If you’re looking at successfully buying a small business... take it carefully. While there are many advantages in buying an existing business there are also many lurking pitfalls.
Many of these small business takeovers are doomed from the start. And starting off on the wrong foot is one of the main reasons for the dismal small business success rate.
The business buying process is fragile. The buyer is thinking about the payback for 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 realistically is.
On the other hand, the buyer is all logic and objectivity... considering the risks, the downsides, and the cold hard numbers.
So, faced with these two conflicts 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.
Finding common ground takes time and persistence so at times when you are buying a small business you will get frustrated and want to push to get it completed. Driven by your enthusiasm to get on with running the business.
Take a breath and be patient. 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 any painful lessons resulting from a lack of self-awareness.
Take Your Business to the Next Level with my Free 5 Step Business Improvement Course
Get it now and start the course.
This may appear to be a strange place to start the process of buying a business but your first consideration must be you.
Knowing that this is the time for honest self-analysis and beginning the process by looking inside your head. Accepting that not everyone is suited to being a small business owner.
If this is checked off with more “Yes’s” than “No's” then it’s time for the next step... looking for a business.
To find the right business there are more questions to answer.
Why is your why for becoming a business owner? And if you don’t know, or if it is not clear, start by watching this inspiring Simon Sinek video.
Asking again. 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 the day-to-day crises?
Lesson: Remember that not everyone can be a successful small business owner and the emotional and financial costs of failing are high. You must be resilient, accepting 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 or what you could lose!
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 do not even have an engine!
Find a Business for Sale
Choose the right type of business - is this going to be a genuine business or a lifestyle? Are you clear on the difference? A lifestyle requires the owner to be available 24 hours a day, 7 days a week and 365 days a year. These businesses can make a lot of money BUT they are relentless and demanding.
You will spend your life working the lifestyle.
A genuine business is different, as it works for the business owner as opposed to the owner who works for the business.
With a genuine business the business owner will transition from working in the business to working on the business. Spending more time working on the business while the business operations are run by employees who are supported by systems and procedures.
To be honest, in most cases this does not happen immediately, but it can be a clear goal.
After deciding the broad category 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, "Is the commute acceptable?"
This is why today there is the attraction of having a remote online business. It reduces the number of questions to be considered.
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 seller to try and try and discover the real reason for selling. Don't simply accept the seller's first answer. 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 a centre losing a lucrative, traffic-driving contract, such as being a postal outlet.
Talk to people who 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 crystal clear about what you are buying.
Find out how it has been valued. If you buy a small business, what assets are you 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 financial obligations because you don’t want to be buying other people’s problems.
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 value of the business.
Ignore these red herrings as realising these benefits is often far harder and more taxing than imagined.
Be aware that diverse 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 the payback period and return on investment.
If you invested $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 for a small business, you’d therefore want more than 10%. After considering all the risks and challenges you may decide that 20% is acceptable. Understanding that is a 5-year payback.
Ask a lot of questions and use the outside specialised assistance from appraisers, accountants, or attorneys.
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 shortfall, it will require creative deal making and negotiation.
Consider payment terms that include vendor financing. Asking the seller to finance part, or even all, 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.
Another option may be a low offer with some upside potential depending on future performance. 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.
Due Diligence for Buying a Small Business
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 largely 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 is the last chance to confirm that this is the right deal.
If at any time you are feeling unsure or not seeing enough, get the supporting documents. Eliminate any concerns by drilling down through these 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 are discovered. For example, if these are discovered within the first few months how are they to be resolved?
St this stage try to identify all the possible risks – business, financial, market, business structure, competition, industry changes, financial or legal. Then assess what impact they could have on the value of the business.
If you are buying the company (not the assets), you must 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 exist, are necessary and fairly valued.
What would be the replacement cost for 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 is not core or adds no value to the operation.
While buying the assets and the “customers” is usually much simpler, if there is a change of name in the transition there may be loss of customers. Consider this potential risk when negotiating the closing 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 certificates, social security payments, medical aid, or insurance. All licenses must be unqualified and up to date.
Scrutinize the employee contracts and files. Talk to the staff and try to assess their views about the change of ownership. Are there any people with critical skills that need special consideration? Are there any 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 trade union. Review and understand any agreements.
- Understand which unions have, or may have, some impact on the business. Dealing with these can be extremely time consuming and occupy a large chunk of time. Time far 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 the book "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 relationships are like a new romance, “all wine and roses”. But later during a “bust up” things can quickly turn nasty. Make sure that there is a clear process if a shareholder wants to leave – the circumstances, the value and the how.
Finally remember that customers are the life blood of the business. Getting and keeping them is tough. It is both expensive and time-consuming, requiring both an investment of money and resources.
To minimise the loss of customers, have a clear plan of how to engage with them during and immediately after the transfer.