Buying an Existing Business
Buying a business may seem simpler than starting your own, but remember that many businesses are sold because they have inherent problems that prevent them from generating sufficient income. If you're buying a business, it's vital that you conduct comprehensive research and analysis in the same way as if you were setting up the business from scratch.
Decide on the type of business you're looking for. Are you looking for a small local business, or are you aiming for a large national one? What business sector are you're most interested in? Is it manufacturing, retailing, or perhaps services? Are you prepared to change your location and travel? Or would you prefer to stay where you are and travel relatively short distances? Take the time to think about such issues before you begin looking for a business to buy.
Start with these key factors:
- Skills and experience. The most common reason for business failure is people taking on businesses outside their area of expertise, so think long and hard about the skills and knowledge that already exist in the existing business, and whether you can add to those skills. You should be looking for a business that deals in a product or service you have some experience with, especially if the operation is particularly complex or technical.
- Competition. Make sure you know competitors' strengths and weaknesses and what share of the market they have.
- Size. Look at the size of the business, how fast it has grown, and whether this rate is likely to continue, increase, or decline.
- Location. Is the business located appropriately for its target market and within reach of employees with the right skills?
- Need for change. Does the business need any major changes requiring a large investment of management time? If so, you may be able to acquire it at a lower price. If the business is already successful, it can probably continue to operate in the same manner, regardless of a change of ownership.
- Need for investment. How much added money does the venture require? Consider whether you'll be able to secure the necessary financing. Balance the costs of obtaining financing against the anticipated profitability of the business.
Many people find it useful to employ a business appraiser or financial adviser when they are having a business valued. The three methods most often used are:.
- Asset value. To obtain the business's net asset value (that is, its worth, in basic terms), subtract the value of the liabilities (financial obligations, such as outstanding debts, loan repayments, outstanding invoices, etc.) from the value of the assets. The value for the entire business will be the net asset value, plus a value for goodwill—representing the business's reputation and existing customer base.
- Earnings multiple. Divide the company's market price by its after-tax earnings over a one-year period. Earnings should take into account interest charges to be paid after purchasing the business, and any loans needed to make improvements.
- Return on capital. First, you'll need to define a desired rate of return, which can be defined as a ratio of the profit made in a financial year as a percentage of the capital employed. Then the income of the business before interest and tax should be calculated, and this figure should also be given as a percentage of the capital invested. If the figure is less than the desired rate of return, this is not the business for you!
You should be able to obtain much of the information you require from the present owner, including the business plan, financial statements, details about established customers, and so on.
You may wish to hire an accountant to help you examine the books. Make sure that you evaluate the outstanding loans to the business, its relationship with its creditors, and its repayment history. Look at pro-forma income tax returns, balance sheets, and cash budgets. When you estimate how much income the business is likely to generate, it's important to be conservative, especially in the early stages.
Consider conducting a SWOT analysis (Strengths, Weaknesses, Opportunities, and Threats) on any potential business purchase. Look at:
- the present position of the business in the market, its past performance, and its potential for growth
- its available resources: money, assets, manpower, and so on
- the training, experience, and skills of current employees
- its suppliers and supply chain, costs and reliability of material, inventory and inventory turnover, and relations with suppliers.
You'll need to consider whether the existing members of staff are suitable for the business, and how they are likely to react to a new owner/manager. What are the employment costs of the business—salaries and wages, benefits, employment taxes? If you buy the business, will you change the compensation offered? If so, will that change be likely to retain the people you'll need?
Research the competition in detail, including their specific strengths and weaknesses compared to the existing business. Who are the customers? Where are they? Will they continue to be loyal if the business changes hands? Examine external factors, such as industry trends, regulations, and political and economic developments. Consider how much money you'll need for advertising and marketing and whether you'll need to change the way the business is promoted. Look at the business's distribution channels, including their reliability and whether you can maintain them.
Many factors can affect the price that you and the seller ultimately negotiate:
- the three values described above
- an appraisal of the land and buildings, including the condition of the premises and whether improvements will be required
- a valuation of any fixtures or equipment that will convey with the premises.
- the business's location in relation to its customers and suppliers, employees, and competition
- costs of property maintenance
- any issues in the transfer of title, licenses, leases, property taxes, and so on.
- external factors, such as current interest rates and the state of the business's industry sector.
You'll also need to negotiate the transfer value of the inventory, which should be cost or "net realizable value" (NRV), whichever is lower. For redundant inventory, the NRV is zero. A recorded valuation and inventory count should be done by a third party.
Another factor affecting price is the goodwill that comes with the business. Goodwill reflects the cumulative effect of the reputation of the business: its relationship with customers, suppliers, and competition; its market position; and the skills of the staff. A high level of goodwill can make the business more valuable, meriting a higher purchase price.
Without enough information, facts, figures, and forecasts, your view of an existing business's prospects can easily be distorted. Make sure you conduct thorough research so you don't make an expensive mistake.
Examine all financial statements, business materials, and legal documents very carefully. If you don't exercise due diligence, you'll only have yourself to blame for any problems you could have discovered before the purchase.
Before you begin negotiating with the seller, have a price in mind that reflects what you can afford and what you are willing to pay for the business. That way, you'll be prepared when the seller states the asking price, and you won't agree to a higher price than you can manage.
Steingold, Fred and Emily Dostow.
The Appraisal Foundation: www.appraisalfoundation.org
American Society of Appraisers: www.appraisers.org
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