Investing in an existing business is a great way to become an entrepreneur and reap the benefit of immediate profit without having to start something from scratch. When you start a new business, there are a lot of growing pains that you have to endure before you start seeing positive cash flow, so in many ways it makes more financial sense to purchase one. However, even if you are looking to buy a successful, proven business, there can be significant risk. If you prepare yourself properly, you can minimize the risk and ensure that you are making a wise investment.
Understand Why the Business is for Sale
Business owners decide to sell for many reasons, including retirement, health issues, divorce, or a change in lifestyle, to name a few. From the buyer’s perspective, there could be more concerning reasons, such as a problem with the business itself. You will want to get as much information you can about why the business is no longer working for the current owner. Ask them what types of challenges they encountered, how they’ve tried to solve those problems, and what results they achieved.
You may find that some of the seller’s challenges could be easily solved. Maybe there’s a strategy or solution that you can come up with that they could not. Whatever it is, make sure you can handle it before you move forward. Be wary of things like a poor business plan, falling behind the competition, large amounts of debt, equipment issues or location problems. It is your responsibility to protect your potential investment by finding out as much as you can about the business’s successes, failures, and challenges.
Do Your Due Diligence
Due diligence is the process of gathering as much information about the business as possible. During this process you should work with a business broker, accountant and lawyer to assist with your research and ensure that you are buying what you think you are buying. Before entering due diligence, the seller will likely require a signed confidentiality agreement or nondisclosure agreement to protect themselves in case you decide not to buy after reviewing all their documents. Here are a few examples of the numerous documents you should review when going through due diligence.
- Business Licenses and Permits: Make sure the business has all the applicable licenses it needs to operate within its industry and that they are all current. Check to see if the current owner has violated any licensing laws.
- Business Entity Documents: If you are purchasing an LLC or Corporation, review any entity documents filed with the state. Check with the state to make sure the business is in good standing and that the owner has the legal right to sell it.
- Legal Liabilities: Check to see if the business is party to any lawsuit. If it is, and you acquire it, you could be part of that lawsuit. Find out if you would be inheriting any legal liabilities, such as liens or judgements.
- Zoning Laws and Environmental Regulations: Check with your area’s zoning authority to make sure the business isn’t violating any restrictions. Make sure they are abiding by local environmental laws as well.
- Contracts and Leases: Leases can be for the business’s location, but they can also be for equipment. If there is a landlord, make sure they are willing to transfer the lease to your name. Negotiating a new one could result in additional expenses. Vendor agreements and employment contracts should be reviewed as well.
- Client records: Review customer agreements and contracts to get an idea of which ones are helping to drive the business. If a disproportionate amount of business comes from one or a handful of clients, you may want to reconsider buying. If one decides to part ways, it could significantly hurt the business.
- Inventory and Equipment: The value of the business’s inventory will directly affect its overall value. Get an understanding of how much there is, its quality and how well its selling. The equipment is also important. What’s the condition of the equipment? Is it serviceable, or does it need to be replaced? Furniture and fixtures can also affect the operation of the business and how it appears to customers. Determine if anything needs to be replaced and the potential cost.
- Reputation: The business’s reputation can make a big difference in its value and future success. Perform searches on review sites and other online resources to see if there is any negative information you should be concerned about.
Review the Financials
Financials are one of the most important parts of your due diligence. An accountant can help you to review key financial indicators, but you will want to see the past few years of financial statements including tax returns, balance sheets, cash flow statements, accounts receivables, accounts payable, debt disclosure and advertising costs, just to name a few. Evaluate the business’s various income streams. Make sure receivables are collected on time. If the business hasn’t yet reached profitability, make sure there is a clear path for it to become profitable. As you review the financials, try to determine if they tell a good story about the business or not.
Evaluate the Price of the Business
You need to make sure you’re paying a reasonable price for the company you are about to invest in. To do this, you should obtain a business valuation. You can use a valuation expert, such as a business broker, but it’s still good to have knowledge of some basic valuation methods.
One valuation method is the earnings approach, which is based on the idea that the value of the business depends on its ability to produce future earnings. With this method, prior earnings can be used to predict future earnings, which are used to value the business. If the business hasn’t turned a profit yet, earnings models can be used to predict its future potential, but since there is no historical data to lean on, this could be inaccurate.
The asset-based valuation method is designed to estimate the value of the business based on tangible and intangible assets minus debts and liabilities. This is best used for businesses that haven’t turned a profit yet, or capital-intensive industries such as manufacturing and transportation. It considers the current fair-market value for the assets as well as the future return on investment from them.
A market-based valuation is established by comparing a business to similar companies that have already sold. While this method is very useful for getting a ballpark range of a business’s value, it depends on having enough data for recently sold, similar businesses. This approach is best used to account for local factors or to verify a value determined by one of the other methods.
There are many factors that go into the detailed process of buying a business. Knowing what to look for and how to evaluate a deal can help you to reduce the risk of your potential investment. Don’t let the excitement over the possibility of becoming a business owner cloud your judgement or skip through the process too quickly. Buying the right business takes time and it is important that you use that time to be thorough in your research. This will maximize your potential for success and minimize the likelihood of experiencing buyer’s remorse.
If you’re looking to invest in an existing business with a track record of success, contact Corporate Investment Business Brokers (CIBB), headquartered in Fort Myers and Sarasota. We have a large list of profitable, proven Southwest Florida businesses for sale and can help match you with a new opportunity that fits your criteria and budget. Take a look at our listings, which represent a wide variety of industries in Lee, Collier and Sarasota counties, or contact us for more information.
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