Buying a Business- Prepare Yourself
Buying a Business- Prepare Yourself
The following steps need to be taken in order and looked at very seriously. This is just the beginning but it is necessary to be in the right position to make what will be a very big, life changing move.
Step 1: What type of business?- You need to decide what kind of business you want to be in. At least whittle it down to two types. If you don’t, a few things will happen. First, you will be looking for a long time in a very wide circle. It is hard to get a grasp on a good business opportunity when you have no idea where you want to be. If you are all over the place, you are not ready to buy a business.
Second, the people who will most likely be helping you (advisors, brokers, etc.) will not want to be around you for long. They will be spinning their wheels with you and will quickly put you at the bottom of the list. Even sellers who are attempting to sell on their own will get annoyed with you very quickly if you bombard them with questions but otherwise don’t seem too interested in their business.
Step 2: Do you need a partner?- Partners are necessary for two things. Either they will supply you with capital or they will provide you with skills you may not have. The latter is a better reason for a partner and a combination may work as long as you are going in with an even money 50-50 deal. I don’t recommend picking a partner based on their bank account. You will most likely have major problems within 12-18 months. Trust me, I’ve been there.
Running a business by yourself, especially for the first time, is a scary proposition. But having a good accountant, lawyer and a business advisor is the way to go. At one point or another, even your best friend will turn on you as a partner. You are better off having someone that covers your shortcomings as your employee, along with a deal to give them a small piece of the pie while they remain an employee. Having a partner or two holding a large chunk of the business over your head will quickly stifle you and make you regret the purchase.
Step 3: What kind of buyer are you?- In my experience, there are three main types of true buyers: those that look only for high cash flow, those that look for decent positive cash flow with the thought of using their experience to grow the business, and those I like to call bottom feeders.
Bottom feeders like to look for sellers in a really bad position such as fighting partners (see step 2), or negative cash flow due to an inexperienced owner. These are perfect to scoop up for next to nothing because the sellers not only want to get out, but they need to get out. If you are a bottom feeder though, you better be good at turning things around quickly because these businesses are in major disarray. Being able to see how to get them into a positive cash flow or a good light quickly is a necessary skill too. A bottom feeder could also be looking for the opportunity to grab equipment and fixtures cheaply for their already running business. Also keep in mind that it will be next to impossible to get seller financing from these types of purchases. The last thing these people want is to remain tied to the business or their arch enemy ex-partner.
I should point out that if these are “true” buyers, then there are also “false” buyers. These people are either the unprepared and uncommitted buyer that I am trying to not let you be or they are just looking for information. This means either they already have a business and they are trying to scope out competitor info to help them or they are prepping to start a business from scratch and could use the information to help them get a leg up in the process.
Step 4: How am I going to pay for this?- Please don’t make the mistake of thinking that because you are buying an existing business that a bank is just going to hand over the money. Even if this business is doing extremely well, this most likely will not happen. It is true that buying a solid business with strong cash flow will help, but the business type, collateral and your background are very significant.
And no, you can’t just apply for an SBA loan. These are not easy to get and yes you do have to pay them back. The government isn’t that nice. Again, business type, your personal collateral and a lot of other factors determine this loan process. Normally, this is not the fastest way to get a loan either.
Please know that your own money (including your house) as well as friends and family are going to be your main resource. Property involved in the sale is a big help. Keep in mind that the “cash based” business you may be dying to get into is the hardest to get funded by a bank. There is usually not enough proof on the books and in tax records for a bank to give you a loan based on the merits of the business. That’s the main drawback of the cash business.
There is one other way to get a loan. That would be through the seller and it’s called “holding a note”. Risky businesses like bars and restaurants (especially without property), as well as any other retail type business, are a prime target for a seller holding a note. Typically you will being putting down 30%-70% with the rest financed with or without interest for a period of 2 to 5 years. It may take some convincing, but most sellers will give in when they realize that in order to get what the business is worth, they need to hold a note. Business Brokers come in handy when this kind of convincing is needed.
Step 5: What can I afford?- Usually the cash flow of the business is the best indicator to use for valuing a business. Often a “rule of thumb” multiple for the industry combined with factors such as location, years in business, revenue trends, market situations, etc. are used to multiply against the cash flow. When this is the case, the buyer and seller will be closer to being on the same page for determining a fair price.
It is also a good indicator to use because this is how you will determine if you can pay off a loan using the business cash flow. For instance, say a business has a $100k cash flow and you buy it for $200K with 50k down. That means you have a note for $150k. Say that the note has a 2 year time frame with no interest from the seller. That means you will be paying out $75k a year for two years. Can you survive personally on $25k or less a year for 2 years? Don’t forget that things will probably slip a little when you take over and that you may need additional capital as is often the case. Do you have enough in the bank to handle this for 2 years?
You need to know this. Having these scenarios in your head ahead of time will eliminate looking at businesses that don’t completely fit your needs. This will also avoid wasting time, money and energy. It’s not as simple as finding a business with a great cash flow and hoping all is well. Hopefully this very simplified example will show you that it takes money to make money even in an established business. If it were that easy, anybody could buy a company with a million dollar cash flow.
Step 6: Commitment to buy- This sounds obvious but it really isn’t. You will be wasting a lot of your time, seller time and broker time if you are not absolutely sure you are ready to do this. In addition, you will waste money if you get an advisor involved to help you determine if this business is a fit and worth purchasing (I highly recommend this by the way) without being mentally ready and committed. Believe me when I tell you that a seller or broker is not going to give you much financial and business information unless you are committed enough in the buying process. An uncommitted buyer is very easy to spot, especially to a business broker.
Congratulations! You are now ready to start shopping for a business and will be prepared to buy when the right opportunity presents itself. I know I have said it a few times before, but I highly recommend using a business advisor to prepare yourself in determining the right business and price range for you before business hunting.
Again, having a broker between you and the seller is also a good idea. Most importantly, do not get a lawyer involved at this time. Unless you need a pre-emptive agreement made between you and a potential partner, attorneys are unnecessary and a hindrance at this stage. They really should not be introduced into the process until you are in the due diligence stage.
Best of luck with the next part of the game… the buying process.
Buying a Business Prepare Yourself - To learn more about this author, visit George J Sierchio's Website.
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So you have decided that you would like to run your own show and buying an existing business versus starting from scratch is the way to go. This is a very wise decision if you have not been involved in a start-up before. The question then is: Are you ready?
The following steps need to be taken in order and looked at very seriously. This is just the beginning but it is necessary to be in the right position to make what will be a very big, life changing move.
Step 1: What type of business?- You need to decide what kind of business you want to be in. At least whittle it down to two types. If you don’t, a few things will happen. First, you will be looking for a long time in a very wide circle. It is hard to get a grasp on a good business opportunity when you have no idea where you want to be. If you are all over the place, you are not ready to buy a business.
Second, the people who will most likely be helping you (advisors, brokers, etc.) will not want to be around you for long. They will be spinning their wheels with you and will quickly put you at the bottom of the list. Even sellers who are attempting to sell on their own will get annoyed with you very quickly if you bombard them with questions but otherwise don’t seem too interested in their business.
Step 2: Do you need a partner?- Partners are necessary for two things. Either they will supply you with capital or they will provide you with skills you may not have. The latter is a better reason for a partner and a combination may work as long as you are going in with an even money 50-50 deal. I don’t recommend picking a partner based on their bank account. You will most likely have major problems within 12-18 months. Trust me, I’ve been there.
Running a business by yourself, especially for the first time, is a scary proposition. But having a good accountant, lawyer and a business advisor is the way to go. At one point or another, even your best friend will turn on you as a partner. You are better off having someone that covers your shortcomings as your employee, along with a deal to give them a small piece of the pie while they remain an employee. Having a partner or two holding a large chunk of the business over your head will quickly stifle you and make you regret the purchase.
Step 3: What kind of buyer are you?- In my experience, there are three main types of true buyers: those that look only for high cash flow, those that look for decent positive cash flow with the thought of using their experience to grow the business, and those I like to call bottom feeders.
Bottom feeders like to look for sellers in a really bad position such as fighting partners (see step 2), or negative cash flow due to an inexperienced owner. These are perfect to scoop up for next to nothing because the sellers not only want to get out, but they need to get out. If you are a bottom feeder though, you better be good at turning things around quickly because these businesses are in major disarray. Being able to see how to get them into a positive cash flow or a good light quickly is a necessary skill too. A bottom feeder could also be looking for the opportunity to grab equipment and fixtures cheaply for their already running business. Also keep in mind that it will be next to impossible to get seller financing from these types of purchases. The last thing these people want is to remain tied to the business or their arch enemy ex-partner.
I should point out that if these are “true” buyers, then there are also “false” buyers. These people are either the unprepared and uncommitted buyer that I am trying to not let you be or they are just looking for information. This means either they already have a business and they are trying to scope out competitor info to help them or they are prepping to start a business from scratch and could use the information to help them get a leg up in the process.
Step 4: How am I going to pay for this?- Please don’t make the mistake of thinking that because you are buying an existing business that a bank is just going to hand over the money. Even if this business is doing extremely well, this most likely will not happen. It is true that buying a solid business with strong cash flow will help, but the business type, collateral and your background are very significant.
And no, you can’t just apply for an SBA loan. These are not easy to get and yes you do have to pay them back. The government isn’t that nice. Again, business type, your personal collateral and a lot of other factors determine this loan process. Normally, this is not the fastest way to get a loan either.
Please know that your own money (including your house) as well as friends and family are going to be your main resource. Property involved in the sale is a big help. Keep in mind that the “cash based” business you may be dying to get into is the hardest to get funded by a bank. There is usually not enough proof on the books and in tax records for a bank to give you a loan based on the merits of the business. That’s the main drawback of the cash business.
There is one other way to get a loan. That would be through the seller and it’s called “holding a note”. Risky businesses like bars and restaurants (especially without property), as well as any other retail type business, are a prime target for a seller holding a note. Typically you will being putting down 30%-70% with the rest financed with or without interest for a period of 2 to 5 years. It may take some convincing, but most sellers will give in when they realize that in order to get what the business is worth, they need to hold a note. Business Brokers come in handy when this kind of convincing is needed.
Step 5: What can I afford?- Usually the cash flow of the business is the best indicator to use for valuing a business. Often a “rule of thumb” multiple for the industry combined with factors such as location, years in business, revenue trends, market situations, etc. are used to multiply against the cash flow. When this is the case, the buyer and seller will be closer to being on the same page for determining a fair price.
It is also a good indicator to use because this is how you will determine if you can pay off a loan using the business cash flow. For instance, say a business has a $100k cash flow and you buy it for $200K with 50k down. That means you have a note for $150k. Say that the note has a 2 year time frame with no interest from the seller. That means you will be paying out $75k a year for two years. Can you survive personally on $25k or less a year for 2 years? Don’t forget that things will probably slip a little when you take over and that you may need additional capital as is often the case. Do you have enough in the bank to handle this for 2 years?
You need to know this. Having these scenarios in your head ahead of time will eliminate looking at businesses that don’t completely fit your needs. This will also avoid wasting time, money and energy. It’s not as simple as finding a business with a great cash flow and hoping all is well. Hopefully this very simplified example will show you that it takes money to make money even in an established business. If it were that easy, anybody could buy a company with a million dollar cash flow.
Step 6: Commitment to buy- This sounds obvious but it really isn’t. You will be wasting a lot of your time, seller time and broker time if you are not absolutely sure you are ready to do this. In addition, you will waste money if you get an advisor involved to help you determine if this business is a fit and worth purchasing (I highly recommend this by the way) without being mentally ready and committed. Believe me when I tell you that a seller or broker is not going to give you much financial and business information unless you are committed enough in the buying process. An uncommitted buyer is very easy to spot, especially to a business broker.
Congratulations! You are now ready to start shopping for a business and will be prepared to buy when the right opportunity presents itself. I know I have said it a few times before, but I highly recommend using a business advisor to prepare yourself in determining the right business and price range for you before business hunting.
Again, having a broker between you and the seller is also a good idea. Most importantly, do not get a lawyer involved at this time. Unless you need a pre-emptive agreement made between you and a potential partner, attorneys are unnecessary and a hindrance at this stage. They really should not be introduced into the process until you are in the due diligence stage.
Best of luck with the next part of the game… the buying process.
Buying a Business Prepare Yourself - To learn more about this author, visit George J Sierchio's Website.
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George J Sierchio Video - George J Sierchio - There are a few reliable sources of finding businesses for sale. There are also some awful sources. Take a look at my tips on how to best find a business to buy.
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