Tips on Buying a Business- What Can You Afford?

Financing an acquisition of a small business is nothing like a mid to large level merger or acquisition. So forget about leveraging the business' assets to get a loan from a bank even in a good economy. Forget those that say you can buy a business with no money down too.

Those theories are for big transactions (multi-million dollar transactions) with people that have immense experience as a business owner of a business that size or as a very high level player in that arena. And there is money that gets put down, but it comes from outside investors who are counting on the "buyer" to give their money a return on investement in a set timeframe and then get out.

Put it out of your head because whether you can wrangle a bank loan, non-traditional lender loan (such as a business loan specialist at an investor institution) or a seller note (which is really the best way to go with small businesses), you will need to put up your own money or prove you can get some backing from a family member etc. And you will need to pay off said loan with business proceeds.

So here's a more practical way of looking at a small business purchase...

Usually the cash flow of the business is the best indicator to use for valuing a business. It's also a good way to determine what you can afford when combined with how you will fund the business.

The business cash flow is what you will be using to pay off a loan or return your personal money used for the purchase back into your pocket. 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.

Take this tip on buying a business: 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?

Determine how much excess capital you may need upfront and not when the problems arise. Yes, buying a business gives you a running start, but it's very likely that you won't be running on a smooth track for the first few months after the transition from the seller.

It takes money to make money, but it also takes money to buy a business that makes money. If it took $50k to buy a business with a $200k cash flow, then everyone would and could find a way to make this happen.

Don't kid yourself like I see so many first time business buyers do. If the business you are looking at is doing well and you have no down payment money equal to at least 20% of the asking price (more like 50% for a seller note situation) as well as limited business owning experience, YOU ARE NOT IN THE DRIVER'S SEAT since you can't afford the business. So acting like you know what you're doing is just going to get you in trouble or most likely told to take a hike, to use my usual blunt terms.

Be prepared and know what you can afford so that you'll have a much better and less drawn out buying experience.