I know we normally talk about starting a business from scratch, but just suppose you wanted to jump ahead and buy an existing business. What should you look for then? Well, that’s what this article is all about. Let’s look at a few things you really should check out before you part with your hard-earned money:
Establish a value for the business. Is it worth the asking price?
This is an obvious question to ask, but it can be fairly tricky to answer. Why? Because different businesses are evaluated differently. Some businesses are evaluated based on cash flow, while others acquire their value based on gross sales versus net revenue. Is the business growing or has it hit a plateau? You may want to use more than one of these factors, or it may be totally appropriate to use something entirely different. So, now that I’ve made this as clear as mud, how do you know what criteria to use when deciding worth? Quite simply the best ways are:
- Ask an expert in the industry how they would assign a value to a business. After all, they know the industry and should be able to help you gauge the value.
- Where possible, check to see what similar businesses have sold for. This is a lot tougher when dealing with home-based businesses because they aren’t as obvious and easy to see. When a storefront on Main Street sells, everyone knows about it, but most home-based businesses are operated without any outward indication that they are there. If you drove down my street, you would never know that a publishing and marketing firm was operated from an office on the second floor of the house. That means you have to do a little more digging. Look at recent incorporation changes or “d/b/a” changes with your local Secretary of State. Check the business for sale ads in the paper and follow-up with the sellers. You’re going to have to get creative and really do your homework if you don’t want to get burned.
Check the current owner’s tax returns for the past 3-years.
I know this is hard to believe, but people won’t always tell you the truth when you ask them how much money their business makes. It’s shocking, I know, but it’s true. That’s why you want to check their business returns. Even in this case, you may find owners who try to “pad” the amount by saying something like, “Our tax returns show $100,000 in revenue, but we actually made $250,000.” In this case, you should stick with what is written on the tax forms. If the current owner refuses to show you the returns, or at least some audited financials, that should raise a HUGE red flag. For me, that would be a total deal breaker.
Observe the business traffic and/or sales for yourself.
Don’t totally rely on estimates from the owners alone. Try to do some research for yourself. For example, if you’re buying a website, create a 1 pixel transparent tracking graphic and ask the owner to embed it in the website. Since this “tracking graphic” is served from your web host, you will be able to see how many times it’s called. If the site owner tells you that he gets 10,000 visitors per day, but your “tracking image” is only called five times, you know there is a problem. Something doesn’t add up and you’ll need to get this reconciled before you proceed.
Ask lots of questions.
Very few business owners will voluntarily reveal problems in their business. After all, they are trying to sell it to you – warts and all. It’s up to you to pull that information out if you don’t want to face any horrific surprises later. You need to dig, dig, dig until you hit solid rock. Once you’ve asked all the questions you can of the owner, you may want to give this tips a try:
- Search for the business on Google to see if there are any complaints. Add words like “lawsuit,” “fraud” or “complaints” to the search.
- Check with the local Better Business Bureau to see if they have a record.
- Look for mentions of this business on industry forums. What are other people saying? That’s a really good indicator of the company’s standing in the marketplace.
How will you pay for the business?
In many businesses, you will probably need to arrange financing. This is usually less of a concern in home-based businesses because the start-up and operating costs are usually less. After all, it takes a lot more capital to operate a department store downtown than it does to run a drop shipping mail order business from your kitchen table. Still, this may be a concern and it’s one you need to think about. Will the current owner finance? Sometimes they will and often with better terms than you would get from a commercial lender. It pays to ask. Sometimes, you’ll even find an owner willing to maintain a stake in the business until you have paid it off.
This is by no means an exhaustive list of things you’ll need to consider, but it does give you a good start. When you buy an existing business, you are attaching your name and your reputation to that business. This can be a real plus if the business is highly regarded, but it can ruin your good name, if the business has left a lot of unhappy customers in it’s path. That’s why it really pays to do your homework before you spend the first nickle.
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