How to Buy An Existing Business: A Step-By-Step Guide
Many people dream of owning and operating a business, citing that it’s essential to achieving the American Dream. It’s not uncommon to hear stories of people saving every last cent they earn to start their own company and watch it flourish. But, as business and economic landscapes change, more and more prospective business owners are opting to buy existing businesses instead of starting from scratch.
There are many benefits to buying an existing business, but above all else, business owners have a higher chance of mitigating risk and closure than launching a new venture. After all, it’s estimated that “30% of new businesses fail during the first two years of being open, 50% during the first five years and 66% during the first ten.” 1
But, buying a business isn’t an easy task to undertake. You need to have a solid plan under your belt to even have a chance of success. That’s why we’ve developed this guide to help you. With it, you will learn how to buy an existing business by gaining insight into what to look for in a prospective business, understanding why business owners sell their small businesses, evaluating a business’ financial and legal standing, and more.
Table of Contents
1. Why do owners sell their business?
When buying a business, it’s important to think about the reasons why the current business owner is trying to sell it. There are many reasons, good and bad, why small business owners make the decision to sever ties with the businesses they started. As someone who is considering buying an existing business, it’s vital that you understand those reasons so you go into the buying process with the understanding of the seller’s motivations.
Many business owners opt to sell their business due to:
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Lifestyle Changes
- Being an entrepreneur is often a job that easily exceeds the standard 40 hour work week. It’s natural to want to retire after getting a business off the ground and running it for many years, whether that means passing it to a trusted associate or selling the business altogether.
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Exploring a New Venture
- Many business owners want to start a business, set it up nicely in terms of revenue, and then sell it to turn a profit and go on to a new venture. This kind of reason can be a great opportunity for a prospective business owner. While this is generally a noble reason, we do recommend extra research if a business owner cites this reason.
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Capitalization
- After years of hard work, many business owners simply opt to sell in order to pull out their capital after years of building the business.
While these reasons seem to be mostly positive and constructive towards someone looking to purchase, not all business owners have the same motivations. In fact, many small business owners have not-so-great reasons why they want to dispose of their companies and you need to be able to spot the red flags.
Some red flags to keep in mind include:
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Financial Turmoil
- Even if a business is profitable, the business owner can still have made bad financial decisions that land them in hot water. When this happens, they see liquidating the business as a way to relieve them of debt or other financial burdens. It’s important to uncover and assess the business’ financial information to make sure you aren’t buying something that has financial challenges.
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Internal Issues
- Internal issues that result in a split are, of course, never good. We advise that you be wary of the issues themselves so you can understand the reasons behind the sale, so you know for a fact that they don’t have to do with any potential downfalls in the business. Examples of these include management problems, other disputes among staff and ownership, or even issues with equipment or resources that make running the business difficult.
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Burnout
- Owning a business can be demanding, which often leads to burnout. Burnout can lead to declining revenues and discouragement of employees. If this is the case, you’ll have to pick up the pieces the old owner left behind, which can be challenging.
When you’re going into the process of buying a business, it’s vital that you ask the right questions, to dig deeper into why an owner is trying to sell a business. Doing so will help you find out if you’re making a sound investment.
Choosing which business to buy.
Before you begin the process of looking for a business, you need to figure out the kind of business you want to buy. Not every person can run any business, so it’s important to evaluate your needs and wants from top to bottom.
You need to really evaluate what kind of business you want to buy in order to have the best chance of success. Some of the criteria you should keep in mind are the business’ physical location, its industry, the size of the business, and the lifestyle you have versus the lifestyle the company currently operates under. These are great baseline figures to think about because, even though you’re buying this business, you’re integrating into something that already exists. So, if you go to a company that you’re not compatible with and try to force it into something that it’s not, it can be difficult to move forward.
We encourage you to write out a series of needs and wants that you are looking for in a business. That way, you will have something to reference once you begin your buying process. Below is a form you can fill out with some questions to consider.
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Location
1. Where is the company currently located? Are you in that area or planning on relocating there? If not, would you relocate the business?- __________________________________
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Industry
2. What industry does this company currently operate in? Do you have experience in this industry? How will buying this company benefit their position within their chosen industry?- __________________________________
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Size
3. How many employees are you prepared to support immediately upon purchase and how will that affect the well-being of current employees? How do you foresee growth taking place, gradually or rapidly?- __________________________________
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Lifestyle
4. What is the culture of the company you want to purchase? Is it a good “cultural fit,” in that it will fit with your lifestyle? Will it require you to work weekends and/or evenings? Is you family on board with your decision to buy a business - how will it impact them?- __________________________________
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Investment
5. How much are you willing to put down to start this business? What financing options are available for this level of investment? Do you have enough money to live on for at least 6-12 months (or longer depending on the financial condition of the business you are buying) while you get your newly acquired business running smoothly and generating positive cash flow?- __________________________________
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Once you’ve got your list of important characteristics determined, you are ready to start looking for businesses for sale that match your search criteria. Searching on BusinessBroker.net is a great way to find businesses for sale.
It may also be beneficial for you to have a helping hand to guide you along the way by way of a business broker. Business brokers work as many home brokers do – they help you find businesses that fit your buying criteria. Business brokers act as intermediaries between buyers and sellers in the brokerage process. They are trained in business transfers and have experience and knowledge in evaluating businesses from all essential angles.
A business broker can help you narrow down your options while also finding companies that fit into your above criteria without the stress of having to do it yourself.
To find a business broker near you, check out our business broker directory.
3. Evaluate initial information about a few businesses that interest you.
Consider each of the main characteristics you’re looking for in a prospective business as determined in step 2. Now, in conjunction with your business broker, find several small businesses you’re tentatively interested in and compare them to your wants and needs. Feel free to take notes directly on this page as you evaluate the businesses.
Note: As you’re going through this process, it may be beneficial for you to reach out to other business owners to learn more about industry standards that may impact or restrict your options related to these business characteristics. For instance, there may be certain industries that tend to be relocating to another area, or certain laws coming into effect that may impact operations. Even if something monumental like this isn’t going to impact your chosen business, it is always helpful to get another perspective before jumping in.
Industry- Business 1: ________________
- Business 2: ________________
- Business 3: ________________
- Business 1: ________________
- Business 2: ________________
- Business 3: ________________
- Business 1: ________________
- Business 2: ________________
- Business 3: ________________
- Business 1: ________________
- Business 2: ________________
- Business 3: ________________
Depending on which business meets these core needs, you can narrow down your search by choosing a handful of contenders to evaluate further.
4. Evaluate the business you’re considering.
Once you’ve found a few businesses that fit your base criteria, it’s time to start a more extensive evaluation process. In this stage, it may prove helpful to have an attorney and accountant on call who can assist as needed with specific questions or issues that may arise. Your business broker may have trusted attorneys or accountants that they use regularly so check with your them first before hiring anyone on your own.
This biggest thing to keep in mind during this step is to do your due diligence. But, luckily, your business broker will have a comprehensive list of items to check during your due diligence period.This checklist and corresponding analysis and collection of data will enable you to see if it is as much of a fit for you as you initially thought and will also point to any improvements you think are needed if you choose to move forward with the purchase.
Even though you’re not making price negotiations right now, that doesn’t mean you shouldn’t go through the business’ financials with a fine-tooth comb. Accurate financials are critical for making an informed decision, and the financial statements and income tax returns must mirror each other. You will want to review the past three years with your business broker or trusted advisors, as well as your accountant and attorney so they can spot specific things you might not know to consider. And if you want to move forward with a business you’ve evaluated, it’s a good idea to create a business plan with the information you find. This will help you in the next step when you’re making a written offer.
5. Make a written offer through your business broker.
Now that you’ve evaluated your prospective businesses and found the one you want to move ahead with, it’s now time to write up an offer with your business broker. To start, list out all the tangible and intangible assets of the business that will transfer to you. Other items to include in your offer are:
- The offer price
- Terms of payment
- If you will need owner financing
- How long the owner has to accept or counter
- A negotiation clause
It is also vital to include a non-compete provision in your written offer to prevent the current business owner from opening a new business near you with the money from the sale. Along with that, it’s a good idea to require the owner to sign a statement that they have disclosed all of the assets and liabilities of the business, including liens, judgments, and lawsuits.
Have your business broker and attorney review the written offer you’ve drafted before you submit it to the business owner to ensure that everything is accurate. At this point, the owner will either accept, reject, or counter the offer you’ve given. We recommend really leaning on the expertise of your broker to navigate you through the offer process.
5. Secure the required funding.
Whether the buyer and seller ultimately agree to the sale, you need to find the appropriate funding. Most small businesses buyers finance a considerable portion of the purchase price themselves, but it’s important for the buyer to have enough money to make a down payment and cover the business's capital requirements, which sometimes means getting loans. There are several ways to get funding. It’s important to learn about all your options before you proceed to the next step.
Seller Financing
Also known as a seller carryback, seller financing is a loan the owner of a business gives to a new buyer to cover some or all of the cost of the purchase. The seller will be the de facto lender and hold the note on the business. This is beneficial because you can get cheaper financing and a faster close. In light of that, you need to also be aware that seller financing may bring higher interest rates and large balloon payments down the road.
Business Loan
You can, of course, go through a bank to get the loan you need to cover your business costs. This is generally a safe option because you can get a relatively low and stable interest rate and have access to refinancing options. Business loans can have downsides, however, like needing to see existing healthy cash flow and needing to have excellent credit.
Personal Savings
As we mentioned above, you can rely on personal savings to finance the purchase of your new business. This is a great option because, of course, you won’t have to rely on another person or entity when buying your business. But, this can also open you up to potential rejection and straining your personal finances if the seller wants more than you originally anticipated.
Retirement Savings
Tapping your retirement savings, such as a 401(k) account, is also an option. Similar to the personal savings option, this provides the benefit of not having to rely on another person or company for funding. However, be aware of penalties and fees you may face based on how old you are when you withdraw funds from a retirement account -- make sure the benefit of doing so outweighs the cost.
Again, we recommend weighing your financing options with your business broker because they will know what your situation is and guide you towards the right path for you.
7. Finish the sale
- Finalize the terms of the sale
- Draft a sales agreement that is explicit in its terms, and have an acquisitions attorney involved
During this final step, you need to finalize the terms of the sale, gather the last bit of paperwork to transfer everything over to your name. Several documents are required to complete the transaction. The purchase and sale agreement is the most important of these, but other documents often used in closings include:
- Escrow Agreement
- Bill of Sale
- Promissory Note
- Security Agreement
- Settlement Sheet
- Financing Statement
- Employment Agreement
Closings are generally done either through an escrow settlement or through an acquisitions attorney. In an escrow settlement, the escrow agent will gather the money to be deposited, the bill of sale, and other relevant documents and hold them until all conditions of sale have been met. After that occurs, the escrow agent acts on the documents and funds in accordance with the terms of the contract.
If you go through an acquisitions attorney, they will draw up a contract and act as an escrow agent. Whereas escrow settlements do not require the buyer and the seller to get together to sign the final documents, attorney-performed settlements do.
Once all of the T’s are crossed and the I’s dotted, it’s time to celebrate – you’ve just bought your new business! Congratulations!
About Business Broker Network
BusinessBroker.net (BBN) was started in 1999 and is a marketplace for businesses- and franchises-for-sale on the internet. Essentially, BBN connects thousands of business buyers and sellers each month. Learn more about how you can find a business broker today.
1 https://www.investopedia.com/slide-show/top-6-reasons-new-businesses-fail/
