Buy Existing Business vs. Startup Decision

Should you start your new business or consider other options? You may have definite advantages and motivations in starting a business from scratch.

• Start and set up the way you want
• No inherited ill will
• Easier to start from scratch than to fix things (including employee attitudes, customer dissatisfaction, etc.)
• Your idea gets an exciting, fresh beginning

There are also some distinct general disadvantages.

• The market can't support another competitor
• High cost of equipment
• More work for you
• No history
• No one to go to for advice
• No Business or brand name recognition
• Must build awareness and market from scratch
• Heavy promotional burden and costs
• Can't find a suitable location
• Lack of competitive advantage

When assessing whether or not your business is financially feasible you may want to pause and consider two other options:

• Buy an existing business, even though it is not your exact business or even close
• Invest in a franchise operation. (we'll discuss this in a separate lesson)
  

There are quite a few good reasons to consider buying an existing business. In general, you may gain key assets and save time and effort.

• Get up and running quickly
• A successful business may stay successful while you get up to speed
• May have equipment and assets you want
• Set-up and installation costs are cheaper or not necessary
• Their clientele may be your clientele.
• Get the "best" location or acquire a favorable lease
• Expenses, scale, and revenues are known
• Easier to get licenses and permits
• Easier to get loans and other financing
• Intangibles: Goodwill, Brand Name.
• Supplier relationships are established
• Trade credit may be established
• Inventory is in place
• Get key employees on your team
• Get trained experienced employees and staff
• Prevent competitor from entering area
• Little competitive backlash or reaction
• May be able to use the experience and advice of the previous owner
• May be a bargain
• Others?
  

There are some really good reasons to avoid an existing business that you are interested in.

• It may be a loser
• Ill will from previous owner's practices
• Poor employees
• Poor location
• Obsolete, worn out facilities or equipment
• Un-sellable inventory
• Business is over-priced

Finding a Business for Sales

• Magazines
• Newspapers
• Realtors
• Flyers
• Online
• MLS
• Drive Around and Look
• Trade Shows and Conventions
• Word of Mouth - vendors, Chamber of Commerce, etc.
• Others

Sample 1 | Sample 2 | Sample 3 | Sample 4

There are four levels of seriousness in the process of buying a business:

1. Initial interest
2. Revealing confidential information
3. Letter of Intent - making an offer
4. Negotiations and Escrow

A clear Letter of Intent reveals the intentions of all parties during the negotiation process. It is drafted to show that both parties have a level of seriousness and committment to making a business acquisition happen. It lays out the principle terms to ensure that the parties have a meeting of the minds before entering into time and money consuming negotiations and revealing of private and secure or sensitive information. It usually assures binding confidentiality. The letter may be preliminary or be close to final and will be drafted to clarify:

• Are the terms binding, non binding or some terms binding?
• Is it initial terms or a finalizing agreement?
• Is there a time period involved?
• Are negotiations exclusive between these parties?
• What conditions are being agreed to and what conditions are being negotiated?
• How and where will disputes about the Letter of Intent be resolved?
• What laws or legal issues will be involved?
• Are parties free to abandon negotiations at any time?
• What representations or warranties are each party getting?
• Compensation expectations and fees, deposits, etc.

The specific components of the deal being negotiated that may be in the Letter of Intent or in the final agreement should include:

• The basic structure of what the sale of the business includes: for example is it an asset sale, purchase of stock, assumption of liability and debts.
• How much money is involved
• How and when will payment be made
• Finalizing date or deadline for discussions
• Contingency upon obtaining financing

Most sellers don't want to limit their negotiations to one party for too long and fear a buyer will back out at the last minute, fail to pay or bring lawsuits. Most buyer's fear closing a deal and then finding out something is wrong or they are stuck with debts or liabilities.

What if you are the Seller? Read the Article Things to Consider When Planning to Sell a Business

extra credit MYBx9 - How a buyer can avoid old debts and sellers's liability.

When evaluating the opportunity to buy an existing business you should have some questions to ask. Who do you ask to get get good answers and a good range of answers? Be prepared to ask some specific questions of:

• the owner or owners,
• spouses,
• the business'
  • lawyers,
  • landlord,
  • bookkeeper,
  • accountant,
  • suppliers,
  • customers
  • real estate agents and property managers
  • surrounding businesses
  • and employees.

Here is a list of general questions to start with and items to inspect or ask to see. If you like what you are seeing and hearing, then we will proceed to a more specific and in depth set of questions to use in your evaluation and decision making.

1) Why does the owner wish to sell? - new competition, traffic re-routing, leases expires, cash flow, etc.

2) What is the physical condition of the business?

• Tangible: building, equipment, inventory...
• Intangible: accounts receivable, lease, financial records, mailing lists, trademarks, patents, copyrights, goodwill, accounts payable contracts...

3) What are you buying?

• Stock purchase of a corporation means you buy the business assets, assume its liabilities (debts), and assume contracts and other formal/legal relationships.
• Asset purchase you buy only the assets of the company; usually all contracts must be renegotiated between the new parties and debts remain with the seller. (Sole Prop. and Parts.)
• Buy the Company Assets and some or all of the liabilities, contracts or legal relationships. (Sole Prop. and Parts.)

Be sure you have a clear written agreement in all cases

4) What is the potential for the company's products & services? - customer characteristics, vulnerability to competition, seasonality, fads, changing demographics or lifestyles...

5) Legal Aspects to consider?

• Complexity of transferring title (liens, etc.)
  
• Liabilities and their responsibilities
  
• Bulk Transfer requirements (section 6, Uniform Commercial Code)
  
  • A sworn list of property
  • A list of creditors
  • A notice to creditors 10 days prior to taking possession
    
• Rights & obligations with suppliers, employees, lessors, lenders, customers...
• Organizational structure for management
• Legal form of business
• Covenant not to compete
• Legal liabilities: physical premises, product claims, labor relations...

6) Is the Business financially sound? - accounting practices (creative?); financial records: income statements, balance sheets, tax returns, owner's compensation records.

• 2-5 years of monthly Income statements
• 2-5 years of quarterly Balance Sheets
• Product sale records by item and line
• Asset list
• Depreciation Schedule
• List of Creditors and Liabilities
• Accounts Receivables
• Owner's compensation record
• Any lawsuits, liens, contracts, etc.

LEASE:

• Years; years left
• Terms, cost, $ per square foot, triple net
• Fees, dues, obligations with the complex
• Transferable, renewable, options

KEY NAMES, PHONE #'s, ADDRESSES:

• Owners
• Landlord
• Accountant
• Bookkeeper
• Key Employees
• Key Customers and key accounts
  

When you buy a business there are three types of returns on your investment:

• Owner's Salary
• Return on Funding of Purchase (payback your investment)
• ROI - Return on Investment. You want a reasonable return rate on your investment given the amount of money at risk and the work you are expending to earn it.

Below are seven ways to calculate the price you should pay for an existing business. All seven are used with varying degrees of worthiness depending upon judgment, financial data, guesswork, forecasting, past practice and market conditions among other things.
click here for a Word document version of the worksheet below

1) Targeted Earning Required = Salary+ROF+ROI
calculation based upon your expectations and goals

2) Annual Earnings = 3 to 5 times annual earnings, or more
calculation based upon industry standards and future earnings potential

3) BALANCE SHEET APPROACH: Owner's Equity = Assets - Liabilities
calculation based upon the current balance sheet data

4) ADJUSTED BALANCE SHEET APPROACH:

• Real Estate Appraisal
• Furniture & Fixtures by Office Furniture Reseller
• Machinery by Machinery Dealer
• Vehicles by Bluebook/NADA publications
• Business Consultant
  

calculation based upon market prices or expert opinions

7) EXCESS EARNINGS FORMULA (Combined Approach)

a. Assets Value

b. Earnings

c. Appropriate ROI (Bank Prime Rate + 2%) = Interest Rate

d. Cost of Money = Interest Rate x Assets Value

e. Excess of Earnings = Earnings -Cost of Money

f. Value of Excess Earnings = Multiplier x Excess Earnings

Determine Multiplier: (use scale of 1 to 10)

Risk
Competition
Industry
Company
Company Growth
Desirability
Total/6 categories = multiplier

BUSINESS VALUE = Assets Value + Value of Excess Earnings
calculation based upon the current balance sheet data, market factors, expectations, and a combination of factors used in above methods