If you’re looking to successfully buy a small business... take it carefully. While there are many advantages in buying an existing small business there are also many possible pitfalls.
Many are doomed from the start. With starting off on the wrong foot one of the main reasons for the high small business failure rate.
The business buying process is fragile. The buyer is thinking about the value of all their years of sweat and tears. Biased by seeing all the upsides and good times thinking their business should be worth much more than it probably is. On the other hand, the buyer is all logic and objectivity... considering the risks, the downsides and the cold hard numbers.
So at a this time it would be useful for the buyer to consider these wise words by Eleanor Roosevelt:
To handle yourself, use your head; to handle others, use your heart.
At times when you are buying a small business you will get frustrated and want to push to get it completed... so you can get on with running the business. Take a breath and be patient. In the long run doing everything correctly step by step will pay dividends many times over.
This step is not to scare you but to improve your chance of success and minimise the painful lessons.
It may appear to be a strange place to start but the first consideration is you.
Begin the process by looking inside your head. Accept that not everyone is suited to being a small business owner, so this is the time for honest self-analysis.
Do you have the skills to be a business owner? Are you willing to ask for help? Are you keen to learn new skills? Is living in a world of change and challenges appealing? Are you prepared and committed to take on the responsibilities and challenges to be a business owner?
All ticked off with more “yes’s” than “No’s”? Then it’s time forh the next step... looking for a business.
To find the right business there are more questions to answer. What is your business why? And if you don’t know, or if it is not clear, start by watching this inspiring Simon Sinek video. Are you committed enough? Running a small business is relentless – late nights, weekends, are you prepared.to make all the required sacrifices? Are you tough enough to thrive on the never-ending challenges of the market, of employees and day to day crises?
Lesson: Remember that not everyone can be a successful small business owner and the emotional and financial costs of not being successful are high. You have to be resilient, accept that there might be failures on the path to success. Are you committed enough to keep going?
What type of business would be the best for you? Are you planning on a lifestyle business or do you have grander plans?
Understand how much you can afford – cash savings, family and friends, are you prepared to use any personal assets as sureties to borrow money. Accepting that there is a relationship between what you put in and what you get out.
While there are many “get rich quick” or “get rich with no investment” schemes touted on the internet there is one thing to remember.
if it looks too good to be true... it is!
There are many shiny “paint jobs” out there that may not even have an engine!
Find a Business for Sale
Choose the right type of business - is this going to be a business or a lifestyle? Are you clear on the difference? A lifestyle requires the owner to be available 24/7 and maybe 365. These businesses can make a lot of money BUT they are relentless and demanding. You will spend your life working the lifestyle.
A business is different, designed to work for the business owner. Here the business owner will transition from working in the business to working on the business. A business run by employees and supported by systems and procedures. To be honest in most (all?) cases this does not happen immediately, but it is a clear goal.
When it is clear the broad type of business you want you can start looking around for ones that fit your budget. Every step adds another dimension like the “ideal” business may be located a distance from your residence... adding another consideration.
Which is why today there is the attraction of having a remote online business.
Depending on the type of business there are many ways to find sellers. Through a local business broker, local advertisements, the internet or approaching businesses that meet your “ideal” criteria. The last one may be the most daunting but is often the best option as it cuts out any middlemen (more PC middle people?).
Negotiating the Deal
Contact the business owner and discover the real reason why they are selling. Don't simply accept the seller's word for this. While people do retire or become ill, the real reason may be more ominous. With anything from a national retailer moving into town and taking away customers to losing a lucrative, traffic-driving contract, such as being a postal outlet.
Talk to people who are know the history of the business. This could include local realtors, other businesspeople, the local chamber of commerce, and suppliers.
If the business resides in a mall, talk to other business owners in the mall about mall management, lease rates, anchor tenants, etc. A departing anchor tenant can mean a huge drop in business traffic for the mall or management may be in the process of renewing leases at a higher rate.
What is Included in the Sale?
Be specific and narrow down what is included in the sale.Be clear what you are buying.
Find out how it has been valued. If you buy a small business, what assets are you actually getting? People selling businesses often have a spec sheet prepared, listing the assets involved and an estimate of their value. Ask for details if anything is unclear. And be sure to find out if the assets listed are free and clear of debts and liens because you don’t want to buy other people’s problems.
Pay attention to any intangible assets such as goodwill. Sellers tend to inflate the potential future value of their reputation and the established customer base.
Negotiating the Price
Be clear that you are buying the current business and not the future potential. You are not interested in factoring in all the developments that may increase the value of the business. Many business owners will talk in glowing and exaggerated terms about all the unfulfilled opportunities and how these will increase the business value. Ignore these red herrings as realising these benefits is often far harder and taxing than imagined.
Different types of businesses have different methods for valuation. The buyer must be aware of these and make sure that the basis makes sense to them.
While there are many methods for valuing a business the one that is easy to understand is payback period and return on investment.
If you are investing $1 000 what return would you want? For example, if the interest from the bank is 5% you want more than that “risk free” rate. Then what other options do you have for the $1 000 – you may be able to get 10% from the stock market or a property investment. As the risk here will also probably be lower than a small business, you’d want more than the 10%. After considering all the risk sand challenges you may decide that 20% is acceptable.
Ask a lot of questions. Where needed use the outside specialised assistance from appraisers, accountants or attornies.
Financing the Deal
At this stage you need to reconcile what you want with what you have. If you think about other major purchases like buying a house there is usually a shortfall! What you want costs more than what you have.
To cover any shortfalls will require creative deal making and negotiation.
A low offer with some upside potential depending on future performance may be an option. This type of offer works well if the current owner is staying on for the transition or will be taking a share of the business.
Consider payment terms that include vendor financing asking the seller to finance part of the purchase of the business. A common arrangement is for the seller to carry a promissory note for part of the purchase price. To make this attractive to the seller consider offering a premium interest rate.
Due diligence is an extremely important part of the buying process so as a start connect your head and your gut! While this exercise is mainly based on objective assessment it is also the time to listen to your “gut feelings”.
Using a detailed due diligence checklist will ensure you overlook nothing during this time pressured phase .
It the chance to confirm that this is the right deal. If at any time you are feeling unsure or not seeing enough get supporting records. Eliminate concerns by drilling down through more detailed business records. If you are still not satisfied you may want to get your own audit done.
Consider the things that could go wrong after the due diligence and have a contingency or a strategy for adjusting the price. Make provision for how any major discrepancies discovered say within the first month are resolved.
Identify all the possible risks – business, financial, market, business structure, competition, industry changes, financial or legal – and what impact they could have on the value of the business.
If you are buying a company, you need to be extra careful. Be sure that there are no contingent or unforeseen liabilities. Make sure that there are no outstanding claims against the company and understand if the company has any committed obligations.
Ask for and examine the last three years of the business's financial statements. If they exist, review the management accounts and compare budgets to actuals.
During the buying process if there is a change in any major assumption or economic or industry condition – step back and re-evaluate the complete project.
Examine the Inventory and Assets.
If you are just buying the assets? Ensure that they are necessary and fairly valued. What would be the replacement cost of any major machines or equipment? Is there any equipment that is redundant and not adding value to the operation? Are all the inventories current? With inventory stocks look at the date of the last purchase or the last issue. Ask questions if these are not recent.
Over time businesses may acquire inventory and equipment that that is not core or adds no value to the operation.
Buying the assets and the “customers” is usually much simpler but if there is a change of name in the transition there may be loss of customers. Consider this potential risk when negotiating the final price.
Pay special attention to any listed intangible assets, such as goodwill. They are difficult to value and sellers can easily inflate the value of their reputation and the established customer base.
Other Due Diligence Issues
Ensure that there is documented clearance from all statutory liabilities – tax clearance certificate, social security payments, medical aid or insurance. All licences must be unqualified and up to date.
Scrutinize the employee contracts and files. Talk to the staff try to assess their views about the change of ownership. Are there any people with critical skills that need special consideration? Special conditions of service?
There are many items that should be included in the due diligence but the following are some that are more critical. Check for any past or pending litigation. Request certified copies of the business's financial records. Evaluate trade secrets and intellectual property. Inspect any corporate documents or other registrations. Verify all claims made by the owner, speak to major vendors and major customers.
Understand the role and relationship with any recognised union review and understand any agreements. Understand what unions have or may have some impact on the business. Dealing with these can be extremely time consuming and occupy a large chunks of time. Time better spent on establishing and growing the business.
Review all policies and procedures. Are there defined and documented systems?
Closing the Deal
Before going into the final negotiation read Never Split the Difference by Chris Voss and if possible try and get in a bit of practice with some low-key negotiations.
Follow the wise advice of Chris Voss and never make the first offer. If there is a difference between the seller’s price and your planned offer, consider what other elements you could include to make the deal more acceptable.
Mistakes made at the beginning are difficult or impossible to correct later and one mistake can turn a good deal into a horrible deal.
Be patient – this can be an emotionally and intellectually challenging time. It can become very frustrating
Agree on a fair purchase price. This should involve using your newly acquired negotiation skills
Be prepared to walk away if the negotiation doesn’t go as planned. It will be a grave mistake to get so caught up in wanting to make the deal that you push past the price you're prepared to pay.
After agreeing the price, the closing date and any other sale conditions with the seller put the agreement in writing. Although this is often drawn up by a lawyer it does not release you from the responsibility of fully understanding all the clauses and their significance. It can feel like a waste of time when all you want to do is get on with the business, but it is your last chance.
The last step before finally signing the sale agreement is to agree the transition process. Will the seller stay involved for a period? For how long? What will they do?
Final Steps When Buying a Small Business
The ownership of the business is finally transferred.
If there is more than one shareholder, then a shareholder’s agreement is essential. In the early days it is like an new romance “all wine and roses” but later during the “bust up” anything can happen. Make sure there is a clear process if a shareholder wants to leave – the circumstances, the value and the how.
Getting and keeping customers is tough – it is both expensive and time consuming. Requiring an investment of money and resources to understand and acquire them. To minimise the loss of customers, have a clear plan to consider and if necessary engage them during and immediately after the transfer.