Here’s What You Need to Consider Before Buying A Small Business
Deciding to own your business can be a thrilling yet difficult process. Contrary to what a lot of people might think, the financial prospects of buying a business and running a small business are also appealing. Entrepreneurs, through acquisition, purchase their company using a combination of debt from banks and equity from investors and structure the purchase so that they can retain a meaningful economic stake in the business. However, if you want a successful acquisition, navigating the complexities of purchasing a business demands attention to various factors. In this blog, we’ll discuss the key considerations to keep in mind while buying a business.
Table of Contents:
Preparing For Your Search
Before you begin your search for Buying A Business and choosing the right one for yourself, you need to understand and plan for the cost of the search you are going to conduct. Searching requires financial investment in other resources such as time, energy, and lost income. You need to plan out the financial costs before you officially move on to raising the funds you need for the search and the acquisition itself. You also need to identify your personal needs, skills, and preferences, such as location, potential industry, and size.
For starters, they need to go through a self-assessment to know whether they are making the right decision to buy it.
- Are you willing to work long hours with irregular timing? (as you are going to acquire a small business that you need to work a lot for.)
- Are you ready to place the needs of the business before your own or your family’s needs?
- Do you like being in a leadership role? Do you like to take control of your work environment?
- Do you have a great deal of self-discipline? Are you a self-starter and can you do the work even if you don’t feel like it?
- Do you have a broad range of business management skills and a high level of information consciousness?
- If things go wrong, do you gear yourself up promptly and move on to another challenge instead of brooding over a long time on the same issue?
- If the answer to all these questions is a big yes, then it’s more likely that you’ll succeed in small business ownership.
An honest assessment of your personal strengths, weaknesses, and even hobbies is crucial to making a sound decision.
Choosing The Right Business
Choosing the right business to acquire is often a tough choice and one of the crucial ones. Many factors affect a person’s choice of what kind of business they will buy. Flexible, intelligent, hard-working, and motivated entrepreneurs are constantly in search of “profitable” processes, services, and products. The characteristics associated with profitable endeavors are quicker, better, cheaper, and friendlier. Before buying any business, you need to be aware of the changes and trends unfolding in a certain industry.
Typically, businesses fall into these categories:
- Manufacturing
- Wholesale/ Distribution
- Retail
- Service
In terms of prevalence, there are two more categories to be added:
- Food-related
- Automotive related
For first-time buyers, you may have to consider many businesses from different categories before landing the right “one” for you. You need to continuously ask yourself which industry you can expect to do well in. Brainstorming possible business ideas that match your skills and interests is also beneficial in choosing the right business that aligns with your area of interest. Hiring a small business broker can enlighten you about categorizing business opportunities as start-up, fragmented, home-based, relocatable, or distressed and seeing the possibilities in terms of location, products, size, and history.
Making An Offer
Once you get clarity on buying a small business you’re planning to buy, there’s still a long path to take in terms of evaluating whether it’s really a good company for you to buy. How does business work? Who are the customers of that business? Are there any key employers or suppliers?
Hiring a Business Broker in such a case lets you dig deeper into the documentation and information about the business. As you dig deeper and do the research, you’ll either learn that you should eliminate the company from your consideration or decide that you would like to move forward. This preliminary due diligence is what makes you come to the point of getting ready to make an offer.
Offer Price And Deal Terms
Most small businesses sell for between three and five times their adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). Considering these factors, you’ll send the seller a first offer for the company as an indication of interest, or IOI. The IOI is typically just a one-page letter that contains few details about the proposed action, other than the pric,e and is not binding on either the buyer or the seller.
IOI is useful just to get an agreement on pricing, even if it’s just a range, before investing time in the other terms and conditions of the offer.
The Letter Of Intent
Along with pricing, you need to decide on the terms of your proposed acquisition, such as the amount of seller financing. The buyer and the seller often negotiate the price and other terms of the acquisition. This process begins with a formal letter called the letter of intent (LOI) that contains the important terms of the initial offer.
The negotiations between the buyer and the seller often center first around the price and then move on to other financial arrangements, contingencies, a plan for confirmatory due diligence, and an agreement with the owner granting exclusivity for a few months to let the buyer make preparations to buy the company.
Completing The Acquisition
After you get an LOI signed by the owner, you enter the phase of what is known as confirmatory due diligence. In this phase, you not only have a signed LOI, but you also have to continue to conduct further research into the organization to confirm that your understanding of its finances and operations is correct.
This phase is the most time-intensive portion of the acquisition. You’ll be spending more time in the company than before to learn and understand everything you can. You’ll finally gain access to employees, suppliers, and hopefully customers too.
At the same time, you’ll also be meeting with lenders and equity investors to raise funds for the deal. You also need to manage outside professionals for various important tasks. For instance, you need to hire an attorney to prepare formal acquisition documents to Buy A Business and watch out for hidden liabilities. While reviewing the financials and getting quality earnings reports, you need an expert accountant.
One of the crucial questions that arises in completing the acquisition process is, ‘How will you pay for the acquisition?’
Typically, the case comes from a bank loan, some will come as a loan from the seller, and the rest will be equity that you will raise from individual investors. Suppose you are wondering who these individuals are. In that case, they can be individuals in your community such as doctors, lawyers, owners of other small accounting firms, and executives who become good candidates as investors.
Conclusion:
Buying a small business is a multifaceted endeavor that demands careful consideration at every step. From self-assessment to choosing the right business, navigating negotiations, and completing the acquisition, thorough research and planning are essential for success. It’s a challenging journey, but with diligence and strategic decision-making, it can be immensely rewarding.
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Your Deal is Almost Done, Then Again, Maybe Not
Having a letter of intent signed by both the buyer and the seller can be a very good feeling. Everything can seem as though it is moving along just fine, but the due diligence process must still be completed. It is during due diligence that a seller decides whether he or she is going to finalize the deal. Much depends on what is discovered during this important process, so remember the deal isn’t done until it is truly finalized.
In his book, The Art of M&A, Stanley Forster Reed noted that the purpose of due diligence is to “Assess the benefits and liabilities of a proposed acquisition by inquiring into all relevant aspects of the past, present and predictable future of the business to be purchased.”
Summed up another way, due diligence is quite comprehensive. It probably comes as no surprise that this is when deals often fall apart. Before diving in, it is critically important that you meet with such key people as appraisers, accountants, lawyers, a marketing team and other key people.
Let’s take a look at some of the main items that both buyers and sellers should have on their respective checklists.
Industry Structure
You should determine the percentage of sales by product line. Additionally, take the time to review pricing policies, product warranties and check against industry guidelines.
Human Resources
Review your key people and determine what kind of employee turnover is likely.
Manufacturing
If your business is involved in manufacturing then every aspect of the manufacturing process must be evaluated. Is the facility efficient? How old is the equipment? What is the equipment worth? Who are the key suppliers? How reliable will those suppliers be in the future?
Trademarks, Patents and Copyrights
Trademarks, patents and copyrights are intangible assets and it is important to know if those assets will be transferred. Intangible assets can be the key assets of a business.
Operations
Operations is key, so you’ll want to review all current financial statements and compare those statements to the budget. You’ll also want to check all incoming sales and at the same time analyze both the backlog and the prospects for future sales.
Environmental Issues
Environmental issues are often overlooked, but they can be very problematic. Issues such as lead paint and asbestos as well as ground and water contamination can all lead to time-consuming and costly fixes.
Marketing
Have a list of major customers ready. You’ll want to have a sales breakdown by region and country as well. If possible, you’ll want to compare your company’s market share with that of the competition.
The Balance Sheet
Accounts receivable will want to check for who is paying and who isn’t. If there is bad debt, it is vital to find that debt. Inventory should also be checked for work-in-progress as well as finished goods. Non-usable inventory, the policy for returns and the policy for write-offs should all be documented.
Finally, when buying or selling a business, it is vital that you understand what is for sale, what is not for sale and what is included whether it is machinery or intangible assets such as intellectual property. Understanding the barriers to entry, the company’s competitive advantage and what key agreements with employees and suppliers are already in place, will help ensure a smooth and stable transition. There are many important questions that must be answered during the due diligence process. Working closely with a business broker helps to ensure that none of these vital questions are overlooked.
Copyright: Business Brokerage Press, Inc.
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