying your own business.
How to Negotiate When Buying a Business: Vet the Market
Depending on the industry you're involved in, methods of negotiation may differ. Certain businesses, namely those that cater more toward industrial services and materials for example, will need to negotiate based on market fluctuations. You can prepare for this by studying trade publications and attending networking events for those in your industry.
When vetting the marketplace, George Landegger, the managing partner of Sunbelt of Westchester County in New York, suggests using economic factors to your advantage when you begin negotiations. For instance, you can say to a seller, 'I really want to be in this business but prices are rising and I really don't know what's going to happen in the future. There's a lot of uncertainty here and [to make my business viable], I can only offer you this price,'" says Landegger.
How to Negotiate When Buying a Business: Making First Contact
There are many ways that you can find a business to purchase. If you live in a small town or in a city with many independently-owned businesses, you may be able to start the process of negotiations through word-of-mouth or personal business contacts. You may even be able to reach out to a potential seller through the use of social media, or via numerous online buyer/seller websites that can be easily discovered through a simple Google search. It's even possible to find a business to purchase through the usual online marketplace suspects, such as Craigslist and Ebay.
In addition, there are many business websites that you can go to that cater specifically to the buying and selling of businesses, including Bizquest, BizBuySell, and MergerPlace. Another is InfoUSA, says Landegger. "If there's a specific type of business you want, you can go to one of these companies that have lists like InfoUSA and you can buy a list and you can search by SIC code, which is the government definition for different types of businesses. Every business has a SIC code. So, if you're looking for a specific type of business, you can find a resource [through the website] and then actually knock on the doors of those businesses saying, 'I'm an interested buyer and I'm considering buying your business,'" says Landegger.
After making contact with the seller and determining their legitimacy through a publication such as Crain's, the Better Business Bureau, LinkedIn, Google, or Facebook searches, or even through mutual associates, the next step should involve a face-to-face meeting, preferably on location at the business in question. But, before you go about taking the next logical step of making a formal offer, halt! Before you say anything that can color any future negotiations, consult professional counsel, namely a broker.
How to Negotiate When Buying a Business: Hire a Broker
You may think your Google searches and Amazon book purchases have adequately prepared you to buy a business, especially if you're a first-timer. However, there's no substitute for actual experience, and buyers who go at it alone are often blindsided by unforeseen issues that arise during the process.
"Obviously, I have a bias," says Mark Thorsby, president of the International Business Brokers Association based in Chicago. "First thing you need to do? Get a broker," he says. According to Thorsby, he's seen "hundreds, maybe thousands" of clients attempt to navigate a business purchase without proper counsel in the beginning, only to have to hire a broker before all was said and done. Thorsby describes the buying and selling process as being much more detailed and intricate than novice buyers imagine, an art if you will.
There are many aspects that need to be negotiated when purchasing a business, many more than in a typical real estate acquisition."As an example, often what you're paying for is the book of [a] business," says Thorsby. This is also referred to as the goodwill of a business. "That is, the customers that a business has acquired over time," Thorsby explains. "Under new ownership, you hope that you would be able to keep all the same customers as opposed to starting a business from scratch and having to acquire all new customers. So, what are those customers worth to a new owner of an enterprise?"
In addition to existing customers, should you choose to continue the legacy of the previous business instead of altering the focus of the establishment, there many be tangible assets (machinery, vehicles, kitchen equipment, etcetera) that will need to be negotiated as part of the purchase agreement. Unfortunately, there is no rule of thumb as to how much goodwill or assets are generally worth. That is where a broker comes in. According to Thorsby, one of the best attributes of a broker is that they've had extensive experience in comparing prices across a specific industry in a specific region. Thus, they can determine if the asking price of a seller is a good one or if they're attempting to take you for a ride.
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How to Negotiate When Buying a Business: Find the Seller's Achilles' Heel
Despite warnings to the contrary, some business owners attempt to purchase a business on their own - and succeed. Jamey Hamm, owner of Roots Cafe in Brooklyn, New York, negotiated the purchase of the assets of a business from the location's previous owner two years ago, and received a lucrative deal in return. Hamm wasn't even in the market for a cafe when he because a first-time business owner. He was simply a patron who mentioned to the previous owner that he might someday like to own his own business. Six months later, the owner, who was looking to sell the business, offered him the chance to live his dream. The former owner had bought the existing business from the owner before him, and had been unsuccessful in turning a profit. Hamm didn't have a business plan, nor did he have any previous experience in running a business. Within two weeks, he'd secured a private investor (his wife's grandmother), and successfully negotiated the purchase of the existing assets of the business for $8,000 less than the seller's asking price.
His negotiation tactics were not only based on his intuitive thought process related to the value of the items, but also to the fact that the seller was looking for a quick sell. On the other hand, he was unsuccessful at renegotiating the terms of the lease with the landlord. In this case, the landlord had the upper hand--the business was in a location that was ideal to him and close to his home, so he chose to forgo further negotiations in lowering the rent. "Negotiate to the point where it's worth it to you," he says. "I negotiated the contents of the business more because I knew [the seller] wanted to get out of [the business]. The landlord, she wasn't going to budge. I felt like I could make [the business worth the cost of the rent], and this is the area I wanted to be in," he says.
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How to Negotiate When Buying a Business: Make an Offer
Before you make an offer, take a good look at how much more money that offer will cost you. Does it require seller financing? Do you want the final sell of the business to be subject to certain types of performance criteria (that is, will the business have to perform a certain way for an established trial period before the final close)? One extremely important factor is determining if any of the existing inventory (if you intend to purchase the existing inventory) is obsolete. "The seller might not consider it to be obsolete but the buyer might consider it to be obsolete, so the value of the inventory might be different," says Landegger. "You want to offer a price that you think will be accepted. You can lowball it and expect the owner to do a number of different things," he says. "He can either say 'I'm not interested in you at all, don't talk to me again,' or he might make a counter offer," says Landegger. "Or he might accept; you never know."
As in the case of Hamm, Landgedder says that small business owners might have it slightly easier. "For a smaller business, a lot of owners truly want to get out because they're tired of the business or planning to retire," he says. In this instance, it's important to negotiate how long the seller plans to remain active in the business. The buyer will need to decide if she wants the seller to leave right away, or if she wants the seller to stick around a little while until she gets a handle on how to run the operation, should she she choose to keep it in it's existing model. In that case, a salary or some sort of compensation should be negotiated for the seller from the buyer, explains Landegger.
How to Negotiate When Buying a Business: Secure Financing
In addition to hiring a broker, a buyer would be wise to seek the counsel of an accountant in order to make sense of the complex financial details of a business before either party signs off on any aspect of the sell. A valuation specialist may also need to be called in to provide a quote for the estimated business value. Once the logistics of inventory and business value have been worked out, the final step in the process is for the seller to buy it. Unfortunately, as it has been for the last few years, most banks are loathe to provide any type of business loans to buyers, especially first-time buyers, without huge amounts of red tape wrapped around numerous stipulations. As a result, your best bet is to seek out private financiers, namely family members or associates as Hamm did.
On the other hand, dealing with family may not be your best bet, says Thorsby. "The rule of thumb is to never do business with family. But usually colleagues, people you know in the community who know you [can be of assistance]. Maybe you've worked with them, [maybe] they've worked with you in some way that you have some business relationship as opposed to just family and friends," he says. As a negotiation tip for potential investors, you may attempt to offer your investors shares based on a future valuation of the business or even a percentage of ownership within the company.
"The important thing when you are buying a small business is that you are adequately financed so that you don't have to set record revenue numbers in a new business the first day in order to pay the loans," cautions Landegger. "People borrow too much money, and [they] can't pay their loan, and bingo, [they're] upside down and in bankruptcy." For this reason, and to receive the best deal that you deserve, negotiate the lowest price possible with the seller, and close the deal with the aid of a loan whose terms you've negotiated to best fit your financial situation. Most important, never accept the first offer for any loan or sell price and never be too eager to take "no" for an answer.