Buying an Existing Small Business

Not every entrepreneur needs to invent a better mousetrap in order to start a business. Sometimes, "your" business is already out there, being operated by someone who is waiting for you to call and make an offer.

If you don't want to start a small business from scratch, buying an existing business may be an excellent alternative. Let's take a look at some of the advantages and disadvantages of buying an existing business.

Advantages of Buying an Existing Business:

• Immediate operation. Operations can start immediately.
• Quick cash flow. Existing inventory and receivables can produce quick cash flow.
• Existing customers. Customers and suppliers have already been located, and relationships with them have been established.
• Existing goodwill. Goodwill toward products or services has (presumably) been created.
• Easier financing. Financing is easier to obtain because the business has a track record.
• Competition eliminated. Buying a business may eliminate a competitor that you would have had if you had started from scratch.

Disadvantages of Buying an Existing Business:

• Cost. Buying a business is sometimes, but not always, more costly than starting one from scratch.
• Problems. There may be inherent problems in the business, some of which may not be apparent until after the sale.
• Obsolete goods. Inventories and equipment may be obsolete.
• Personality conflicts. Your personality may clash with existing managers and employees.
• Uncollectable receivables. Bills owed to the business by its customers may be old, stale, and ultimately worthless.

The steps involved in purchasing a business are similar to those necessary whenever you make any major purchase. Caution should be exercised throughout the whole process, not only because it will help you find the business that is right for you, but it will also help you avoid being taken advantage of by unscrupulous sellers. Your attorney or accountant should be actively involved in your search. You may also want to consider our detailed description of selling a business from the seller's point of view.

Finding Businesses to Buy

If you're in the market to purchase a business, there are many sources available to find a business for sale. If you know what type of business you are looking for, trade associations for that industry may be a good place to start your search.

If you are looking for a business in a particular area, you may want to contact the local chamber of commerce in that area to see if they can provide any assistance.

Other resources to consider:

• Newspapers. Most newspapers, from large metropolitan publications to small local publications, have a classified ad section in which businesses are listed for sale. Some, such as The Wall Street Journal, even have a specific classified section of businesses for sale.
• Internet. There are many internet sites that list businesses for sale and there are more appearing all the time. You can do a general search of sites that offer businesses for sale, or you can do a specific search for the particular type of business you're interested in.
• Business brokers. Another route to finding a business is to go through a business broker. A business broker matches people who want to buy a business with people who are selling one. One of the benefits of using a broker is that the broker, at least a good one, will screen businesses that are for sale to determine if there are major problems and make certain that the business being sold exists. The broker will also guide you through the process of buying, and help you deal with snags that may develop along the way. However, the broker's fee to sell the business will probably result in a higher sales price for you, even if the seller is the one who's nominally paying this commission.

If a particular business seems like a promising choice, you'll want to contact the owner (or the broker, if the business has been listed with a broker) to find out the general facts about the business. From this information you can decide if you want to proceed further.

Researching the Purchase of an Existing Small Business

After finding a business for sale that seems a likely prospect for you to run successfully, spend enough time to thoroughly investigate the business. You should definitely get your lawyer and accountant involved in this process, as well.

By thoroughly investigating the business (doing "due diligence," in business-speak), you increase the chances of making a decision that is right for you. The time spent investigating the business, the industry, and the market will make you confident that your decision to buy (or not to buy) was the right one.

In many cases, the seller will not give you any sensitive information about the business unless you have signed a letter of intent that, essentially, makes a non-binding offer for the business, and you have also signed a confidentiality agreement promising that you won't use the information for any purpose other than making the decision to buy.

Keep in mind that if a business is for sale, there must be a reason why. That reason may be because of a problem such as poor cash-flow, bad management or a poor economy. A thorough investigation should reveal any existing problems and enable you to weigh those problems in your purchasing decision.

A business investigation is usually performed before the business is bought, but can continue after the sale. In such cases, some of the sales proceeds will probably be held in escrow until the investigation is complete, or your contract may provide that the seller will reimburse you if certain types of problems turn up. A business investigation involves taking a hard, objective look at every aspect of the business. In many instances, however, time will not permit you to investigate the business as thoroughly as you would like. However, certain basic inquiries should be made. At a minimum, you should examine the following documents:

• Organizational documents— documents that show how the business is organized, such as partnership agreements, articles of incorporation, and business certificates, should be examined to determine how the business is structured and capitalized.
• Contracts and leases— documents such as property and machinery leases, sales contracts, or purchase contracts should be examined to determine the exact obligations the business is subject to.
• Financial statements— financial statements for the past three years (and longer if available) should be examined to determine the financial condition of the business.
• Tax returns— tax returns for the past three years (and longer if available) should be examined to determine the profitability of the business and the whether any tax liability is outstanding.

Below is a checklist of documents you should obtain from any business you are thinking about buying:

• Asset list, including real estate, equipment, and intangible assets like patents, trademarks, and licenses.
• Real and personal property documents (e.g., deeds, leases, appraisals, mortgages, loans, insurance policies).
• Bank account list.
• Financial statements for the last three to five years.
• Tax returns for as many years as possible.
• Customer list.
• Sales records.
• Supplier/purchaser list.
• Contracts that the business is a party to.
• Advertisements, sales brochures, product packaging and enclosures, and any other marketing materials.
• Inventory receipts (also take a look at the inventory itself, to check the amount and condition).
• Organizational charts and resumes of key employees.
• Payroll, benefits, and employee pension or profit-sharing plan information.
• Certificates issued by federal, state, or local agencies (e.g., certificate of existence, certificate of authority to transact business, liquor license).
• Certificates, registration articles, and any amendments filed with any federal, state, or local agencies (e.g., articles of incorporation for a corporation, articles of organization for a limited liability company).
• Organizational documents (e.g., corporate bylaws, partnership agreements, operating agreements for limited liability companies).
• List of owners, if more than one (e.g. all shareholders if a corporation, all partners if a partnership, all members if a limited liability company).

Making the Final Decision

Once you've found out everything possible about the business, you'll have to make the final purchase decision. Here are a few suggestions of things to think about before you make the final decision:

• Make absolutely sure you've gathered all the information you can. Don't be surprised if gathering the information takes you several months. Above all, don't rush into the decision until you've explored every nook and cranny of the business.
• Make sure you show the information you've gathered to your lawyer and accountant. Ask them if they think the purchase is a good idea.
• Make sure you fully understand the true reason the current owner wants to sell. If the business hasn't been doing well, you should know precisely what the problem is and how you can fix it. Don't buy a business on the vague hope that somehow you'll magically turn it around.
• Make sure your decision is from the head as well as the heart. Don't buy a business just because you've fallen in love with the idea of being your own boss or because you really like the building where the business is located. Don't buy it unless you are reasonably sure that you can make some money from it.
• Make sure you know how to run the business you want to buy. If you don't, take the time to learn more about it or make arrangements for the current owner to stick around after the sale to show you the ropes. If the business is sold to someone else in the meantime, you'll still be better off than you would be if you bought a business you didn't fully understand.