How To Choose The Right Business To Buy

how to choose a business to buy

Your secret to success with a business you buy depends on choosing the right business to buy.

Usually businesses are started by people in their area of professional knowledge, skill or experience. You should think long and hard about your own professional qualifications and knowledge. Choose one to three fields that best match your skills and experience.

At this point you should also consider size of the business, location of the business, how many employees would you like to handle, how much turnover are you looking at as well as the sales volume of the business.

All these factors will also impact the cost price of the business.

Pinpoint the geographical area in which you would prefer to have your business. Assess the labor pool and cost of doing business in that area along with the wages and taxes to make sure that you fully understand the cost of operating the business.

Pay attention to the kind of businesses that already exist there. It is not uncommon for certain kinds of businesses to be located in certain targeted parts of the city or town.  

In order to start looking for available businesses for sale you can check the local newspaper’s classified ads section under business opportunities or business for sale.

For an online resource you can visit the business retail network at www.businessresale.net.

What is also less uncommon is making offers on existing businesses that are not for sale. But this is the approach that some people take. When we find a business that they are interested in, they can approach the business owner themselves or through their attorneys and make an offer.

At this point you can consider hiring the services of a business broker. Most of the business brokers are hired by sellers to find buyers and help negotiate the selling price. If you decide to hire a broker they will typically charge a commission between 5 to 10% of the purchase price.

how to evaluate a business to buy

Preliminary Examination of A Business

  • Why is the business for sale.
  • Who is the seller.
  • Business reputation.
  • Are there any problems in running the business.
  • Is the business current.
  • Information from Better Business Bureau and trade associations.
  • Examine asking price, earning potential.
  • Base fair market value on brand, earning statement, it returns, growth potential, assets, balance sheets.
  • Ask to see accounts and balance sheet.
  • See earning potential statement.

Taking A Closer Look At The Business

Whether you decide to go about finding a viable business yourself or you take the assistance of a business broker, you will have to take the help of other professionals, like a banker, accountant and attorney to really be able to examine the business closely. These professionals are required to examine the finances, business potential and the resources of the business.

Getting together a team of professionals to evaluate a business is commonly known as an acquisition team.

Doing the Preliminary Analysis

The intent is to know exactly what business you are buying and from whom. The preliminary analysis starts with the most basic question, why is the business for sale?

This is important because you do not want to buy a business that is being sold because of no potential for profit, facing problems due to raw materials, dwindling demand, an upcoming change in laws and regulations etc.

A preliminary analysis will also answer questions like:

  • what is the general perception of the business
  • what is the reputation of that particular business
  • what is the potential for the future 
  • does the business control enough market share for it to be profitable and to recover the cost of buying it.
  • are the raw materials in abundant supply
  • has the business changed in the past
  • what is the business’s reputation and relationships with existing customers, suppliers and mentors
  • are their any pending complaints or violations which can be checked with the Better Business Bureau, industry associations and license and credit reporting agency.

After the preliminary analysis is over your acquisition team will examine the businesses potential return, its asking price and if it is in tandem with the fair market price.

The amount that you pay will take into account financial health of the business, earning history, growth potential and intangible assets such as brand name, agents and copyrights.

Balance sheets, income statements, cash flow statements, footnotes and tax returns for the past three years are all key documents to determine the health of the business. They will help in identifying any underlying problems and less tangible information.

Business avaluation checklist

Business Evaluation Checklist

The following is a list of questions that will tell you whether the business you are considering is a sound and profitable financial investment.

  1. Why is the business for sale?
  2. What is the potential for future growth and sales?
  3. How are the sales expected to grow or decline in the future if the current market strategy stays in place?
  4. If the business is in decline can you save it and make it successful by implementing new strategies?
  5. Is the business currently in good financial condition?
  6. Have you seen the audited year-end financial statements for the business and reviewed the most recent ones?
  7. Have you seen the tax returns for the past five years?
  8. Have you seen copies of all businesses current contracts?
  9. Is the business currently under investigation by any government agency?
  10. If it is what is the status of the investigation and what was the violation?
  11. Is the business currently involved in a lawsuit or has it ever been involved in one in the past?
  12. If so what is the status of the result?
  13. What is the status of any debts or liens against the business?
  14. What are they for and what is the amount?
  15. How much does the business right off as bad debts every year?
  16. How many customers does the business serve on a regular basis?
  17. What is the market for this business, where are your customers located, is your customer base local, state wise or international?
  18. Is it a seasonal business?
  19. Does the business cater to a few major clients or does it have sales on a volume basis?
  20. Can the business survive without its few major customers and clients?
  21. What is the marketing strategy used to advertise its products and services?
  22. Does the competition uses same methods?
  23. How successful other marketing methods being used currently?
  24. Does the business have any exclusive rights to market and sell any particular product?
  25. Will this exclusive rights be transferred to you once you purchase the business?
  26. Does the business for any patents for any of its products or trademarks?
  27. What percentage of sales do these trademarks represent?
  28. Did you get the right to these patents and trademarks when you purchase the business?
  29. How many suppliers and merchandisers does the business?
  30. Are the materials required to run the business available from only a few suppliers or can they be easily procured?
  31. What would be the impact on your business if you lost your current supplier?
  32. Will you be able to find a substitute goods of appropriate quality and price?
  33. Is the demand for the businesses seasonal or short-term, do you expect to see the demand of your product to sustain itself or grow in the future?
  34. What is the market share of this business for a particular product or service?
  35. How much competition does your business face?
  36. Are other competitors successful in competing against you?
  37. What has been the change in the competing businesses recently?
  38. Has any of them gone out of business, for instance?
  39. Does the business have all the machinery and equipment required?
  40. Do you need to purchase any new equipment?
  41. What is the worth of the businesses current inventory?
  42. Is it current and sellable and will you be able to use it?
  43. How many employees does business have and what positions do the?
  44. Are the wages of employees high, average or low?
  45. Does the business have a high employee turnover?
  46. If so why?
  47. What benefits programs does the business of its employees?
  48. Such as retirement plan, insurance etc.how long have the companies top executives been with the company?
  49. Would they be any change in the personnel of the business after purchase?
  50. What are the key positions in the business?
  51. Do any of the employees of the business belong to any union?

More Aspects To Check

  • Inventory
  • Lowest level of inventory.
  • Accounts receivable.
  • Net income.
  • Working capital.
  • Sales.
  • Fixed Assets.
  • Operating environment.

Other issues to examine before buying a business

These are some of the issues that you need to examine our part from the financial health, documents and financial history of the business.

Excessive or insufficient inventory

Before you buy a business you need to take a careful stock of the inventory that is present. Many first-time buyers get lured by the inventory but should realize that excessive inventory may be obsolete and it costs money to store and insure it. Excessive inventory also might mean that there are several dis-satisfied customers who are either experiencing delays in the shipment of orders or are returning items that they are not happy with. At this point also examine the shipping and return policies that the business practices.

The lowest level of inventory.

You can avoid making mistakes of taking on excessive and obsolete inventory by asking the business seller to reduce the stock to the minimum level that the business can carry at any one time. You can also add a clause to a purchase agreement specifying that you will only buy inventory that is current and salable.

Accounts receivable

Uncollected receivable accounts can interfere with the growth of the business. They can even require taking extra loan to run the business. Take a careful look at accounts receivable turnover, credit policies and cash collection schedules a puzzle as the teaching of receivables.

Net income

Using net income ratios allows you to have a better perception of how well the business is growing. There are several ratios that you can use each of which will tell you something different about the financial health of the business. For example ratio of gross profit to net sales is used to determine whether the businesses profit is in line with similar businesses. The ratio of net income to net worth when considered with a potential increases in interest, total price and similar factors can tell you whether you would earn a reasonable return on your business or not. The ratio of net income to total assets are can tell you whether the business is getting a favorable rate of return on assets or not.

Your accountant can help you figure out all these ratios and calculate the income and profit before and after taxes. Your accountant can help you analyze the returns that the owner is getting from his current business and how much can you expect to increase those figures in the future. Business analysts can also help you analyze how changing certain management techniques can help you grow your revenue without having to spend a lot of more money.

Working capital

Working capital is defined as current assets less than current liability. It is the cash flow that any business requires to function. A business cannot stay functional and load without the presence of an adequate working capital one of the important issues to calculate is the ratio of net sales to the net working capital. This tells you how efficiently the business is being run to maximize profits.

Sales activity

You need to analyze the sales figure of the business carefully. Sometimes the figures on paper may appear to be more favorable than they actually are. You need to calculate the rate of growth in sales and earnings as well as whether this growth is due to increase the seawall in all increasing prices. You’ll need to look at the overall market place to determine the demand of the product in the future and how you can use various strategies to increase your sales. Examining the marketplace will also tell you if the market is already saturated or static. This might be one of the reasons why the seller is trying to unload the company.

Legal Issues To Check

Check for liens against the business.

Check legal history to uncover any prior judgements.

Add ‘hold harmless and indemnify’ clause to contract.

Check insurance policy. Make sure you can assume it till you can renew it in your own terms.

Have the business worth evaluated.

Check with the city hall and move to office of public records. Check for any labor disputes, guarantees and pending patents.

The transition time involved with buying an existing business

The transition time is the duration that it takes for you to settle in after you have purchased the new business. Settling in means that the operations resume as normal, or the business starts working as you had intended it to before buying it. If you plan to buy the business lock stock and barrel and continue to run things as they were, you are going to have a smooth transition time. However if you intend to create a lot of changes, change marketing strategies, hire new employees or make radical changes in the functioning of the business, then the transition period is likely to be longer and more complicated.

The transition time also includes the feelings of the business seller as well as the employees about you taking over. When the business seller is happy selling the business to you, he is going to be more forthcoming and helpful to help you take over the business, it is common for sellers to provide training for an agreed duration of time. The seller may also agree to being available over the phone or e-mail for a specific duration of time after this training is over. Any new training that you intend to provide to your existing employees is also part of the transition time.

When someone new purchase is a business, it can be a reason why the employees might feel insecure about their jobs. If you intend to keep employees in the business, you should also try and make them feel secure in their jobs as well as their future prospects with the business. The happier and more secure an employee of the business feels in his/her job, the more they will feel responsible for contributing to the growth of the business.

Building respect and appreciation from employees is important. When you first take over the business, try and include people in key positions in your future plans. Making radical changes without consulting or informing the employees might make them feel insecure in their current jobs. In order to have a smooth transition period and the least amount of problems with your employees, keep channels of communication open.

Taking on an existing business can have its own set of complications and difficulties but with hard work, and honesty you should be running things efficiently.

Summary

  • Look in an area of interest, expertise, experience.
  • Find out about the laws, regulations and costs governing the functioning of a business in a particular area.
  • Look in classifieds for businesses for sale.
  • Take out your own ad, although few people do this.
  • Approach businesses that interest you, even if they are not for sale. Use your business network contacts to find out about viable businesses.
  • Approach businesses that are not doing well that might want to sell.
  • Use a business broker to prescreen, negotiate and help with the paperwork and documentation.
  • Collect an acquisition team of reliable professionals like bankers, lawyers and solicitors to evaluate the business as a sound buy.

 

Buying An Existing Business Vs. Starting Afresh

buy a business

Starting a business from the scratch can seem intimidating. A first-time business owner can get discouraged by the fact that you have to build a completely new customer base, develop marketing techniques, hire employees, establish cash flow and get adequate funding for the business which can be a challenge in itself without a previous track record.

In order to avoid these problems, one can buy an existing and established business or a business model (like a franchise).

Many experts will tell you that buying an existing business is less risky than starting a new business, as long as you do it after evaluating the business on its assets, financial reports, annual profit, cost of running the business etc.

Advantages of Buying a Business

If you are able to find a good and sound business to buy, it is usually less risky because you are taking over an operation that’s already (and hopefully) generating an profit.

  • An existing business already has a customer base, reputation as well as employees. 
  • There is likely to be a marketing strategy in place as well as necessary business relationships with suppliers and distributors. 
  • You will not have to reinvent every aspect of the business such as setting up new procedures, systems and policies. 
  • You are already purchasing a successful business model. 
  • You do not have to look for experts and professionals to hire. 
  • Any employment need is probably already fulfilled by existing employees. 
  • Existing employees already know how the business works and do not require additional training unless you are planning to bring about changes in the business.

Disadvantage Of Buying An Existing Business

Cost is a major dis-advatge of buying a running and a functional business, even though you avoid a lot of other costs in the leg run.

When starting out yourself and building a business for yourself, you have the option of starting small. Some of the biggest corporations today have started out as one room operations.

However, lending institutions are more willing to give a loan for the purchase of a business which has a proven track record. When you buy a business unit you will also purchase valuable legal rights such as patents, copyrights which in themselves are profitable commodities.

Evaluating A Business Before Buying

However, as we pointed out right in the beginning of this post, the success and the risk of buying an existing business depends upon having carefully evaluated the business, having taken professional help and advice from your attorney, accountant and other professional business appraisals.

In most of the cases of buying an existing business you will definitely need the help of such professionals to evaluate the true worth of a business.

Not doing so could result in you getting stuck with obsolete inventory, and corporate employees or outdated distribution methods.

In the next few post we will talk about how to buy a business successfully.