When you buy a business, you are actually buying the cash flow. Any needed assets come with the cash flow. Whether you need lots of assets or few assets, the cash flow is used to determine the value of the business. It also funds the debt service, all operating expenses, and your living wage. If the business doesn’t need many assets, it can be an advantage, as you just have to keep the cash flow as is and don’t have to replace broken or worn equipment. The cash flow must be large enough to justify the asking price. If any business doesn’t have cash flow large enough to justify the asking price, then the asking price is the market value of the assets. Five things to consider when purchasing a service business include the following:
Good Financial Records
Service businesses that are for profit may be large or small, but they operate under the same principle. They must make a profit to stay in business, and they must have good financials that show proof of their profit. That would include profit and loss statements, balance sheets and tax returns for the past three years and the current year. A cash flow statement for those years should be included in the marketing packet prepared by the business broker. Financial institutions will loan to purchase service businesses now more than a few years ago, but their preference is still to have assets they can put their hands on if the buyer defaults on the loan. An ideal situation is to find a seller who will carry the note for his/her business.
Non-Compete Agreement
The non-compete agreement is extremely important when purchasing a service business. Many were started by entrepreneurs who turned their prior job into a business and have built the customer base. If the seller started the business and is very active in the business, the customers may think of him or her as the business and a long-term relationship may have developed. This is a positive thing; but, as a buyer, you want precautions in place to protect the business after the sale. Included and very important to include in the non-compete agreement is the area protected. This needs to be a large enough area and for a long enough time to prevent the seller from competing with you. Options to explore are the limitation of the business as to where it can operate and if expansion is a viable option to grow.
Training Period
The seller will agree to train you with no pay for a certain time period. Two weeks is long enough for most businesses. Depending on the business, however, it may take a longer training period, which would also be an introduction period. There are times when a buyer will pretend to be working for the seller for a period so customers and employees can get to know him/her before being introduced as the new owner. It is important to wait until after closing for any training, as you or the seller will not want the employees or customers to know about the sale until it has actually closed. During the training period after the closing, it is important for the customers to see you with the seller, showing confidence in your ability to take care of their needs. During the due diligence before closing, investigate the suppliers, customers, and contracts in addition to the financials. As with any business purchase, it is wise to operate the business as it has been operated while you learn the business. Although you will probably want to make some changes and incorporate your ideas, immediate drastic changes are not a good idea. Change is tough on everyone, and you especially don’t want to frighten and confuse your employees. It is expected that the employees will remain with the business, but they are not required to do so. It is important to have a smooth transition and make the employees see they are important and secure in their jobs.
Competition
Before buying the business, check out the competition. Is there a similar business in your service area; and, if so, what does the business you are buying do or offer differently from the competitor? If the financials show a good profit, will the change of ownership cause a loss of customers?
Business Plan
Last, but not least, be sure to write a business plan so you have a guide to follow. Also, a good well-written business plan is necessary to get a good loan to purchase the business or borrow money as the business grows.
