Buying a small business is one of the best ways to get an instant, positive ROI on your money. Often faster than starting a new business, even though you have to invest significant capital when buying a business.
However, purchasing a traditional brick-and-mortar business can be quite complicated and expensive. Since I have gone through the process several times, I want to help you buy a small business in 2022.
Access to Capital
The first step to buy a business is to get funding. There are many options available to you, and you should consider trying to get the largest position you can, with the income you have, to purchase the most profitable business you can afford.
And the key to that is the word afford. You don’t want to leverage yourself so far that you get a business loan that you can’t afford to repay. You also don’t want to refinance your house and have the same problem. In general, you want to err on the side of caution, especially if this is the first business you are purchasing.
Available Liquid Capital
You will most likely have to put up some cash to buy a business, regardless of what the YouTube gurus tell you on their preroll ads. Nothing is for free. while it is possible to get purchasing power elsewhere, and you may find a business owner that is willing to do some seller-financing, I doubt that you would find someone willing to 100% seller-finance without some serious interest on the loan, or worse–a major flaw in the business.
If you are going to pursue any kind of financing when you buy a business, you probably also need to have some cash in the deal as well, to give yourself some stake in the game. Most banks and even third-party lenders want to make sure you have a reasonable amount of personal equity in a business.
This can be cash in your bank account, but it can also be equity in your house, another business, property, etc. As long as you can get access to that equity somehow, then you can use it to purchase, or partially purchase an existing business.
Unless you have the money saved up to buy a business, you’ll need to obtain financing through a lender who is willing to give you a business acquisition loan for your purchase. There are many different types of lenders out there, so it’s important to do your research and find one that fits your needs.
Banks are going to be your cheapest way of getting capital, and many countries have small business banks that can assist you, with both financing as well as information and even training. A typical bank will be able to offer an existing business with an asset a good rate.
This means, that if the existing business you are looking to purchase has some property, materials, or equipment, you can borrow against those assets. Borrowing against tangible assets allows you to secure much lower interest rates than if they were going to be offering you an unsecured loan, or against intangible assets.
The risk of an unsecured loan is much greater for the lender, and so interest rates must go up to match. This can have a huge effect on your bottom line at the end of your loan payment term, so be careful you don’t end up accepting a high-interest loan on a small business that doesn’t make enough money to cover your monthly payments.
The other option is to let the seller of the business finance the sale, and this means that they sell you the business, and loan you the money to pay for it. Usually, you end up paying more for the business, and a hefty interest rate on top of the purchase price, but the benefit is that you put no money down buying an existing business. You may also need to blend one of the previous options as well, such as putting up some of your own cash.
Locating an Existing Business for Sale
The second step to buying an existing business is to find one. Sounds easy, small businesses are all over, right? They are, but not many of them are willing to sell, especially under favorable conditions and a fair price for you. You do have some options, though.
It could be beneficial to buy a business with declining business revenue, or other distressing factors. They might be harder to find, but with some due diligence, you can do it. Look for sectors that are generally hurting, to find a good business in need of some cash.
Right now, at the tail end of 2021 and the COVID-19 crisis, there are plenty of businesses that are holding negative balance sheets. But remember, there is more to a small business than what color is on its financial statements.
Just like a shrewd investor in the stock market, you always buy low and sell high. Any business right now that is struggling and has reduced market value for whatever reason is an opportunity for you to capitalize on a purchase.
Just make sure that some value of the business is still there, consider what an existing business with a negative cash flow statement may have outside of the immediate situation:
- business contacts
- existing customers
- an established brand
- sales records
- the company’s reputation (or brand recognition)
- patents or trademarks
- business’s location
- company car
- sales agreement on hold
- accounts receivable
- business’s assets
Every business that was once successful most likely has some future cash flow, and maybe the problem is just the current economic climate, or the previous owner didn’t understand how to pivot into the current situation.
I have seen businesses being bought purely for their sales records and established customer base. If these things that an existing business owns are of value to you in the future, then buying an existing business with these assets is an investment. The business owner may not be in a financial situation to hold until the accounts receivable come in, and would rather sell than apply for financing at the bank under unfavorable terms.
Now, buying any distressed business is a risk. The reason for the slow down in growth may be factors that you can not turn around either, and you would be in the same boat as the current owner. You would need to have some experience and some deep knowledge of the market and the business operations before considering approaching the business owner with any kind of offer or purchase agreement.
I bought my first business from an online marketplace, where all of the small business owners were motivated in moving forward with a business sale. The advantage here is that most websites that serve to connect existing business owners with buyers, is unless they are specifically a business broker, there is likely only a very small fee for viewing and connecting with the right business.
This means you can save money significantly by doing your due diligence by yourself. Just make sure to request, and other paperwork to get a sense of the business operations before moving forward with buying a business.
The other benefit, is you get to see an asking price (most likely) upfront, placing each small business you are interested in into either the maybe pile, or the no pile right away.
Once you have zeroed in on one or two potential existing businesses you are considering, it’s time to start working on vetting them for final purchase. You will want to get a hold of many different records, and depending on the business purchase, you may have an easy or a difficult time getting everything, but in order of importance, ask for the following when considering buying an existing business:
- three years of tax returns
- three years of prepared financial statements
- interim financial statements (if close to the end of the fiscal year)
- current client list (redacted to hide details)
- employee/contractor list (redacted to hide details)
- commercial liability insurance information (if applicable)
- business licenses
- balance sheet
- cash flow statements
- cash flow projections
- marketing strategies
- management practices
- company culture policies
- advertising costs
- organizational documents
Most of this is pretty self-explanatory, but you will want to get as much of this list as you can, plus all the documents that you think you may need specific to the niche or the area that the existing business specializes in.
You can also use third-party resources like the Better Business Bureau, although be aware that many of those sites are just memberships, and don’t offer solid information about the business itself, only that it is able and willing to spend a small bit of money to be considered members.
Take Some Things with a Grain of Salt
Also, don’t rely on Google Reviews alone for a taste of how the customer base feels about a particular business. As you are probably aware, most of these review sites are filled with the loudest and angriest 1% of customers/clients and don’t represent the full picture of a companies reputation.
The more information you gather when you are doing your due diligence, the better informed you will be about the purchase price when you offer to buy a business.
Purchasing a Small Business
Once you are confident about buying an existing business that you have properly done your homework on, and you are prepared to move forward, the first thing you will need is a purchase agreement.
Initial Purchase Agreement
Now, this initial purchase agreement doesn’t have to be binding and the business owner is under no obligation to accept your terms, but it is a good place to start. I suggest not discussing the purchase price with the owner until you have sent it along with all other conditions in your purchase agreement.
This agreement should include the purchase price, and any conditions of sale, as well as a sample schedule of events.
This will likely be the most important factor you will be working on with the current owner, and it will be the biggest negotiation for buying an existing business.
Typically, you want to calculate the annual profit of the business, that is how much money is left after deducting expenses from revenue. There are some other factors, and we have another article about EDIBTA and other calculations, for more complicated transactions.
The general rule of thumb is to take this annual profit and multiply it by a number known as a multiple. The multiple is usually around 3-6 and it represents the number of years of profit that the business will take to pay for itself. The lower this number is, the shorter you will pay off the business with profits, and the larger the longer it will take.
As well as the obvious total price of the business acquisition, also include any terms of the distribution of funds. This included any deposits, holdback, seller financing, and other caveats to the purchase price and funding directly.
Conditions of Sale
Similar to buying a house, you can set certain conditions when you purchase a business. These can include conditions of financing, seller support, working capital, maintaining a balance sheet, extra due diligence, transition period, etc.
These conditions are important when buying a business, especially if you are relying on funding from a bank or other lender. The banks won’t likely be willing or able to offer you funding until you have this purchase agreement signed and executed. This means that you want to make sure you have a condition for financing in place, in case your business loan falls through, or you could be on the hook for your deposit, or worse.
Once the agreement has been signed and executed, you will want to start your transition period after the closing date has passed. A transition is simply the process of moving all assets, contacts, operating instructions, employees, legal documents, and other factors involved in operating your new business, and making sure you have all the information you need for small business administration.
This process can take a long time, and you should make sure your agreement has a sufficient amount of time and support to accommodate months to even as long as a year for the final transition. Work with the current owner to make sure that the business acquisition goes smoothly, and you as the new owner have enough time to feel comfortable with your new business.
Ensure that your legal documents include the necessary business licenses–government as well as professional license–that you may require for running it.
Using a Business Broker
Using business brokers in this process can help to alleviate some of the hurdles and obstacles that a business purchase may throw at you, but do be aware that all brokers charge a fee, and while they are representing you as the seller or the buyer, they will get a small percentage of the purchase price as a commission. Be aware of the fees and the costs that using a broker will charge you for buying a business through them.
Most brokers are upfront about their fees and are usually heavily regulated in Canada and the U.S. to ensure that they are offering fair services at a fair price. If you want to contact several brokers and let them know ow about your intentions, you may get a second or third opinion and different costs for each broker.
As a buyer though, a broker can represent your interests when it comes to negotiation, as well as the difficult task of getting all of your due diligence done promptly. They can provide an invaluable service to someone inexperienced in buying a business.
New Small Business Owners
If this is your first business, you may still have a full-time job, and your goal should be to maintain your income with your 9-5 while also getting a good grasp on your business to make sure that any decline in revenue from the inevitable fact that you are new to this, and now you have own business and may not be able to take over without suffering a small dip in productivity.
This is a common occurrence for most new business owners, and the key to mitigating this effect is planning. Have a solid plan in place that outlines your goals, objectives, strategies, and how you will measure success. By having all of this in writing, you can make sure that any decline in productivity or revenue will be short-lived as you work on implementing your long-term plan for your small business.
Now you are the Business Owner!
Small business owners are the backbone of western culture, and although they have taken a beating in the past decade or so by larger corporations, they are still the glue that keeps your community together. Be proud of this! Help your community when you have the opportunity, and they will reward you with their loyalty.