There has been considerable attention paid to the challenges and pitfalls of starting a small business from scratch. It is certainly true that the first few years of a new business can be very challenging and, in most cases, unprofitable. While being able to create a business’ culture and operating systems from the beginning can be a big plus for an entrepreneur, there is a lot to be said for letting someone else handle the start-up headaches.
Buying an Existing Business can be a Smart Alternative
Any entrepreneur wishing to start a small business should consider purchasing an existing one before taking the plunge into the start-up fray. An existing business usually has a client / customer base in place and operating systems that, if not effective, can serve as a foundation for improvement. There are also vendor relationships established and a certain amount of good will in the community that are important considerations.
The key to purchasing an existing small business is to spend the time needed to ensure that it has a reasonably solid financial and operating structure in place and has a decent reputation in the community. Here are four things to consider before purchasing an existing small business.
Purchase the Business Assets, Not the Business
It is always best to purchase a business’ assets and create a new corporation or entity as opposed to buying the business itself. This will create a better tax position because the taxes will be based on the selling amount, not what the seller spent on the business’ resources. Also, purchasing just the assets protects the buyer from responsibility for any liabilities or law suits carried by the seller. With this in mind, it is also important to obtain an indemnity from the seller which further protects the buyer from actions taken by the seller prior to the sale.
Perform Due Diligence to Ensure that the Business is on Reasonably Sound Footing
It is imperative to review the seller’s accounting, operating, and marketing information to determine the business’ viability and potential for expansion. Reviewing accounting spreadsheets such as balance sheets and profit and loss statements can by very useful, and take a close look at staffing, office expenses, and marketing materials to estimate overhead costs. The seller will require the signing of a “nondisclosure” statement to ensure confidentiality of the information, but any buyer should be able to access financial and operational information. If it is refused, beware!
Determine How the Accounts Receivables, Prepaid Expenses, and Office Leasing Will be Handled
Discuss how the accounts receivables will be handled. The seller may want to keep them or they can be included in the sale of the business at a reduced rate to account for any defaults that may occur. It is also important to discuss any prepaid agreements that the seller has made such as insurance or advertising. The arrangements for handling these agreements need to be addressed upfront. Also, find out about the lease arrangements to determine if it is reasonable to assume responsibility for the current lease or negotiate a new one. It may also be more efficient to move the business to a different location.
Develop Letter of Intent
This document can be very useful in spelling out the primary terms of the sale such as purchase price, identification of specific assets being included, and the transition process from seller to buyer. It will also include non-compete language which protects the buyer from the seller opening up a new business and becoming a competitor. The letter of intent helps to create good faith between the seller and buyer and will make the development of the actual contract easier.
Determine if Employees Will Remain with the Business after the Sale
Losing important employees at the point of sale would be very compromising to the buyer. Therefore, negotiate with the seller to meet with employees to determine their interest in remaining with the business, at least for a period of time. This will reduce the likelihood of being caught off-guard by a mass exodus of employees.
Be Methodical in Purchasing an Existing Business
Buying an existing business can be the right thing to do if the priority is to become operable and profitable quickly. However, it will also require larger financial resources upfront or, at least, the ability to borrow money for the purchase. Every entrepreneur’s situation is different, so it is well worth the time to determine if purchasing an existing business is practical or if starting from scratch is the best avenue to take.