Amidst all the bad economic news these days, there is a silver lining: It might be the perfect time to buy a business—for the right buyer, that is. The volume of businesses sold is reportedly way down for the year, more than 70 percent according to some business brokers, which is more of a result of the tightening of the credit markets than a dearth of opportunities. In fact, organizations that track the industry like the International Business Brokers Association, which represents the nation's 1,950 business brokers, as well as online markets like BizQuest.com and USABizMart.com, which post business-for-sale opportunities, report that the listing volume is steady or up compared to past years.
In many ways, the market for businesses is running in parallel with the housing market: supply currently exceeds demand. When you add together the dearth of motivated and financially qualified buyers with an ample supply of businesses for sale, you wind up with a buyer's market; the first many brokers say they've seen in decades. That means that those buyers that can go knocking on doors with cash in hand, or at least with a solid credit score, will find they have far more power to negotiate the terms of buying the business of their dreams. At the same time, given the number of companies struggling through the tough economy, buyers have to be more careful than ever about making sure they don't get stuck buying a lemon.
So where do you get started? The first step you need to take if you want to buy a business is to find a business you want to buy. This guide will provide you with an overview of how to determine what business suits you, what you can afford, and how to perform due diligence on the business.
Searching for a Business Opportunity
1. Determine Your Commitment
When it comes to buying a business, the window shoppers seem to outnumber the serious players, says Larry Greene, managing partner of Business Team, a brokerage in Newport Beach, California. "I get calls from the same guy every few months asking me about my new listings," he says. "He's been doing that for six years." While there's nothing wrong with having some fun by shopping around, finding your dream business will require an organized search in which you can narrow your focus on those businesses that both fit your skill set and your financial requirements—both how much you can spend as well as how much income you can expect to bring home.
2. Establish What You Can Afford
Brokers say that most people go about looking for a business backwards by looking at some "magic" income numbers such as the same salary they made from their last corporate job, rather than looking first for an industry where their skills could translate. While few would begrudge the investment banker who dreams of buying a restaurant or a bed and breakfast, the truth is that he or she probably couldn't land the necessary financing to fund such a radical career switch. That's why it's important to you're your finances into account. Here's a quick checklist to help you determine what you can afford:
- What kind of down payment can you afford to make? With an SBA loan, you will likely be required to foot at least 20 percent of the total purchase price up front.
- Do you have the kind of good credit, typically a FICO score of more than 700, which would enable you to secure financing from a bank or other lending institution?
- What kinds of collateral, such as equity in your home, can you bring to the table?
- Do you have access to any other sources of income?
3. Figure Out What Skills You Have
Before you even begin searching for a potential business, you should narrow your choices by asking yourself some of the tough questions up front that will help get your search off on the right foot, says Larry Martin, head of Benbrook Business Services in Chester, New Jersey. Begin by looking at your own qualifications. Ask yourself the following questions:
- What skills do you have that would translate best to owning a business? For instance, do you feel comfortable selling?
- Is there a particular business sector like retail, service or manufacturing that matches up well with your skills?
- Are there any specific qualifications like a professional license that you would need before acquiring a particular business?
- Do you want to manage employees or would you rather run the company yourself or with your spouse/partner?
4. Consider Lifestyle Impact
Todd Gilson spent three years looking for a business before he finally bought Accent Purchasing Solutions, a printing shop located in Fort Collins, Colorado, in early 2008. In addition to looking for a business that would benefit from his 12 years working in marketing, Gilson says he and his wife (who has a job outside the business) used three main filters in narrowing down their choice: what they could afford, what the business would earn, and whether it was within 60 miles of their home. It's crucial to consider the impact that buying a certain business would have on your lifestyle, such as what type of hours you are willing to work, whether you're willing to relocate for a business opportunity, and whether your spouse would be willing to be part of the business and/or use your home as collateral in a deal. Using a network of brokers and e-mail alerts he set up on sites like BizBuySell.com, Gilson says he finally found a business that met all his criteria: the shop earns about $2.5 million in annual revenue with good cash flow and is located just a few minutes from home. "So far it's the best thing I've ever done in my life," he says. "But I still lose sleep over the debt."
Narrowing the Search
Once you have lined up your support team and done your homework on your financing options, it's time to begin drilling down into specific businesses you have interest in. This is the point where you research needs to move from the phone and computer and into the four walls of your new potential business. But this is also where many breakdowns begin. Many buyers approach sellers fully expecting to get every proprietary detail of the business up front like detailed tax returns and customer lists, "but that's simply not going to happen," says Peter Berg, of Transworld Business Brokers in Florida. Consider that most sellers will be approached multiple times by potential buyers, so understanding that you won't be able to get every piece of information about the business up front is something you'll need to be comfortable with, at least for a while.
1. Sign a Nondisclosure Agreement
The first step then, is to agree to sign a standard non-disclosure agreement and then schedule a meeting with the seller. At that point, you'll also get access to other cursory, though more detailed information on the business such as a pro forma financial statement that shows the kind of cash flow the business has generated for the owner over a certain time period, including any benefits and perks paid directly to the owner—a figure known as the seller's discretionary cash flow. Larger businesses might even share audited financial statements, which would highlight the business's EBITDA. (See Sidebar for a more detail look at the difference between SDCF and EBITDA).
2. Meet with the Seller
This is also where you should schedule a phone call and an actual site visit with the seller. A mistake buyers make at this stage, at least, is ignoring the fact that the seller likely hasn't told his or her employees that he or she has put the business up for sale, Berg says. That means the buyer needs to be somewhat flexible in communicating with the seller—such as by willing to talk or visit after normal business hours or on weekends to avoid creating tension in the workplace.
3. Be Prepared with Questions
When you do get your audience with the seller, it's your chance to begin crossing out the inaccuracies you might find between what you found in the listing and what you see with your own eyes, such as the condition of the building or the amount of inventory in the warehouse. "This is where you start to follow your instinct and to see if something smells wrong to you," Berg says. This is also where you can start asking seller the kinds of questions that will help you either get excited or cold feet about buying the business. The goal, again, is to try and get a feel for the business beyond what any numbers might tell you by asking questions of the seller like:
- Why are you selling?
- How has the business been coping with the down economy?
- What part of the business drives the largest part of revenues?
- Who are you customers? Do any of them make up more than 10 percent of revenues?
- What keeps you up at night about the business?
- How much vacation do you take each year?
- How much salary do you take home?
- What's kept you from expanding the business?
- Would you be willing to stay on as a consultant to the business?
After learning what you can from the seller, it's time to ask yourself, "Is this a job I could have fun in?" and, "Is this the kind of business I can really grow?" Trusting your gut might lead you to walk away—or even plunge ahead.
The Difference Between Income and Cash Flow
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) is the figure that offers a fairly reliable estimate of the kind of cash a business generates to pay down debt, pay taxes and offer a return to investors.
Sellers' Discretionary Income (SDI) or Seller's Discretionary Cash Flow (SDCF), on the other hand, is a figure used more often in smaller businesses because it accounts for the salary that the company's owner pays himself, along with any other benefits or perks like a company car or life insurance policy.
In other words, SDCF = EBITDA + owner's salary + perks and benefits.