Should you buy an existing business versus starting from scratch?
There’s no shortage of opportunity. According to one Internet source, at least 12,500 businesses were for sale in the U.S. as this magazine went to press. Though there is more opportunity in the Southeast, more than 1,600 of the businesses for sale were headquartered in the Midwest. Yet where and what kind are not the keys to successfully buying a business.
“Valuing the business appropriately is the biggest concern,” says Anne Hach, director of the Key Entrepreneur Development Center at Tri-C’s Corporate College. “Another risk is that you inherit the problems associated with the company.”
Here is what you need to know before buying, according to Hach.
Why consider buying an existing business?
Because when you buy a business you get something tangible an established business. There are already systems in place as well as an identity in the marketplace. Most likely, you’ll be able to learn from the mistakes of the original entrepreneur enabling you to leap frog some of the potential hurdles of a start-up company. With an existing business you will avoid many issues such as identifying employees and having a heavy promotional burden. Plus, the company already has a history and a track record.
What is the first thing you should do when starting the process of acquiring an existing business?
You should have a general understanding and interest in the type of company you buy. Interest is perhaps more important because if you are not passionate about the industry you will spend far too much time working at something you do not enjoy. Understanding the industry is paramount because you need to be able to recognize opportunity.
What should buyers considering when placing a value on a business?
The due diligence process is extremely important. You need to understand what you are getting from the financial, legal and marketing aspects. There are three different types of buyers and it’s important to know where you fit. A ‘strategic buyer’ places a higher value on the transaction because acquiring the company fits into a larger picture of an existing business strategy. For example, when you play monopoly and you own Park Place, you put a premium on getting Board Walk. There is also the “competitive buyer” who is willing to pay a premium to buy out the competition. Lastly, the ‘discount buyer’ looks for properties that may be in trouble or need help. The discount buyer is in the most precarious position and it’s imperative that he or she has a solid improvement plan in place before buying.
Once you identify a business, what is the next step?
Evaluate the cost of buying the company versus the cost of starting from scratch with a cost/benefit analysis. Account for hidden costs such as unforeseen legal issues, employee problems and quality of inventory. A thorough due diligence process should reveal everything. According to Peter Brosse, a shareholder of Meyers, Roman, Friedberg & Lewis, the amount that you invest in due diligence is a function of the size of the deal. At a minimum a buyer must have an accountant review the financial records, insurance professional review the insurance situation and an attorney to review leases, contracts and the like. If, as part of the deal you are purchasing a building or other real estate, there are additional issues to consider like title, survey and environmental assessments.
What’s a textbook example?
A classic example of the difference between starting a company and buying one can be seen in the restaurant business. With a new restaurant entrepreneurs need to invest in equipment and furniture as well as all the other costs of starting a business like marketing, renovation of the site and hiring and training employees. When buying an established restaurant, entrepreneurs pay less for the furniture and equipment, they don’t need to renovate the building (even if they make improvements) and they already have the employees on board.
What are the basic fundamentals potential buyers should consider?
- Make sure to complete the tasks associated with the due diligence phase.
- Base your valuation of the company on tax returns or audited financial documents, not internal reports and statements.
- Talk to current customers.
- Consider the ability to leverage seller financing.
- Clearly establish roles and expectations (if any) of the seller.
- Determine whether key employees will stay through transition.
ANNE HACH is director of the Key Entrepreneur Development Center at Tri-C’s Corporate College. Reach her at (866) 806-2677.