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The decision to buy a business is a big one—but when you pull the trigger on buying an existing business, you get the opportunity to become an entrepreneur without starting completely from scratch. And lots of people consider buying a business each year, so you certainly shouldn’t feel like you’re thinking about something totally out of left field!
Every year, more than 500,000 businesses change hands, and that number is expected to skyrocket in the next several years as millions of baby boomers begin retiring and selling their businesses.
Buying an existing business is so popular because it lets you skip past some of the pain points and costs of launching a brand-new company. But the journey from finding a business for sale to closing the deal can be long and complicated.
Before you begin your journey to buy a business of your own, find out everything you need to know to avoid buyer’s remorse, and all of the business loan help you can get.
From understanding the pros and cons of buying a business when you’re still just thinking about the idea, to closing the deal and getting the keys. Here’s a rundown of how to buy a business, from start to finish.
Buying a business is kind of like being in the market for a home. Although some people like the history and character that come with an older home, others don’t want the baggage that can saddle an older home and prefer something turnkey. Similarly, there are plenty of advantages when you buy a business that’s already been around for a while, but there are drawbacks, as well.
1. Proven Business Concept
When launching a brand-new business, the bulk of your time will be spent on the planning phase. You’ll have to write a business plan and figure out how to turn that plan into a reality.
But when you buy a business that’s already up and running, you’ll typically have all of this in place:
Granted, each of these things may not be in great condition, and the business might not be turning a profit yet. (That part is really important!) However, an existing business has some structure that will save you time up front, letting you quickly see what you need to zero in on. Particularly if you’re testing a new market or entering an industry that you don’t have much experience in, zipping past the difficult startup phase can be a huge advantage.
2. Lower Operating Costs
One of the major benefits of buying a business is that the operating costs are lower. For example, startup costs for a brand-new restaurant can run upward of $450,000 for initial supplies, food and beverage, signage, and a customized build out of the kitchen. With an existing business, your initial operating costs are lower because—unless your acquisition is pretty atypical—many parts of the business are already in place and ready to go once you’re at the helm.
You don’t need to spend as much of your budget on hiring employees, developing marketing strategies, or building a customer base because those come with the transaction. Instead, you can pour more cash into expanding the business and adapting it to your vision.
3. Easier to Obtain Financing
While the move to buy a business isn’t always a safe bet, lenders and investors see it as lower risk than launching a new company. This is because there’s a history of financial performance that a lender or investor can use to gauge how the business has performed to date and to predict future performance. Plus, like we mentioned, there’s also existing data around the company’s market position, competitors, brand recognition, and customer base.
All this makes investors more likely to invest in the business and can make lenders more comfortable in giving you a business acquistion loan. The current owners can even participate in financing the transfer of ownership by giving you a loan (more to come on this in a bit).
4. Intellectual Property on the Table
If your business-to-be has patented their products or has a copyrighted slogan or trademarked logo that wins over customers, then that intellectual property value will probably transfer over to you. That means when you buy a business, you sometimes buy more than what the eye can see.
This isn’t on the table with every business acquisition, but it could be critical if you’re dealing with something that you think could be expanded even more. What if you turned this small business into a national franchise? All of a sudden, that patent and copyright becomes a lot more valuable. Patents, copyrights, and trademarks are often included in sales of software companies, tech businesses, and creative businesses (e.g. music, design, and art).
What goes up must come down, right? Now for the drawbacks of choosing to buy a business:
1. Higher Upfront Purchasing Costs
By buying an existing business, you’ll be able to save money on operating costs, such as inventory and equipment. However, you’ll probably face some pretty sizable purchasing costs. In fact, those purchasing costs might be greater than what it would take you to start a business.
That’s because, in addition to the obvious assets, you’re also buying ownership over the following:
All of these items will be the subject of negotiations between the buyer and seller and factor into the final purchase price.
If you’re looking to buy a business you didn’t start, you’ll necessarily be a bit less familiar with its inner workings and the details of its products, processes, employees, and financials. This could be a bit of an obstacle, especially when you’re just starting out. This is especially true if you are entering an industry that you lack experience in. You’ll need to spend a lot of time learning the ropes, and prepare for the learning curve to be steep.
3. Risk of a Hidden Problem
Ever watch a show where the second a buyer closes on a house, they find out the inspector missed a massive crack in the foundation? Too late to go back on that purchase now!
Well, as a prospective business buyer, you’ll also go through a fairly intensive due diligence process, where you’ll gather information about the business and the current owner. But no matter how much information you uncover, you always run the risk of taking on an issue that you’re not aware of or that’s worse than it appeared. For example, equipment could be damaged, or the brand might have a bad reputation. Once you buy a business, you buy those issues, like it or not. A bit later, we’ll tell you how to catch most of these problems before it’s too late.
If you’re set on wanting to buy an existing business, then of course it’s crucial to make sure you pick the right business for you. The easiest way to set yourself up for success is to buy a business that you’re passionate about improving and taking to the next level. But passion alone isn’t enough—experience and knowing which questions to ask when buying a business are also important when making your choice.
Here’s how to pick the right business to buy:
Narrow down your passions, interests, skills, and experience. You’ll be happier if you buy a business that dovetails with what you already like and have some experience in.
For example, if you’ve been a line cook at a restaurant for several years, maybe you’ve decided you’d like to own your own restaurant. Or maybe you’ve been an employee for a long time at a company that’s now on the market. In that case, who better to buy the business than someone who knows it as intimately as you?
Although you might just want to buy a business for the financials alone—by its expected return on investment—it’s also important to align yourself with the business’s immaterial goals. After all, the more knowledgeable and familiar you are with the business’s model, products or services, customers, industry, and trends, the more innovative and successful your new ideas will be.
This is where you’ll need to decide on the more hard-and-fast aspects of your new business acquisition.
For example, figure out how much you’d ideally want to change the business, and assess whether that lines up with your budget. Calculating the ideal size, location, sales, staff, and so on of your business is an important step, since it will give you a scale to keep in mind when you’re shopping around.
Money isn’t the only thing you’ll be spending. Look at the time and energy commitments you’re planning to invest to make the business “your own.” Some managers prefer to be “on” at all times, in the weeds with their employees, while others prefer to delegate and, one day, own multiple businesses.
The amount of resources you’ll have to invest depends in large part on the people and processes already in place and on the experience you have in the industry. For example, if you’re buying a tech company but lack technical expertise, you’ll need to invest time learning the ropes from existing staff.
There are plenty of reasons a business owner might put their business up for sale, including something as simple as an innocuous lifestyle choice like retirement, or something more worrisome—like when there’s a fundamental problem with the business. If you’re about to buy a business, you’ll want to know exactly why this business isn’t working anymore for its current owner.
You should ask the current owner what challenges they’ve encountered, what they’ve done to try solving those problems, and how those attempts fared. During every conversation with the current owner, you should ask yourself, “Do I have what it takes to meet these challenges with different or better solutions?”
Be on the look out for:
Make sure you know as much you can about the existing business’s successes, failures, challenges, and future opportunities. In addition to speaking with the owner about these concerns, also talk to existing customers, existing employees, locals in the area, neighboring businesses, and so on. They’ll give you an honest view of how the business is doing, without the bias of the seller trying to convince you to buy.
There are plenty of ways to find the right business for sale that fits the criteria you’ve decided on.
Business brokers legally represent the seller, so you should be careful about conveying certain information to them (such as how far you’re willing to go in negotiations). However, a broker can help you understand what kind of business you want, prescreen businesses to cut out all the failing companies, keep negotiations civil and smart, and help you with all the necessary paperwork. Note that, with a broker, there’s a commission involved, but it’s typically paid by the seller.
As the buyer, you’ll want to have a good accountant on your side to review the business’s financials. It may also be beneficial to have a good business lawyer to represent you in negotiations and to help you understand how the transaction will be structured.
If you’re looking to buy a business for the first time, a business broker may be worth the cost. But if you’re confident you can handle the process on your own, hold off on hiring a broker until the very end—because even the savviest entrepreneurs can have trouble filing forms and following proper legal procedure.
Due diligence—the process of gathering as much information and intel as you can before you buy a business—is a critical step in your journey to becoming a business owner. During this period, you should work with an accountant and lawyer to make sure you’ve got all the information you need to move forward.
Before you can begin your due diligence, the seller will most likely ask for a signed confidentiality agreement or nondisclosure agreement. By signing, you agree not to disclose any confidential information about the business that’s uncovered during the due diligence process. This protects the seller in case you decide not to buy after reviewing all the documents.
There are plenty of business documents, files, agreements, and statements that you’ll want to collect and analyze, ideally with the help of a lawyer and accountant.
Here are some of the must-have documents when doing due diligence in the process of seeking to buy a business:
1. Business Licenses and Permits
First up is to make sure that the business you’re looking at has all the business licenses and permits it needs. If you’re going to take over the business, you want to make sure that the current owner hasn’t run afoul of any local business licensing laws. Businesses in certain industries, particularly highly regulated ones like food services and child care, need a valid permit to stay open.
2. Organizational Paperwork and Certificate of Good Standing
If the business you’re buying is a sole proprietorship or partnership, there may not be official “founding” paperwork. However, a registered business entity, such as an LLC or corporation, will have organizational documents on file with the state. For an LLC, this is the articles of organization. For a corporation, this is the articles of incorporation.
The secretary of state in your state should also be able to produce a certificate of good standing for the business you’re interested in. This certifies that the business is approved to operate in the state.
3. Zoning Laws
Check with your area’s local zoning laws to make sure that the business you’re purchasing isn’t violating any restrictions. While some localities allow mixed use commercial and residential zoning, others have tight restrictions on where businesses can be located. This especially goes for businesses like bars and nightclubs that may not be desirable in a residential area.
4. Environmental Regulations
Has this business been secretly dumping chemicals into the nearby reservoir or violating other environmental laws? (We certainly hope not, for everyone’s sake!) Make sure the answer is a firm no before signing on the dotted line. Double-check that this business abides by all of the area’s small business environmental regulations.
5. Letter of Intent
The seller issues a letter of intent (LOI) to the buyer when both sides have agreed on a price point and about which business assets and liabilities will be included in the transaction. The price proposal, along with the terms and conditions of the business sale, should all be included in the seller’s LOI.
The LOI is an indication from the seller that they are serious about seeing the deal through to the end. Once you have it in hand, you can feel more comfortable forging ahead with the remainder of due diligence.
6. Contracts and Leases
Half the fun of the choice to buy a business is all the stuff it comes with. Whether that means a lease for the location, equipment, or something else, you’ll want to make sure the landlord is alright with transferring over these legal documents to your name. Otherwise, you’ll need to negotiate a new lease, which can significantly add to your expenses.
You’ll also want to review any outstanding agreements that the owner has with vendors or customers. This can be very revealing. For example, if your review indicates that 90% of the business’s revenue comes from a single client, you’ll want to think twice before buying. If that client parts ways with the business, it could put a serious dent in the business’s potential.
7. Business Financials
Before you buy a business, make sure to examine its past few years of financials, including:
Double-check that the tax returns and financial statements have passed a CPA audit—don’t accept those financials from the sellers themselves.
Use the business’s financials as an opportunity to analyze its income stream. The business you purchase doesn’t necessarily have to be profitable yet (particularly if it’s a young business), but there should be a clear path to profitability.
Be in the know on whether the business’s debts and liabilities will be included in the transaction or not, and be wary of taking these on. For example, if some of the outstanding receivables the ex-owner was dealing with are too old—90 days or more, for example—then they’ll be pretty tough for you to collect on. You might be better off asking the seller to insure them or contact the customers themselves.
8. Organizational Chart
You won’t want to walk in blind. If you buy a business with employees, make sure you understand how they rank and relate to one another by asking for a business organizational chart. This should also include compensation data, management practices and processes, benefit plans, insurance, and vacation policies.
9. Status of Inventory, Equipment, Furniture, and Building
Make sure to critically analyze these aspects of the businesses, since their values will directly impact the cost of the business.
You’ll want to check:
Sites like Whayne.com can be used to look up equipment and obtain price estimates.
10. Other Important Documents
This list of documents will tell you a lot of information about the business, but there’s probably more you’ll want to examine. Your attorney or accountant should be able to identify additional documents specific to the business you’re interested in.
For example, ask the seller for property documents, equipment/asset listing, brand assets for advertising materials, an account of intellectual property assets, insurance coverage, employee policies and contracts, incorporation information, and customer lists.
Once due diligence comes to a close, you’ll need to make your final decision about whether to buy the business. If you decide to go ahead, the sales agreement is what ties it all together.
The agreement will enumerate the final purchase price and everything you’re purchasing, including:
Have a lawyer help you put this document together—or, at the very least, review it before you sign.
Before you finalize the move to buy a business, there’s one very important step—the buyer and seller have to agree on a price. This is where many deals fall apart because buyers and sellers often place very different values on the same business, and several factors affect a business’s value.
Buyers and sellers usually use some kind of pricing model to get a ballpark number and frame negotiations. During this process, it can be very helpful to call in an independent business valuation professional to make an objective determination of value. Valuation services, which can be found online or through word of mouth, cost around $3,000 to $5,000, but they can save you thousands more in the long run by coming up with a good estimate of value.
Whether you do this yourself or hire someone, it’s helpful to have some knowledge about how businesses are valued. To get some insight, we spoke with Mike Bilby, CPA and certified valuation analyst, at Concannon Miller.
Bilby said small businesses should understand three main approaches to valuing an existing business:
Best used for: Businesses that are already turning a profit or have a positive forecast of earnings.
The earnings approach values a business based on its historical, current, and projected profits. Specific methods you may come across that fall into this approach include the capitalized earnings method and discounted cash flow method.
For businesses with a history of fairly stable profits, that history can be used to anticipate future earnings and value the business. Even if a business hasn’t generated a profit yet, earnings models can be used to predict how much the business might earn in the future. The disadvantage of the earnings approach is that it relies on a prediction of future earnings, which may not be accurate.
Best used for: Capital-intensive businesses, such as manufacturing and transportation businesses, and businesses that aren’t profitable yet.
The asset approach measures the value of a business’s tangible and intangible assets minus debts and liabilities. Tangible assets include things like equipment and real estate, and intangible assets include things like patents, trademarks, and software. The asset approach considers the current fair-market value of the business’s assets but also the future return on investment that the owner could get from those assets.
Best used for: Accounting for local factors or confirming a price that you arrived at based on one of the other two approaches.
The market approach measures the value of a business based on how much comparable businesses have sold for. It’s a good way to get a ballpark range for a business’s value and to account for local factors that the other approaches may miss, such as the business’s location in a particular neighborhood.
It might be confusing to get all these approaches straight in your head, but the point of all of them is to assess the current financial health of the business, as well as its growth potential. In reality, Bilby says, none of these methods exists in isolation. All three of these approaches can be used to arrive at a fair price for a business, and the final price will always be the one that both the buyer and the seller agree on.
Once you and seller agree on a number, the next step is to get the money. There are a few different ways you can gather up the capital you’ll need to purchase a business—some specific to buying an existing business, others pretty standard.
Here are some of the ways to finance a business acquisition:
If you’re able to cover the costs of buying an existing business, that’s always an option. This is more likely if you’re buying a small business rather than a chain. Of course, you’ll want to consult your accountant before ponying up a large lump sum of your own cash. Also, make sure that you’re not using all your money because running a business takes capital, too.
Many businesses are also funded with money borrowed from family. If you go this route, you should understand the tax implications for gifts and family loans. Make sure that you and your family member put the exchange of money in writing and follow IRS rules for family loans.
Some sellers will agree to holding a note, or accepting staggered payments—sort of like a lender. This way, they get guaranteed income for the coming months (or years, depending on your plan).
There are rules around seller financing, particularly if you plan to use another form of debt financing as well. For example, sellers have to be on “standby” if you’re also getting an SBA loan, meaning they have to agree that they won’t be paid back until you pay off the SBA loan.
Some sellers might also be willing to trade in some assets, like some furniture they really loved or the company car, for a lower price.
By turning to a partnership instead of buying a business solo, you can divide the payments you’ll be making while still owning that company.
Taking on a partner isn’t only useful to cut costs, though: you can also bring someone on board with more specific experience or a different skill set. Just don’t forget to draw up a partnership agreement, so co-ownership doesn’t cause any problems down the line.
By selling company stock to its employees, you can get a big discount—making up 50% or even 90% of the business price by some measures. You’ll probably want to sell non-voting stock, if possible, to retain ownership over the business. In order to issue stock, you’ll have to organize the business (or re-organize it) as an S-corp or C-corp.
It might be possible for you to lease the business instead of buying it outright—with the option to make the big purchase down the road once you’re able to afford it.
Understandably, not all sellers will be open to this option, since they more likely than not want to wash their hands and walk away from the sale. However, if leasing is something you’d be more comfortable with—even though it may cost more money in the long run—you might as well ask.
Choosing to buy an existing business will give you tons of documents to approach a bank or alternative lender with: financial histories, tax returns, employee records, cash flow analyses, inventory and equipment valuations, and much more. This wealth of data makes business acquisitions a good candidate for loans because lenders aren’t working with a risky blank slate.
If you’re looking for a small business loan, here are a few potential financing options that might help in buying a business:
With a traditional term loan (or a short-term loan if the purchase price is relatively low), you’ll borrow a set amount upfront, then pay it back—plus interest—over a predetermined amount of time.
This is a pretty ideal format for buying an existing business: you’ll get the cash you need to make your purchase, then pay the lender back over time as the business generates revenue.
Although rates and terms vary depending on your financials—like your personal credit score—as well as on the lender, you can usually expect a term of 1 to 5 years and interest rates between 7%-30%, for amounts ranging from $25,000 to $500,000.
An SBA loan—one of the largest, lowest-cost, most affordable financing products out there—isn’t actually funded directly by the US Small Business Administration. Instead, the SBA guarantees a big portion of the loans you can take out from a bank or alternative lender.
With up to $5 million in financing, terms of a decade or more, and interest rates in the single digits, SBA loans are the dream for most entrepreneurs. For buying an existing business, the 7(a) loan program is the way to go. It works pretty similarly to the above term loans, with a set repayment schedule and a lump sum of cash upfront.
For asset-based loans, you’ll borrow capital against a certain asset, which acts as collateral in case you default on your payments.
When buying an existing business, you’re taking on all of its assets—which means you have a lot of potential collateral to help finance your purchase. These loans will be much smaller than the cost of a business purchase, of course, since you’re only financing a part of the buyout (based on the value of the collateral), but they can still be very helpful.
You can use three different kinds of assets as collateral for financing:
Choose one—or all three!—to help you finance the right amount for your business acquisition.
How Debt Financing Is Different When Buying an Existing Business
As we mentioned before, getting a business acquisition loan is typically easier because the lender has a history to assess.
But just like with any business loan, lenders will scrutinize all of the following:
For term loans and SBA loans for when you buy a business, banks typically require buyers to put down a 20%-25% down payment on acquisition loans. However, the SBA recently made some changes that make it easier for buyers to obtain SBA 7(a) loans for buying a business. Now, the SBA requires the buyer to put down just 10%, and only half of that (5%) has to come from the buyer’s own cash. The rest can come in the form of a seller’s note as long as the seller agrees to be on full standby—meaning that the seller won’t be paid back on their note until after the bank is paid.
When getting a loan for buying an existing business, you’ll also have to provide a formal business valuation (like we discussed before), explain your relevant experience, offer an updated business plan, and show financial projections for the business under your command.
In short, you’ll want to tell a story of how you will improve the business.
When you’ve finally found the right business, done your due diligence, agreed on a fair price, and gathered the capital you need, make sure you (or a broker) have all 10 of these documents, notes, and agreements in place:
This document will prove the actual sale of the business, officially transferring ownership of the business’s assets from the seller to you.
This is the final count of the cost of your purchase, including all prorated expenses—like rent, utilities, and inventory.
If you’re taking over the business’s lease, make sure your future landlord is in the know. On the other hand, if you’re negotiating a new lease, double-check that everyone understands its terms.
Does the business come with any vehicles? If so, you might have to transfer ownership with the local DMV—make sure to get the right forms complete by the time of sale.
Similarly, all patents, trademarks, and copyrights might require certain forms to get transferred to you, the new owner.
Check the SBA’s Consumer Guide to Buying a Franchise to see if you’ll need to file any franchise documents.
It’s standard practice—and generally a good idea—to ask for a non-compete from the former owner. This way, the previous owner won’t set up a competing shop right across the street!
This document is in case the seller is staying on as an employee. Make sure to file this agreement if so.
The IRS Form 8594 will list the assets you’ve acquired, and for how much. This document is pretty important for your tax returns, so don’t forget it.
Bulk sale laws have to do with the sale of business inventory and are designed to prevent business owners from evading creditors by transferring ownership of the business to someone else. To comply, prospective buyers usually have to notify the local tax or financial authority about the pending sale.
You should now have all the information you need to buy a business safely, smartly, and successfully.
Some pointers to remember:
Although there’s a lot involved in buying an existing business, you’ll be rewarded when you’re finally at the helm. You will be able to revitalize what might have been a stale company with fresh ideas and fresh leadership. Good luck!