Entrepreneurship doesn't always have to center on starting your own business from scratch. If you have sufficient capital on hand, it could be worth thinking about buying an existing business. Buying a business can mean that most of the legwork present in starting up a new company is already done: building up a customer base, honing a brand, hiring talent, and much more. But this purchase is a large undertaking that's not without risk and could also potentially set you up to lose a lot of money.
In simple terms, here's what you need to ask the seller when you're thinking about buying a business.
1. Why is the business for sale?
This is the first question to ask because people often sell businesses due to retirement, health issues, receiving business interest in a divorce settlement with no desire to continue operations, or wanting to move on to other ventures. But they may also be trying to sell the business simply because it isn't profitable, so if the buyer doesn't fall into the other categories, you should tread carefully.
2. What was the annual revenue in the last two years?
Business cycles are common, and social and economic fluctuations can affect a business in turn. You still want to get at least two years' worth of financials that clearly depict revenue, net profit, and burn rate over time — and make sure it’s verified by an independent accountant.
3. Does the purchase entail buying the business assets or stock?
Buying a business often refers to the "whole package," but the original owner could still have equity as part of the deal. Determine if their sale offer only accounts for business assets and equity, or if it includes both. You could only receive certain business assets in the deal and will need to outline them in your sale agreement. Also, consider whether you’re interested in the whole package or only certain assets like proprietary technologies, customer lists, or real estate.
4. How was the asking price determined?
Every business owner should have a professional business valuation done by an experienced consultant before they start scouting buyers. If the current owner didn't get a professional valuation, can they explain how and why they set the price that they did? Does the profitability of the business and value of assets in place support the asking price? You don't want to start negotiating until you have a clear idea of why they're asking for this specific price.
5. Does the business have any open lawsuits and/or major litigation in the past two years?
A business can be profitable but give an owner impetus to sell if they're still paying off a judgment or have open lawsuits. You want to find out if the business was sued in recent years, and why, followed by any open litigation or judgments. The suit could be frivolous, or it could be indicative of a problem likely to reoccur. Each business has its own set of legal risks, so assess the situation before committing to the purchase.
6. What is the debt load relative to current and potential profitability?
All or most of the business liabilities will also be included in the purchase. Know which liabilities you will be assuming and how their outstanding balances affect current and potential cash flow and how they factor into the asking price.
7. How long has the business been operated by the current owner?
You don't have to be an owner-operator to run a business, but you should have a clear idea of who holds those distinctions and how long that has been the case. A business that has gone through several owners in a span of less than five years could indicate flighty entrepreneurs or an incredibly volatile market for this particular type of business.
8. How much capital do I have access to?
Buying a business is more than just assuming new assets and liabilities: Along with the capital on hand, will you require additional financing to complete this transaction and where is it coming from? In addition to the components you're purchasing, how much cash will you have on hand as a result of your available capital so that you can cover payroll, current liabilities, and other day-to-day operating expenses?
9. What happens after the sale completes?
On your end, you need to have a solid plan for what's going to happen once the purchase is finished and you now own the business. How involved is the original owner going to be in the transition? How many key employees and suppliers will stay on, and what are changes you plan to make to current operations management?
10. Is there any unique advantage to buying this business, or should you consider starting your own?
When you consider the asking price relative to your access to capital, and operational aspects of the business, you should determine if you'd have a better risk tolerance buying this business or starting your own. If the customer base is steady, it could be more favorable than starting from scratch. But if the reputation isn't the best, is it something you can improve or are you better off starting a whole new business?
Frank Jenkins, CPA writes for CountingWorks, an accounting news and advice website. Reach him at [email protected].
About Frank Jenkins Jr
Frank Jenkins Jr. CPA is the managing partner of Adams, Jenkins & Cheatham, a CPA practice based in Midlothian, VA. Frank specializes in Consulting services, tax planning, audit & assurances. "I genuinely care about our clients because I have a personal connection with them." He is active in the community and belongs to the AICPA and the VSCPA.
