So, you want to buy a business? You’ve come to the right place. Buying a business can either be one of the greatest purchases of your life or one of the biggest mistakes you’ve made.
But don’t worry, we won’t let you make the mistake. That’s why we’re going to ask you the tough questions. Think of this as a test. If you still think buying is a good idea by the end of this article, then you’re in business, baby!
Questions You Should Ask Before You Buy a Business
How do you know that buying this business is the right move? Here are the top four questions you need answered first:
1. How invested am I?
2. What is the business worth?
3. What are the costs of running the business?
4. What is included?
1. How Invested Am I?
Before you even think about how to go about buying a business, you need to ask yourself, How invested am I?
Stop doing business as usual! Lead your team, grow your business and create a world-class culture with EntreLeadership Elite. Start your free trial now.
Imagine waking up on a Monday morning one year from now. Are you still passionate about this line of work? Your vocation needs to be a vacation. Otherwise, running a business is too much work. If you’re only in it for the money, you’re setting yourself up for misery.
If you already own a business and you’re thinking about buying a second one, you need to evaluate your personal bandwidth. Can you emotionally and financially handle running both businesses?
And if you’re looking to buy a business just to make money, you’re going to run out of steam real fast. There isn’t enough money in the world to make you work as hard as you’ll have to work running a small business. You have to love it, believe in it, and have a calling on your life.
Spend some time around the business. Sit in there for a week to see how it operates and learn all the ins and outs. If you’re not familiar with this field, could you find a competitor in another city who would mentor you? You need to become somewhat of an expert before you even think about buying.
If you’re truly invested and passionate about this new business opportunity, move on to question two!
2. What Is the Business Worth?
A business is only worth the income it creates. It doesn’t matter if it’s in a really great location or if it’s a well-known brand name. Those things have no value if they’re not creating income, so figure out the net profit of this business.
Notice that we said net profit—not just sales. When determining the business’s worth, you need to focus on all three areas—the gross revenue, the expenses and the profit it generates as a result. Become an expert on the business’s financial performance. Ask to see their past three years of financial statements so you know what you’d be getting yourself into before you commit.
Once you’ve done that, ask what you’ll make on your money (that’s the net profit). You can make 12% with a mutual fund, so if you’re going to take the risk of buying a small business, you want to be able to make at least 20% on it. For example, if you take $100,000 and buy a business, it has to make at least $20,000 a year.
Another number to look at is the book value. If you collected all the receivables (which is the money owed to the business) and you sold all the equipment and the inventory, then closed the business, what would you have in your pocket? That’s the book value. So if the business currently has $40,000 in inventory, $30,000 worth of equipment and $30,000 in receivables, the book value of that business is worth $100,000.
Somewhere in between net profit and book value is a fair price. If the net profit of this business is $60,000 and they’re asking $185,000 for it, then that’s a pretty good buy. But you need to really get into their books and make sure their numbers are real.
But listen up—if someone says their business earns $65,000 a year but they only pay taxes on $40,000, then that means they only make $40,000. If you don’t report it to the government, you don’t count it. Don’t do anything under the table. This business is only worth what’s reported to the government, so again, look at the tax returns.
Even if you’re great with numbers, it’s a good idea to find a financial expert to help you through this process. It’s an extra set of eyes to review and verify all the documents and give you an unbiased opinion on whether or not this is a good deal.
3. What Are the Costs of Running the Business?
As you’re researching what the business is worth, you’ll come across the costs of keeping the business running while you’re researching what the business is worth, but your homework doesn’t stop there.
Take time to really examine the business and understand everything that goes along with keeping it afloat. This includes employee payroll and benefits, insurance, taxes, contracts, inventory, leases, cash flow—and anything else that helps run the business.
Think about the future. Do you want to keep the business where it’s at, or is the plan to grow it? What are your five-year goals for this business? Are there any expenses you may need to factor in to get there?
4. What Is Included?
When buying a business, you need to find out exactly what’s included in the asking price. How are they determining the value of their business? Does the price include current inventory? Office equipment? Furniture? Get a list of everything that’s included from the seller and what kind of condition it’s in. You don’t want to be sold on their premium leather couches only to find out they’re all ripped up. And don’t just take their word for it—make sure you go check out their stuff yourself.
It’s also important to know all of the baggage that might be included in this buy. Are there any debts or liens involved? You don’t want to buy a business only to find out you bought someone else’s problems.
One of the best benefits of buying an established business is that customers are included! The business should come with at least something of a reputation (hopefully a good one) and customers already in place, ready to hand you their money. But be aware—many sellers will try to exaggerate how much their reputation and customer base are worth when determining their selling price. That’s why studying their books and knowing their customer satisfaction is so important.
How to Buy the Business
If you’ve been going at this purchasing venture on your own, now would be the time to bring in your A-team. In this case, the A stands for acquisition.
Your acquisition team should include a financial advisor and an attorney. They’ll dig into the books and verify all of the information you’ve looked at up to this point. Have them compare the business’s potential returns and its asking price. Make sure they look into all of the legal records. You’ll want to get their expert and unbiased opinion on whether this is a good deal. A good A-team will tell you if you need to negotiate the price or if you’re better off walking away.
Making an Offer
When it’s time to make an offer, don’t hand over the full asking amount up front, but don’t drag out the purchase either. And you absolutely don’t want to take out any type of debt to make this purchase.
Be ready to pay at least 30–50% of the price in cash up front. As for the rest, try to create a formula that works for you and the seller. For example, if you both agree that $40,000 is a fair price, maybe you give $20,000 up front and the other $20,000 out of profits. Or maybe you decide to give a certain percentage of your first-year profits. Have your financial advisor help you work out a smart deal. Figure it out. But do it fast. You don’t want to still be forking over the money five years down the road.
And whatever you do, don’t take out a loan. If you can’t work out a reasonable deal with the seller, it’s not worth the buy. Walk away.
But if you and the seller have reached an agreement (loan not included), it’s time...
The Purchase Agreement
You should absolutely have a purchase agreement drawn up and signed before you hand over any cash. Here’s where your attorney comes in. Have them write up a contract with every single aspect of the sale in print.
It’s a good idea to include a clause that allows you to back out of the deal if you find out the seller misrepresented the company or hid any important information from you. You may also want to include a noncompete agreement so you know the seller isn’t going to open up a competing business two blocks away and take all their old customers with them.
If you feel comfortable after answering those four big questions and your A-team approves the deal, congratulations! It sounds like you’ve got a great new business venture on your hands.
First-time business owner? Time to start preparing yourself for the hardest work you’ve ever had in your life. When you’re self-employed, your boss can be a real jerk! But you don’t have to do it alone. Take the guesswork out of winning in business with EntreLeadership Elite. You’ll get a customized plan and online leadership training that will give you the confidence to level-up your new business opportunity.