By Trent Lee, the recipient of the award as the No. 1 Business Broker in the country by the IBBA (International Business Broker Association)
Buying a business isn't something people do often, but as a business broker, I've personally helped buyers and sellers through this process hundreds of times. Follow these six steps, and you'll find that the overall process is quite simple.
1. Evaluate your potential for financing.
Your liquid and fixed assets: If you work with a lender, it will want to see that you have a sufficient down payment (10 percent to 25 percent) and that either you or the business has assets that can support the underwriting metrics.
Your debt: Factor in your total debt payments, such as a mortgage, credit cards, car payments and student loans. Then, total that up, and divide it by your monthly take-home income (monthly debt payment divided by monthly take-home pay). This is your debt-to-income ratio. Most lenders will want to see something less than 40 percent.
Your credit score: Do you have a history of late payments, foreclosures or debt default? If so, this is a major red flag for both a seller, who may be offering seller financing terms, and a bank, which will be taking a risk lending money to you.
2. Determine your price range.
I've met with buyers who say they will buy in any price range as long as the business pays for itself. Well, it doesn't work that way. You need to take a number of items into consideration and narrow down a likely price range that is appropriate based on your financials and experience.
A bank will want to see that you have experience in this industry and that you can afford to put a sizable down payment, roughly 10 percent to 25 percent. It will want to see that these funds are seasoned in your account (three-plus months) and that you are not borrowing any portion of the down payment (with the exception of using a self-directed retirement account to fund the down payment).
Find a local or national lender to help you get prequalified and determine a general price range.
3. Find a local business broker.
Once you generally know the industry and size you're looking for, reach out to a local business broker to help you find a potential business.
The first question you should ask when determining which business broker to work with is if they are a certified business intermediary (CBI). You can use the International Business Broker Association (IBBA) and search by zip code to find a professional business broker who holds this designation. This is the gold standard in the industry and will help you determine that the business broker has the experience to help you.
4. Ask if the business can support a loan at the asking price.
Remember, it's not only you personally that has to qualify for a business acquisition loan; the business has to support itself. Make sure that the business can support you and your family for reasonable living expenses and have enough profit left over to debt service the monthly payments you will owe to either the bank or the seller if they are offering seller financing terms. Most lenders will want a debt-service ratio of 1.2 or greater.
5. Make an offer.
Within your offer, outline the price, terms, ideal closing date, and due diligence and contingencies you'll need to sign off on before moving forward. Both a business broker and an accountant can help you compile a list of due diligence documents and complete your due diligence research. Validate income, expenses, net profit, payroll, outstanding liabilities and a host of other due diligence-related items; you'll also want to substantiate the business valuation.
6. Obtain loan approval and other possible contingencies.
Once you've made your offer and completed your due diligence, it's time to finalize and sign off on contingencies. You'll need to obtain final bank approval for the business loan, get landlord approval if there is a lease assignment involved, and obtain any required licensing or permits to take over the business.
At this point, you've likely opened escrow or have a closing or transacting attorney who is holding the earnest money deposit. They will begin drafting closing documents and work with the lender to facilitate the closing. Make sure that the escrow or closing attorney works with the local Department of Taxation to get a clearance letter. This ensures that there is no successor liability (such as past-due payroll or sales tax) that you would be liable for.
Celebration time! Closing on a business is often a life-changing experience. It will certainly impact your life, the community, and your employees and their families for years to come. With the right team and a lot of hard work, you may be the right person to take the existing business you just purchased to new heights.