How to Buy a Business Guide

How to Evaluate and Negotiate to Buy a Business
Checklist Tips, Guide on Buying a Business
Read all of this BEFORE you go into business.

These are the major factors to consider when buying a business, besides the basic steps of legal advice on structure and registrations and accounting basics. If you are tired of working for idiots or a nasty heartless company or clueless corporation, then read on.

Introduction: If you are thinking of buying a small business, a franchise, or entering a corporate partnership, read this page and carefully examine the seller of the business and the business itself. But as important, examine your abilities, goals and family situation carefully before going into business for yourself. If you are looking to buy a "business opportunity" (biz op), reading this page will be helpful before you also read our guide-tips on how to buy a business opportunity and how to avoid business opporunity scams. These three pages go hand-in-hand for checklists on business opportunities.

But first lets look at buying or buying into an existing business: what to look for, what to be cautious about or avoid. Seek competent advice. This is not intended to be specific advice to a particular situation.

Is it a good business you can enjoy running?

1) Be sure you have strong interest, knowledge, ability and preferably some experience in the field of the prospective business. Try to pick something you like or love. Although experience and enthusiasm overcome most problems, your basic business knowledge is critical to identifying a successful business or one with real potential. Don't go into battle with a BB gun. Study attributes of more highly profitable companies. High margins come from near-monopolies in a growth field.

2) Real opportunity comes in growth fields. First and foremost, common to all our guides, is choosing the right business, one that is in demand in a growth field. Then remember, even if the business is in a growth field, is the product truly unique and in demand? Is the demand proven, not just opinions and conjecture??

3) Most important is exclusivity, uniqueness and growing demand for the product or service. The product or service itself should hit you with a "wow" response. It should be something so good and so clever that you and your neighbors or certain segments really want, need and demand it. Rely more on strangers and test your likely ads, appeals, ad copy and perform actual product tests. Get real feedback, not business seller's biased opinion. Nothing is more educational than listening to real stranger prospects and users as to their real opinions. Talking to a few customers of the company, and looking at the customer service records is key.

How to Evaluate the Business:

4) Fortunately, if you ask good questions in writing, the company is obligated to disclose material matters. Most important is the competition and the demand curve, adjusted for economic or industry current and future conditions. You want to be the only provider of this WOW product or service in your exclusive territory. A real business has a virtual monopoly over a demand product in an exclusivearea, like a dealer or a licensee. Likewise, if you are considering buying a franchise, this is just one of many aspects of a franchise you should consider.

5) Careful buyers insist on a complete assessment of the business outlook and climate, and ask about any difficulties the company has had in the last few years, such as materials shortages, changes in industry standards, and substitute products. This would be a good time to ask to view certified as actual financial statements. They do not have to be audited, but that would be nice.

6) But be flexible. Some great products and high potential companies have bad management who keep books poorly and squander their opportunities. The big mistake some buyers make is depending only on a standardized business valuation which shows the company not worth much. That may not reflect real potential that the tired careless and distracted owner tries to explain to you. The truth is probably somewhere between the formal business valuation and the owner's grand outlook of potential. The good deals are found when all these factors line up with a motivated seller, and a business difficult to value. Brokers avoid difficult-to-valuate companies. You must determine what sales and earnings (profits) will or can be in 2 to 3 years.

7) Business valuation methods are several, and probably the best is based on market share and market growth potential as well as actual customer comments in the last few years. Ask to read a series of emails or letters from two or three of the last few years, randomly chosen. Unless you have to depend mostly on banks and formal financing, then formal valuation methods can not be used exclusively. The main issue is sales and demand. Are customers clamoring for the product? Is there a strong loyal following somewhat frustrated by the inconsistency, unavailability and/or poor distribution? Look at it like a turn-around. What can be fixed?

Brokers, Owners, Terms and Negotiating

8) Business brokers may have a conflict with your interests. They typically represent the seller and themselves. They may want the sale more than their concern about your ability to prosper. They tend to avoid the little companies with the eccentric owner who messes around with hobbies and distractions, because the records are weak or scattered, and the earning or sales appear erratic. Get the owner to talk about his or her recent interests and distractions. After about 10 to 15 years, he or she is probably just tired of it. They started it for fun and made some good money. They probably didn't report all of it. But they want out. They are often open to terms of owner-financing. IF the product is unique, demand is strong, testimonials are strong and profits are fair to good---this can be the "gem" you are looking for, especially if there is good owner financing. Remember, if the owner believes in the product and demand, there is less risk to him/her in selling. If they are creative types, they just want to see it flourish while going into something else. Consider letting that seller keep back a small percent of equity (corporation) or a royalty on sales. That gives them incentive to really help you succeed.

9) If you try to negotiate a seller-financing deal, consider many scenarios including what could go wrong, such as no title and the seller dies. Good legal advice on the sales agreement is critical. This is also probably where a bond or insurance comes in to protect the title to the business so it can be held in trust until the original or a reduced amount is paid.

10) On an owner-finance deal, there can be an incentive for the seller to help you make the business succeed. You could even include a "kicker" that if profits and/or sales increase at a certain rate, the seller gets a bonus. Likewise a dis-incentive might penalize the total price if sales do not develop or decline, or if he/she does not put in proper time helping transition for a year or more. The seller must agree to help transition and introduce you to customers as a partner coming into the company.

12) Most on-going businesses purchased are purchased as "assets only" sales. This helps ensure that no unknown debts or liabilities are included in the sale. Obviously the assets must be free and clear, or the balances owed on equipment or properties included must be paid off at closing. Think of a business deal much like a real estate closing, with a business and property lawyer handling the closing. There should be a similar disclosure and settlement statement prepared to be reviewed and signed by both parties.

13) A negotiation strategy depends also upon the age, circumstances and demands of the seller and the potential growth or investments required to increase sales. This is a cash flow projection problem. Obviously you need to allow for loss of the pace during early days of transition, and an agreement that you both should appear as the business for a while and then the owner retires, best a couple of years. Such a period allows the customers to become comfortable dealing with you.

You need to use a business plan cash flow projection system to try varying investment versus sales to see what type of purchase terms arrangement can be best. Of course you are trying for 20% or less down.

For example, if the company needs a lot of improvements to meet higher projected demands, you need more money up front put into the business. An approach can be to act disinterested for a few days, make a relatively low offer of about 80% of the price, then come back in about a week with an offer near the asking price but with a much lower down payment. The seller likely refuses. Give them another week or so (unless it might sell out under you). Then go back and say, "I tell you what. I intend to make this company really go, but I need to invest into it up front, so I will offer you what you are asking, but I can't increase the down payment much. If things go as well as you lead me to believe they could, you should get a bonus in less than two years that makes up most the difference. Over the four years, you'll likely end up with more than you asked for it. This gives us both incentive to make the company strong at the earliest time, because I need that growth to pay you " If that doesn't appeal to the seller, that might make you suspect and ask whether the potential is really there. If the seller really believes in it, they will likely fold to your terms, if no one else is bargaining. About the time you feel the seller is accepting the deal, try to draw out the down payment over about 6 months, in 2 or 3 parts, or like an option and then completion of the down payment.

14) Consider bargaining for only certain rights and key equipment and the company name and trademarks. Or consider a deal where you agree to temporarily set up or separate the sales organization that is the selling end of the business, while you wait a while to buy the production end. The original company focuses on production and your deal is to buy the products at a low wholesale while preparing to buy the production operation assets when the sales operation is smooth and growing in a year or two. You are basically operating on a term purchase agreement where you buy product at steeply discounted rates while perfecting sales and learning more about production. Your lawyer, CPA and/or insurance agent can help on finding some kind of performance bond and/or trust or escrow arrangement to have a third party control the transaction funds disbursements.

Due Diligence, Market test and Owner Assistance

15) Be sure to do good market testing. Be absolutely sure the product or service is up to date and modern enough that people want to keep buying the product. This can be done by interviews and focus groups, and market research tests, and questionnaires. This is especially important if this is an older product in a changing field, like discrete electronic components or auto add-ons.

16) Get the previous owner to assist in strategy development. They may have tried various tactics. Pick their mind for what didn't work and what was risky. You are buying that knowledge of what worked and what failed and why it failed.

Turn-Around, Focus, Strategy and Budgeting

17) Like any business, keep the focus on the most important factors and requirements that must be present: a good product/business in high demand delivered by a good strategy with good management and enough money in a budget based on the strategy. You must have a virtual monopoly on what you are doing in some area to be very profitable. Be keenly aware of new foreign competition or alternative technologies on the horizon. Those are questions in writing to the seller.

18) Next comes good management to execute the strategies. If the situation is right, you are basically involved in a "turn around". The key here is listening to customers, vendors and workers. The lowest level supervisors and workers usually know how to fix the company. And that's a great way to introduce yourself, as someone there to make the company better by listening to the important people, and then really listen and take notes.

19) Enforce your strategies by your budget, which can be modified each six months to a year, preferably yearly with an allowed 10% or so adjustment built into such budget as to re-allocations for what is learned during the year. (that is 10% in each subcategory, not cutting or shifting too much into or out of one category, unless a product is an obvious loser or big winner, which would make an exception).

20) For this turn-around, be sure you know and study business as well as the product and industry. Don't get bogged down in computer projects and reports. Management is all about face time, leading, coaching, thinking, planning, priorities and exceptions. Don't start any computer project unless you have real experts, not wanna-be's. Focus on margins, inventory or sales turns and up-selling and ask for referrals or spend time prospecting. Be polite but strict on credit management. A friendly call, mentioning the bill and then "going quiet" usually works wonders. Tight credit terms and customer credit management can not be over-emphasized. A lot of companies and consumers don't pay their bills, or wait months. Too many of these and you will go out of business. This is one of the few areas where a food business shines, if it is mostly cash and credit card sales. Know enough business law to not get in trouble, such as by not pricing uniformly among a class.

21) Don't dramatically change anything unless it is terribly obviously wrong. Go slow on major changes in terms except to blatantly abusive late payers (get some leverage first). Especially do not change the customer interfaces, except to put service behind your claims of being great. Answer your phones. YOU talk to customers. Back up your people and salespeople. Train people well. !!! Do something to enhance what was being done before, even such as more pleasant on-hold music.

22) Learn which employees are producers. Listen to them. Smooth out production and training before increasing marketing and distribution. Increase marketing gradually in steps to watch for glitches as you "ramp up".

23) Talk to workers before you buy. Be sure you can get along well. Tell them you value their knowledge, skills and experience---and mean it. People are motivated as much by recognition as money. But BOTH is even better !! Read up on turnarounds and case histories.

24) Caution: If the company is technology-oriented, be extra careful that you have experience in such fields and attention to details. If it involves programming, even website programming, someone must be darned good at it to make money. That means training, experience, high intelligence and speed. You don't get that for $15 per hour.

25) As to partners, be very careful. We have a web page discussing this and corporate ventures. The fewer the partners, usually the better. Friends who have gotten over hard situations could be better. Know the partner well. Partners can obligate you, with joint liability by their acts and omissions and errors. Such terms must be laid out very carefully by a lawyer (read "expensive"). These subjects go beyond the scope of this how-to article, and you should also seek competent legal advice.

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The nice thing about buying an existing business is you save time finding customers and working out bugs in the business. If your skill is management, but not sales, this can be a good match. Emphasize balance, strategy, sales and good people. Do your homework and you will likely succeed where many fail. Good luck!

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