Many of us have felt the entrepreneurial pull of running our own business at one time or another. The attraction of being your own boss can be significant, and there’s no wonder so many fail in the first few years. Small business ownership and its operation have proven to be one of the most financially rewarding and intellectually stimulating pursuits that you can follow in your working life, but it does – in most cases – come with a personal and financial cost.
If you’re new at business, it can also be quite frightening, especially knowing the high failure rates for new business ownership; 50% do not make it through the first three years and 70% will be gone after only five years.
From my experience after a decade of being in business, there are many reasons for this including; insufficient working capital, poor leadership or management, an unworkable business concept, inability to develop a strong customer base, divorce or partnership split and just plain old bad luck. It would be great if these potential problems could be eliminated or at least minimized for you as a new business operator.
Well, if you follow my tips (below), they can!
STEP 1: Find out if you are truly fully motivated to operate a small business (whether you start it or buy it). Ask yourself these questions:
- Do you know what kind of business you want to buy?
- Are you “technically” qualified and experienced enough to run the business?
- Do you have the temperament to deal with fickle customers, demanding creditors, and difficult employees?
- Do you have the attention-to-detail that most businesses demand?
- Can you deal with the bookkeeping requirements of the business?
- Are you prepared to devote a great deal of time to the business?
- Can you deal with adversity without losing your cool?
- Can you deal with uncertainty without losing sleep?
- Are you a good people-person who can successfully deal with both customers and employees?
- Can you accept the potentially significant financial loss that investing in a business exposes you to?
STEP 2: Determine what your key reason is for buying and operating a business (in addition to the obvious reason of making money):
- Buying a job to earn a living/being your own boss.
- Acquiring an attractive lease or other real estate.
- Buying prestige (many business owners are respected community leaders).
- Eliminating competition if you already have a business.
- Buying a hobby or retirement occupation.
- Seeking self-fulfilment and control of your own destiny.
- Seeking an opportunity for a child or other family member
STEP 3: Now ask yourself “What is it that I really like to do?”, and “What is it that I am really good at?”
If you have determined that you are a truly motivated buyer and you know the reasons that you want to own and operate a business, then you should begin searching only for those businesses that match what you like to do and ones that match your skills, capabilities and knowledge.
There are many sources of businesses for sale and quite a few businesses can be relocated, but to maximize your opportunity of finding the right business for yourself, you should be prepared to relocate to the business’s location if at all possible. Some good sources of information about businesses for sale include:
- Newspaper classified advertising under Businesses for Sale and Business Opportunities
- The internet including social media
- Word of mouth through friends, family, and colleagues from all walks of life
- Media/Magazines and other periodical publications
- Business Sales Agents
STEP 4: Now that you know what your motivations are for buying a business and where to find a good business for sale, you will need to have some idea about how to apply a realistic purchase price.
This is no easy task! Remember, the seller will want as much as they can get, and you will want to pay as little as possible. The key is to strike a fair deal for both of you. Remember that buying a business is fundamentally a financial investment for most of you and consequently the business is worth only as much as its ability to generate pro ts. If you are going to work in the business as most people do, then the business should also pay you a fair wage in addition to the pro ts. The best way to determine a business value is to work backward from the available profits that a seller can prove.
For example, let us say that a business has a total of $100,000 EBIT (earnings before income tax for the latest full year of operation). A fair wage for the work if you were to hire someone to do it, or do it yourself, is $50,000. But don’t forget to deduct the income taxes that you will have to pay, plus other personal factors ( at least 30%). That gets you down to about $42,000 of profits left to be able to either pay off the business loan or to provide you with a reasonable return on your cash investment.
So, when you do the math to determine the value of $42,000 in yearly payments for 5 years at 10% interest, the amount turns out to be about $165,000. This is the approximate total value of the business and a good starting point for negotiations. If the business has inventory, and/or real estate, and/or accounts receivable (or other current cash assets) that are to be transferred as part of the sale, their value will have to be added to the overall calculated value of the business. The actual sale price will then be negotiated between the buyer and the seller.
This is of necessity a simplistic example of a fairly complicated process. There are many other issues associated with valuing a business and you as a prospective buyer should read as much information on this topic as possible. And of course, before you actually proceed with a purchase you should seek the advice and guidance of competent legal and accounting professionals.
STEP 5: Next, you will need to start thinking about how you will pay for this business.
One of the most crucial steps in the purchase of a small business is to establish the financing necessary to accomplish the transaction. This issue is of equal importance to both the buyer and seller.
There are many sources of financing available to the purchaser of a business and frequently the buyer will use not just one of these sources, but a combination of several. The most frequently used sources of funding are:
- Buyer’s Personal Capital
- Seller Financing
- Bank Loan
By far, the most frequently used funding sources at the moment for the buying small business are a combination of all three funding sources, both conventional and unconventional.
In most sales of small businesses, there can be some amount of seller/vendor financing of the purchase price. It is not something I am an advocate of, however, it can be a solution for a business that has been fairly valued with enough cash flow from the business operations to cover the payments the buyer must make to the seller. The business must be able to pay itself off through the business’s cash flow over a reasonable length of time. The interest rate is a key factor in determining whether the business can afford to pay for itself. To give you an idea of the difference that the spread of interest rates can make in an amount amortized over ten years, consider the following:
• $500,000 for 10 years @ 4% is $5,062 monthly
• $500,000 for 10 years @ 7% is $5,805 monthly
• $500,000 for 10 years @ 10% is $6,608 monthly
The time period of the loan is also a key factor when considering the financing of a business sale. Most buyers forget this factor… I certainly did the first time around.
STEP 6: Once you have completed negotiating the selling price for the business, the next step is to finalise the sale, take possession of the business, and begin operations yourself.
Closing the deal is the hardest to accomplish, and it is the reason why I continue as a Business Sales Agent. It takes experience and gusto to be able to hold your nerve on a business sale deal as the contract is never truly unconditional until the moment it settles. After all, the valuations, due-diligence and negotiations are complete, it is then a matter of getting everything into writing in a form that satisfies everyone so that the transfer of ownership of the business can take place.
The best situation for all parties is to follow an orderly buying and selling process that will move things along in a business-like manner. Click HERE to request a copy of my “Buying a Business Checklist”. The major element of the business purchase and sale process is to complete the Business Sale Contract.
At the closing, the actual legal instruments of transfer are signed and led, money is exchanged, and you (the buyer) becomes the new owner of the business. Once the contract has been signed by both the seller and yourself, and finance has been approved, the contract becomes unconditional, and there is an excellent chance that the sale will actually take place.
The buyer’s and/or the their solicitors responsibilities will include:
- Finalising financial arrangement
- Reviewing/assigning any necessary leases.
- Applying for licenses and permits.
- Preparing any additional legal documentation required.
- Stocktaking inventory of nished goods and WIP (Work in process)
- Final inspection of the business assets.
The seller’s and/or the business’s solicitor responsibilities will include:
- Preparing the lease.
- Providing for an inspection of the business and a stocktake/ inventory count by buyer.
- Preparing any additional legal documentation required.
- Complying with any other provisions in the contract
My responsibilities as the Business Sales Agent will include:
- Ensuring buyer/seller responsibilities are carried out.
- Arranging necessary information from both parties
- Acting as go-between to facilitate communication and information
- Handle buyer/seller anxiety
- Negotiate a contract that is satisfactory to both parties
- Manage the contract to completion/settlement
Also… it may seem obvious, but I’ll state it anyway because there may be more to it than you think. The first thing the buyer does after the closing is to take possession of the business! This may include the following considerations, in addition to the normal changeover of accounts:
- Change the locks on the business property
- Formally notify the employees
- Notify the suppliers
- Notify the customers (if appropriate to the type of business)
- File all new legal paperwork with the proper authorities (titles, licenses, etc.)
PHEW! Well, that’s a snapshot of what it takes to buy an existing business. As involved as it may seem, I truly believe that it is far less trouble than starting a new business, and certainly less risky. If you have an entrepreneurial mindset and would like to consider getting into business for yourself, even if it is only a home-based business to start, consider buying an existing profitable business.
There’s never been a market like this for buying a small business.
Yours in business,