Buying an existing business can provide a quicker, more secure entry into a new market compared to starting from scratch. This guide offers a detailed, step-by-step ‘buying an existing business’ checklist to help you navigate the process successfully, ensuring you avoid common pitfalls and make informed decisions.
You’ve already succeeded as an entrepreneur/small business owner, starting up your own small business and making good profits from it. Now, you’re eager to explore a new market and take on fresh challenges.
But starting from scratch comes with its own set of challenges.
What if there was a way to enter a new market without the uncertainty of building everything from the ground up? What if you could step into a business that’s already up and running, with loyal customers and a solid foundation?
That’s where buying an existing business comes in.
Buying an existing business, known as an ‘acquisition’ in business jargon, offers a shortcut to entering a new market, allowing you to bypass the challenges of starting from scratch.
Fun fact
Statistics indicate a 90% failure rate for new business ventures within five years, while business brokers report that 70% of businesses they sold are still in business five years later.
~ Redefining Business Success: Distinguishing Between Closure and Failure.[1]Buying a business instead of starting one can be a smart move for seasoned entrepreneurs looking to expand their portfolio. And it’s an even smarter option for small business owners who are just entering the entrepreneurial world and want to hit the ground running.
If you’re eager to embark on new challenges and explore possibilities, this guide is your starting point in the journey of buying a business. It will provide you with the initial steps to help you find direction and navigate through the process of buying an existing business.
Let’s begin your ‘buying an existing business’ checklist!
1. Find the right business to purchase
Choosing the right business to buy is crucial and depends on practical factors and personal preferences.
Here’s what to consider:
Firstly, prioritize cash flow and profitability. A business you’re eyeing should already be profitable or show strong potential for future earnings based on solid data.
Starting a business isn’t a hobby; it should be a financially viable venture. Also, assess the business’s long-term prospects. Even if it’s doing well now, if it’s not sustainable in the long run, you could end up losing your investment.
To gauge profitability, start by examining its net profit margin, which is the total revenue minus expenses for the year. You can find this information in the Profit and Loss Statement aka the income statement.
Additionally, consider using tools like pro forma income statements, which predict future profitability based on projected income and expenses. This helps you determine if the business is a good long-term investment.
A break-even analysis is another valuable tool. It tells you the point at which the business’s revenue matches its expenses, giving you insight into its profitability and how it will fare if sales drop.
Lastly, profit-per-client reports can reveal which customers contribute the most to the business’s profits. This information helps you create customer personas for targeted marketing campaigns, ultimately boosting long-term profits.
By thoroughly analyzing these factors, you can make an informed decision and ensure the success of your investment.
Is industry knowledge important?
Short answer—absolutely!
Knowing the industry you’re buying into is key when purchasing a business.
If you’re already familiar with the industry, you’re more likely to enjoy working in it and stick with it for the long haul, which is good for profitability. Your knowledge also helps you spot trends, make predictions, and prepare for changes.
For instance, let’s say you’re a coffee enthusiast looking to buy a café. Your passion for coffee gives you insights into what blends, roasts, and brewing methods are trending. This helps you stock up on the right inventory and connect with customers who appreciate your genuine passion.
So, when choosing a business to buy (or even when choosing a successful small business to start), consider your passions, interests, and experience—they’ll greatly influence your success as a business owner.
2. Evaluate business value
Have you heard about Microsoft’s acquisition of Nokia’s phone business in 2014[2]? The acquisition cost Microsoft around $7.2 billion, and the company ended up losing more than $8 billion!
Microsoft hoped to strengthen its position in the mobile market but ultimately failed to achieve significant success with Nokia’s phone division. This acquisition was widely criticized as overpriced and contributed to significant write-downs for Microsoft in the subsequent years.
Why do we discuss this example here? to ensure that you don’t make Microsoft’s mistake of buying a business for more than it’s worth.
Once you’ve identified a business you’re interested in, the next step is determining its worth. Many sellers tend to inflate their business’s value, so it’s crucial to ensure you’re not paying more than it’s worth.
When it comes to valuing a business, you have two main options:
DIY valuation
You can assess the business’s value yourself. While this approach is cost-effective, it requires a thorough understanding of valuation methods and industry benchmarks.
Professional valuation
Alternatively, you can hire a professional to conduct the valuation for you. Although this option can be pricey, often reaching up to $50,000 or more[3], it ensures an objective assessment by experts.
Business valuation methods typically involve assessing factors such as business revenue, net income, or EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)[4]. However, the specific method used depends on the nature of the business and its industry.
For example, service-based businesses might be valued differently from manufacturing businesses.
3. Negotiate and make an offer
Once you’ve made the decision to proceed with acquiring a business and have a ballpark figure of its value, it’s negotiation time. This usually starts with making an offer, either written or verbal, which initiates the bargaining process.
Expect back-and-forth discussions, where you’ll explore different price points and terms before reaching a tentative agreement. During negotiations, you’ll also decide between purchasing the business’s assets or opting for a stock sale[5].
4. Submit a Letter of Intent (LOI)
After hashing out the general terms of the purchase, the next step is submitting a Letter of Intent (LOI)[6]. This document outlines the negotiated terms, including the purchase price, signaling your serious intent to acquire the business.
The LOI is typically non-binding and grants you exclusive rights to purchase the business for a specified period, usually up to 90 days. This ensures that you’re the sole potential buyer during this timeframe.
5. Conduct due diligence
Before finalizing the purchase of a business, it’s crucial to perform due diligence, which involves thorough research and investigation into various aspects of the business.
This includes assessing:
- Outstanding debts
- Future prospects
- Tax compliance
- Legal standing
- Current financial status
- Individuals involved in its operations
At this point, you should consider partnering with expert professionals such as accountants and business attorneys to ensure a comprehensive due diligence process. Once the LOI is signed, you’ll gain access to detailed information about the business, allowing for a deeper examination of its financial and legal records.
During due diligence, make sure to review essential documents, including but not limited to:
- Organizational papers
- Tax returns
- Financial statements
- Customer revenue data
- Existing contracts
- Lease agreements
- Franchise documents (if applicable)
- Employee details
- Marketing materials
- Any legal records pertaining to ongoing litigation.
- Rental income records if tenants occupy the property
This thorough assessment will provide invaluable insights into the business’s health and potential risks before completing the transaction.
6. Finance the purchase
When you’re ready to buy, securing financing is a crucial step. Typically, buyers use a combination of their own funds and loans to cover the purchase price.
If we talk about loans, various loan options are available, including SBA loans[7], traditional bank loans, and a method called Rollover for Business Startups (ROBS)[8], which allows you to utilize funds from your 401(K)[9] without incurring debt or interest payments.
During the due diligence process, it’s essential to explore all financing avenues thoroughly. Additionally, consider whether the seller offers financing, which can simplify the process. Seller financing involves the business owner providing a loan instead of a traditional lender.
It is recommended you address financing matters early in the process to ensure a smooth transaction when it’s time to finalize the deal.
Tips for preparing a strong financing application
Organize financial documents
Compile all necessary financial documents, including:
- Personal and business tax returns
- Bank statements
- Profit and loss statements
- Balance sheets
Having organized financial records demonstrates your preparedness and reliability to potential lenders.
Improve credit score
Work on improving your personal and business credit scores before applying for financing. A higher credit score increases your chances of securing favorable loan terms[10] and lower interest rates.
Prepare a solid business plan
Create a comprehensive business plan outlining your objectives, market analysis, financial projections, and growth strategies. A well-thought-out plan shows lenders that you have a clear vision for the business and how you intend to achieve success.
Explore multiple financing options
Research different financing options available, such as SBA loans, traditional bank loans, alternative lenders, or crowdfunding. Compare interest rates, terms, and eligibility requirements to find the best fit for your business needs.
Build relationships with lenders
Establish relationships with potential lenders before applying for financing. Networking with banks, credit unions, and alternative lenders can help you understand their lending criteria and increase your chances of approval.
Offer collateral
If possible, offer collateral to secure the loan, such as real estate, equipment, or inventory. Providing collateral reduces the lender’s risk and may result in better loan terms.
Seek professional assistance
Consider navigating the financing process with a financial advisor, accountant, or business consultant. These professionals can offer valuable insights and guidance to help you prepare a strong financing application.
Address any red flags
Address any potential red flags in your financial history or business operations. Explain past financial challenges and demonstrate how you’ve overcome them to reassure lenders of your creditworthiness.
7. Finalize the deal
If everything looks good after due diligence, it’s time to seal the deal. You’ll work with the seller to draft a final purchase agreement outlining all the terms you’ve agreed upon.
It’s highly recommended to have a lawyer review the agreement to ensure it aligns with your negotiations and protects your interests.
Once both parties sign the agreement, you’ll set a closing date and arrange for your lender to provide the necessary funds. The money will typically be held in escrow until all paperwork is completed. Once approved, the funds will be transferred to the seller, and you’ll officially become the business owner.
After the closing, don’t forget to apply for any required business licenses to ensure a smooth transition. While some states may allow you to operate using existing licenses during the transition period, it’s essential to stay on top of any necessary paperwork.
If your acquisition involves a stock purchase, you may not need to worry about obtaining new licenses, as the business entity remains unchanged.
The bottom line
Buying an existing business can jump-start your expansion, but it’s not a move to take lightly—especially if you’re already running another venture. Before you invest, you need a clear snapshot of your own financial standing to confirm you’re ready for additional costs, loans, or other risks. This is where accurate bookkeeping is essential: if your own numbers aren’t solid, you can’t confidently navigate due diligence or negotiate a fair deal.
At CoCountant, we help you evaluate your current books, assess financing options, and vet the target business’s financial health. And once you’ve taken over, our comprehensive bookkeeping services keep your newly acquired venture on solid financial ground, ensuring accurate records for tax prep, cash flow management, and further growth.
Ready to make your next big business move confidently?
