Starting a Business

Tips for buying a business

Determine what kind of business you'd like to buy, consider how you will pay for it, and investigate the seller before entering a business sale.

Published: February 17, 2015
Updated: February 22, 2017

Buying a business often has real advantages over starting a new one. An existing business should already have infrastructure, employees, and most importantly, customers. It's also possible to generate cash flow and profits from day one, provided you make a smart purchase.

Of course, when you buy a business, you also may inherit problems. Here are some tips to consider when buying a business.

Narrow the type of business you want to buy

You are more likely to be successful in a business or industry in which you have experience. Consider your interests, too. What do you want to spend your days doing? Think this through because once you buy a business, you may not be able to change it easily.  

Determine how much you can afford when buying a business

Start by setting aside living expenses for six months. Then, investigate your options for paying for a business. Add up your available liquid assets. Do you have enough to cover the purchase price, or will you need a loan?

Even if you borrow, you will have to put some of your own money down. Speak with your bank about its application process and requirements for commercial loans.

Sometimes, sellers will finance all or part of the price. Seller financing helps ensure the seller will assist with the hand-over, but it may increase the price.

Find a specific business to buy

Today, it's easier to find businesses for sale because of the emergence of business-for-sale online marketplaces. Search for businesses by purchase price, revenues, location, industry, and other criteria. 

Business brokers are another option to find businesses for sale. But brokers typically work for sellers rather than buyers, and usually show only their listings.

Ask around your community about local businesses for sale. Sometimes, retiring business owners are looking to sell.

Determine the value of the business for sale

When you find an interesting business, determine its value. Valuations are based on the expectation of future profits and usually calculated from a business’s earnings before interest, taxes, depreciation and amortization (EBITDA).

Understanding the cash-free/debt-free value of the operating company can only be done if any real estate is valued separately (at a fair market value). Further, any cash in the company should increase the value of the business dollar for dollar, while any interest-bearing debt that you might take on should decrease the value of the business. All the balance sheet items necessary to generate the income statement should be considered included in the sale. In other words, you should be handed over all inventory, receivables, equipment, and all other business assets. You should also expect to assume all non-interest bearing liabilities of the company including trade payables and reasonable accrued expenses (if they exist).

These are all areas that an attorney with experience in mergers and acquisitions or a professional valuation service can help you review and understand. SCORE also offers a tool to help you determine a business's fair market value.

Investigate the seller and the business

When buying a business, independently investigate the seller and the business to determine exactly what you are getting.

As part of your due diligence, look into these aspects of a business sale:

  • Reason for selling: Does it raise red flags?

  • Property included: What real estate, equipment, inventory, intellectual property, bank account balances, customer contacts, and accounts receivable are included?

  • Liabilities: Are there lawsuits, claims, debts, accounts payable, or unpaid taxes?

  • Material contracts: What leases, mortgages, and supplier contracts exist?

  • Customers: Are customers under contract? How many are likely to stay?

  • Market position: Have sales increased or decreased in recent years? How does competition impact the business?

  • Audited financials: What did your CPA find when reviewing the seller's last three years of financials?

  • Employees: Are they aware of the sale? How many will stay? Will any need to be let go? Who will do that — the seller or buyer?

  • Suppliers: Will they continue? Do you want them to?

  • Seller involvement: Is there an advantage to having the seller assist during a transition, or will the seller leave immediately on closing?

  • Contingencies: How much of the purchase price should be held back to cover contingencies or future events that could occur? 

Consult your attorney, preferably an attorney specializing in mergers and acquisitions, as well as a CPA (certified public accountant) before you sign anything, including a letter of intent — even one you think is "non-binding" might have financial consequences. A lot of money is at stake when you purchase a business, and it pays to protect yourself.