Why Buy an Existing Business.
With so many options available to you, the question will become which vein of the business ownership arena
should you pursue? Between franchises, existing businesses and start-ups, it does become a bit
overwhelming. When reviewing all of the possibilities you have to decide what will work best for you
however, your chances of success are clearly best when you buy an existing business or franchise resale
for many of reasons. With any new business you have two challenges: developing the product or service
and then seeing what if anything, people are willing to pay you for it.
Regardless of a company's past performance, an existing business or franchise will, at the very least, have
a history from which you will be able to make certain decisions. Even if the company was not profitable in
the past, your strengths may lend themselves perfectly to turning it into a viable venture. Furthermore, you
have the ability to verify what the company did in the past that resulted in the current status of the operation.
· The business is 'up and running' already.
· It is likely to have an existing client base.
· The previous owners are likely to lend support and goodwill.
· There is a tried and tested business formula to emulate.
· The business can be sold on by yourself.
· Generally more chance of success than starting a similar business from scratch.
· A large investment is often required,
· Business transfer costs i.e. solicitors, surveys, accountants etc..
· A large amount of time and travel required to research the opportunities available.
· May require relocating your self / family.
Ease of Investigation
In order to buy the right business or franchise, you will be required to do a thorough investigation of its past
activities, its operations, its current status, the competition, the industry and its future potential. You will
accumulate this information and then you will have to determine how it measures up with you at the helm.
Clearly, this information gathering will be substantially more accurate and easier to obtain when dealing with
an existing business or franchise, as you will have the resources available from which to get the details.
You will have the benefit of purchasing a company that has an infrastructure including customers, suppliers,
employees, equipment and systems. This will allow you to focus on building the business as opposed to a
start up or new franchise where everything begins at ground zero.
Purchase Price Differences
Buying an existing business or franchise does not mean that it will cost you more. In fact, many times it's
less expensive than building a new franchised location or launching a start-up. Even in those cases where it may require a premium, at least you know what you are getting if you investigate it properly. With a new
franchise, a good Master Franchiser will do demographic studies on population, drive by traffic, potential
customer base and a whole series of studies that will indicate that "theoretically' the business should do well. However, the only thing they cannot guarantee either by law or in reality is whether or not you will be
successful. Also, new locations can take a year or more to build. You can avoid all of this when buying a
Flexibility in Negotiating
You will have far more flexibility when negotiating the purchase of an existing business or franchise versus
any other options available; it's not even close! Everything from the purchase price to financing is open to
negotiation. Doesn't it make more sense to put yourself into an environment where you have the greatest
number of options available?
Business Brokers / Business Transfer Agents
What is a Business Broker and Should You Use One?
A business broker is similar to a real estate broker to the extent that they try to put buyers and sellers
together. Instead of real estate being sold, they focus on businesses. The criteria to become a business
broker varies from country to country and their individual training, history, specialty and area of expertise are things that you must investigate. Some brokers work independently while others work for a brokerage
company. Business Brokers work on commission and if you do not ultimately buy a business then any work
that they have done for you is not compensated. I believe that you should absolutely hire a business broker! However, it is critical that you hire the right one. A Business Broker will provide you with access to businesses that are available for sale that you would never be able to find on your own. They can narrow the search for you to businesses that fit your criteria and they can help you avoid a lot of wasted time. The one thing that brokers cannot do no matter how good they may be is to find a business that is right for you. This is something that only you can do. Brokers clearly prefer to work with knowledgeable buyers and if they have to spend their time educating you then they cannot make money. They can be an effective tool for you to use if you can provide them with a clear mandate of what it is that you are looking to buy. Avoid generalities; explain your strengths, weaknesses and objectives and never mislead them.
Understanding Their Challenges
Ninety percent of the potential buyers that brokers work with never buy a business. While this is part of the risk involved in their chosen profession, this does not give you the right to waste their time. Accordingly, they may be somewhat hesitant when working with new clients until you demonstrate your sincerity and commitment to buying a business. There is no doubt that if you are a serious and educated buyer then a good broker will go above and beyond the call of duty to service your needs. Be respectful of their time and realize that they have to make a living. If at any time you decide to drop out of the hunt to buy a business then let them know immediately. Conversely, if you do not feel that they are extending their best efforts on your behalf then find another one.
How They Can Help You
There are two significant ways that a broker can help you. First, they can provide you with listings and
information on businesses that are available fro sale that you would not discover on your own. In other
words, they have the database from which you can search. Secondly, they can be "used" as the "bad guy".
Once you get into negotiations with a seller you should let the broker deliver any bad news or commentary
that you may have. The reason for this is because you are going to need the seller's help in completing the
deal and thereafter for training and assistance. By letting the broker deal with the bad news you can
maintain the integrity of your relationship and keep yourself in a third party position somewhat if
renegotiations are needed.
Some brokers may try to get you to sign exclusive representation agreements with them, this is now starting to become an industry standard in some Provinces or States. The reasoning behind this is to insure client loyalty to the agent as some buyers will take up valuable time and then deal on their own while the leaving the agent out of luck after spending considerable time on the buyers behalf. Some brokers may request an application fee. If you believe that the broker is right for you then you can consider it if it's a small amount. They must put in writing that if they do not perform their duties then the money will be refunded, no questions asked and when you buy a business if they are involved in the transaction then they must also refund the money. They will ask you to sign Confidentiality Agreements for any individual listings they show you. This is for their protection and it is only fair if they show you a business first, then they should make the commission if you buy it.
The seller is responsible to pay their commission from the proceeds of the sale. Ask the broker to send you
a copy of the agreements that they have in place with sellers so you understand the terms and conditions of their agreements and to see if you have any exposure whatsoever. Generally, the commission is 10% of thetotal deal regardless of the terms of the agreement and this amount is split between all of the brokers
involved. Furthermore, if they work for a brokerage company, part of their share goes to the company. So,
when all is said and done, they don't make as much as you think so don't feel that they are making money atyour expense. Good brokers earn their money; bad ones should not be allowed to handle your business.
What If They Don't Perform For You?
It's very simple; if you do not feel that the broker is working out well then find another one. Remember, they are entitled to receive a commission for any businesses that they may have shown you, so when you hire a new one give them all of these details and have them document how the broker's commission will be split in the event that you buy a business that your previous broker introduced to you.
An Expense That Makes Sense
Even though your broker may earn a handsome commission from the business you buy, they are always at
risk of earning zero if you don't buy. Never begrudge their commission; if they do their job, they are entitled to it. Whenever you meet with your broker over coffee or lunch always pick up the tab. It's a good way for you to express your appreciation for them doing work on your behalf not knowing if it will evolve into any compensation. It really is the right thing to do!
Due Diligence is the period when you will be able to access the company's books and records to verify that
all of the information that you have been told thus far is true and accurate. Most often, people unwisely
believe that Due diligence is simply the time to verify the financial position of the company. While this is true to some extent, a proper and effective Due Diligence goes way past the financials. Sure, you want to be certain that what you have been told is true but realistically even if the numbers are exactly as they were presented to you, then what? All you would have is a confirmation of the past but absolutely no inclination of what the future may hold for the company or the industry.
The Right Approach To Due Diligence
Is this the time to look for things that are wrong with the business? Is this the time to strictly verify numbers? Is this the time to disprove what you have been told by the seller? While each of these approaches is somewhat valid none are absolute. Sure, you will want to employ a part of each of these strategies but an effective Due Diligence is when you can really "check things out". Without question, your approach is to use this period to determine whether or not the future looks bright for the business and the industry. To do so, you must investigate far more than the financial aspect. Sure, the various financial statements will give you a picture of the past and perhaps a glimpse of the future but the past is over and done with. You must thoroughly review the company's sales, marketing, employees, contracts, customers, competition, systems, suppliers, and legal and corporate issues. You want to complete the Due diligence period knowing exactly what you are getting into, what needs to be fixed, what the costs are to fix them and if you are the right person to be at the helm to put the plans in place to make a great future for the business. In other words, learn everything before you buy!
How Long Do You REALLY Need
Every seller and every broker working for the seller will try to negotiate the shortest Due Diligence period
possible. I have heard situations where this was limited to a week or so. You must be aware that unless you have intimate knowledge of a particular business it is impossible and reckless to believe you can truly get a feel for a business in this short a time. The shorter the period the greater the number of surprises you will find out later. Moreover, the chances are that you will not be able to learn enough about the business so you will probably abort the purchase. Or, worse, you will buy the wrong business or negotiate terms and conditions that are highly unfavorable. You need at least 10 days or 20 working days maybe for larger companies. Since a proper investigation reaches farther than just financials you must allow yourself
adequate time to accumulate the information. This strategy lends itself to wondering how to get the seller to agree to this time frame. It's actually quite easy; let the seller know exactly what it is that you will be
investigating. Tell them that you do not want to back out of the deal and if they truly want to move forward
with the purchase they must allow you the time to do the proper investigation. Let them know that you want to buy the business but if they don't let you confirm your commitment through proper Due diligence then you will have to walk away before you start-when you position it this way, you'll get what you want!
Your preparation must begin the moment you believe that the business may be worth pursuing. In fact, after you meet the owner the first time and believe that you may be interested you should begin to organize your plan. No matter how early you are in negotiations, at least start think of what it is that you need to do. Start lists and note areas and specific details related to the business that warrants further review. Once you get closer to a deal keep detailed "to do" lists, broken down by each sector of the business (i.e. Financials, Employees, Sales, Contracts, etc.). Keep your accountant informed of when you anticipate beginning the Due Diligence. Assemble lists of the materials you will need from the company and never ever begin the Due Diligence until you have received all of the supporting documents that you will need from the seller.
Should You Hire An Accountant To Help You?
Absolutely and without question you should use an accountant for this exercise. Even if you are an expert in this area, get an accountant to run the numbers and verify all of the financial activity. There is so much more that has to be investigated that your time is best spent on these areas and hire a professional to help with
Getting The Seller and Their Staff To Cooperate
The seller must let his people know that they are to provide you with full access to all files and complete
cooperation throughout your investigation. Don't let the seller "think" that you are snooping; let them know in the clearest of terms that you are snooping! That's your job. If there is anything that they do not want you to see, then tell them to remove it from the premises.
What If You Find Surprises?
This should probably be titled: "What to do "WHEN" you find surprises" because you will. If you don't, you
haven't looked hard enough. Deal with each on its own and make sure that you thoroughly investigate each so that your facts are bulletproof. However, don't get bogged down with minor issues and you are best to take these as "part of the package". Unless you find something that cannot be resolved or is so detrimental that even if the seller lowered the price by 50% you would still have to walk away you are best to take all of these obstacles in stride. Don't publicize them; investigate them. A few issues doesn't mean that the business is bad. You must weigh them impact against the future viability of the business. Remember your goal is to learn what it is you will be getting into and what the future can be with you in charge. The option
always exists for you to renegotiate once your investigation is completed. You will be in a much stronger
position if you can go to the seller with very specific concerns, which require reevaluation and renegotiation. With this in mind, do not discuss your findings with anyone except your accountant or other advisors. Not the seller, not your broker, not the employees, nobody. It is not their business!
Valuing a Business
There is probably no part of the buying process that worries a potential buyer more than overpaying for a
business. While this is understandable (who wants to pay more than something is worth), it has more to do with misinformation and one's total approach to buying a business than it does to being an expert at
appraisals. The truth is, value is completely subjective. After all, what one business may be worth to you is
entirely different from what it is worth to the next person. While there are cases where people may not
negotiate the best price possible for a good business you must know that no price is cheap enough if you
buy the wrong business. In time, a good business will always justify the purchase price whereas a bad one
may not ever allow you to recover financially.
What is Value?
In a nutshell, value must be measured by what you are getting in return for your money. You have to equate the purchase price against the benefits you will derive over the term in which you can realistically expect to own the business. As an example, you cannot simply measure the purchase price against the income that you will derive from a specific business. What about the daily enjoyments you will get from being your own boss? Or, the sense of accomplishment you will feel from building something? Maybe, it's the gratification that you will get from contributing to the lives of others (i.e. employees). Perhaps it will come from knowing that from the toils of your labor you have been able to provide certain things for your family that you could never even consider if you were working for somebody else. A good business will provide abundant rewards for you so in order for you to truly measure a business' value you have to consider all of the benefits that you stand to gain. Also, you must factor in what you could never have achieved if you don't go into business for yourself. Think of it this way: the average person takes 30 years to payoff a mortgage and 5 plus years to pay off a car. Neither one of these will pay you a salary. While they both have their benefits, neither one comes close to what you can derive from a good business as far as overall benefits are concerned. Even with a home where you will build equity won't a good business do the same thing? Therefore, why shouldn't you take 3-5 years or longer to payoff a good business?
Traditional Valuation Methods
There are two main valuation methods which are far too complex to fully explain in a short article. These are Asset Based Valuations and Cash Flow Multiples. In the former, a value is attached to all of the assets of a business (machinery, equipment, etc.) and you purchase the assets accordingly. Generally, small business purchase do not use Asset Based Valuation Methods to establish the purchase price. For Cash Flow Based Multiples, a formula is used that combines the company's profits, owner benefits, adds back certain expenses and then applies a multiplying factor to this number to establish a purchase price. This is the method that is most commonly used and a general understanding of accounting principles is required to make this calculation. The multiples that are used are generally based upon what other like businesses have sold for but as a very general rule it is usually one to three times the cash flow.
Why These Methods Don't Work?
Despite their ongoing use, traditional valuation methods are so subjective that it is impossible to endorse
them as foolproof. For example, there is no way that you can use other like businesses as a realistic
barometer because no two businesses are the same. Furthermore, the financials being used are historical
date and since the past is over and done with how can you accurately use the past to predict the future?
Insofar as Assets are concerned, unless you fully validate the usefulness of the Assets this too becomes
subjective. Notwithstanding the inaccuracies of these methods, you should use a factor of each to value a
business from every angle possible and then balance it all with what the value of the business is to you.
No Two Businesses Are Alike
Although traditional valuation methods will use other like businesses for comparative purposes do not allow yourself to be lulled into believing that any two businesses are really alike. You may want to explore these situations to see what businesses may have sold for, but you are guaranteed that there are always enough differences to render these comparisons inaccurate. The only time where you can pay attention to a similar business is when investigating a franchise. Even in these situations there will always be an abundant amount of differences such as location, owners, marketing strategies, etc., however the business model itself is supposed to be exact so there is some credibility to making comparisons. You may want to have your broker pull the details on others businesses in the same field to see what the Asking Price was, earnings, down payment percentage and expenses, but other than that, remember that just like human beings, every business is unique.
Good versus Cheap
If your intentions are to find a cheap business you must be prepared to never find one or to deal with one
that may never turn into what you had hoped that it would. It's akin to buying a cheap used car versus a
good used car that you have checked over extensively. Yes, there is a chance that you will get lucky and get one that runs relatively trouble free for as long time, but the odds are that you will get one that requires ongoing maintenance. Now, this may be fine for your basic transportation needs but if you need a vehicle to work as a sales rep on the road where down time means lost revenue then you would want a vehicle that is highly reliable wouldn't you? The same applies for a business; there is far too much at stake to buy something just because it's cheap or affordable. Unless you are a business mechanic you will probably spend so much time fixing it that you won't have time to run it. If you want to dramatically improve your chances for business success then look for a good business that can become great.
How Long Do You Intend on Working?
If you are 55 years old and only want to work for another 5-10 years, your value will be dramatically different for a certain business than an individual who is 15 years younger. You have to consider your overall health, energy level and the payout period on the business relative to the amount of years that you realistically can and will be willing to work.