Buying a Business
Buying an existing business can reduce uncertainty and risk compared to starting a new business.
Buying a Business
Buying a business can help you bypass many of the uncertainties and risks of a starting a completely new business. The idea of having customers the day after you get into the business is very appealing. Yet it is important to understand that when you buy a business, the risks don’t go away, they simply change. This article outlines some of the main advantages and disadvantages of buying a business. Finally, some important considerations are provided for anyone serious about buying a business.
Advantages of Buying a Business
An existing business is a tangible asset that you can see, touch and feel. The business will have customers, financial statements, employees and a history. You will be able to research all of these things to determine if the business really is what it appears to be.
As mentioned in the introduction of this article, one of the biggest advantages of buying an existing business is that you are buying current customers. By contrast, one of the most underestimated aspects of starting a new business is how much time and money it will take to gain a loyal following of core customers.
Location risk can be eliminated when you buy a business. Many businesses fail simply because they picked the wrong location. If you are in a startup business, particularly a retail business, and your startup cash is invested in opening your first location, your entire business depends on the success of that location. Many businesses fail for this reason alone. This risk can be almost completely eliminated when you buy a business.
Added Risks of Buying a Business
When buying a business there will be a seller and probably a business broker who will be highly motivated to convince you of the wisdom of buying the business. It’s important to take into account that their primary interest is to sell the business to someone. Through it all, keep in mind that you are the answer to all of their problems. It’s one thing to buy a business; it’s another to be “sold” a business.
A great number of small business owners don’t keep proper books. It’s not necessarily that they are dishonest; it’s just a fact that small business owners frequently take liberties. The result can be that neither the financial statements nor tax returns provide an accurate assessment of the business you’ll have to run after becoming the owner. As an example, the seller has a spouse and son who each work 20 hours per week in the business and receive no pay directly from the business. Since they aren’t likely to work for you for free, your annual budget will need to replace this with 2,000 hours of paid labor, plus employer payroll taxes, workers compensation insurance and benefits. That’s just one example.
When you buy a business you’ll be called upon to fulfill promises of the previous owner. Employees will tell you how they had been promised a raise. Customers want to bring back products for which they paid the previous owner. Vendors will have their own expectations based on their understanding with prior management. While there are steps you can take to limit your legal liabilities, you can still be the recipient of the disappointment and frustrations of those to whom the promises were made. Before you buy a business, make a thorough effort to understand the expectations of those you will count on to keep the business moving forward.
Five Non-Negotiable Rules When Buying a Business
One: Never, ever, under any circumstances even consider buying a business without experienced legal representation.
Two: Find out why the owner is selling the business. The more fully and accurately you understand the true motivations of the seller, the better your decision—and negotiating power–will be. Don’t simply take the standard answers:
- Ready to try something new;
- Have other business interests that need more of my time;
- Ready to slow down and take it easy.
These should be considered conversation starters. Dive deeper and find out what’s behind them. Find out what’s so unappealing about this business that they don’t want to own it anymore.
Three: Understand the legal differences between buying the assets of a business including its building, fixtures, inventory and even its name, versus buying the company—or the stock of the company. In a stock purchase, you can be buying all the liabilities of the business from its inception, including legal liabilities for lawsuits based on actions that took place before you bought the business.
Four: Notwithstanding the comments above about business owner’s financial statements, insist on seeing the previous five years tax returns for the business. Knowing that you have copies of the tax returns can limit the puffery sellers might otherwise provide about the business’ past performance.
Establish a strong non-competition agreement with the seller. Even in California, where non-competition agreements are largely unenforceable, such an agreement can be binding when it is made in conjunction with the sale of a business. Again, get proper legal advice in your state.
Five: Always have the seller make representations in writing that backup his or her assertions about the business. Structure the purchase such that some percentage (10% – 20% is a common range) is held in escrow for one year after the sale is complete. For any representation of the seller which proves not to be true, the buyer would have a claim against the escrowed funds.
Buying a business could be the perfect fulfillment for your entrepreneurial aspirations. You could bypass months or years of startup frustration. Just be sure to take steps to be a smart buyer so that you get the business you really want to own.
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