There are 28.8 million small businesses in the United States, employing more than 58 million people, according to the Small Business Administration. These small businesses (with less than 500 employees) represent over 99% of the businesses in the United States!
Entrepreneurs think that they need to develop their own plan and build it from the ground up. However, you can purchase an existing business which has advantages you may not have considered, such as an existing stream of revenue and customer base out of the gate. Here are some key considerations to think about before taking that next step:
1. Determine the type of business you are interested in.
This means not only the type of business or product you want to sell, but also includes thinking about the potential for a new franchise opportunity or buying an existing business. Think about your areas of interest and/or passion and look at businesses that fit in with what you love to do.
a. Franchises offer the potential to leverage an existing and known brand name and track record. You also will receive organizational support to help get the business up and running and to help ensure your long-term success. Franchises may have higher start-up costs, as well as ongoing royalty fees paid to the franchisor. In return, there are developed processes and standards to follow which will help you grow more quickly than starting from scratch, in other words, less risk!
b. Purchasing an existing independent or franchised business will be valued based on current revenue and profitability, as well as the business’ current assets and reputation in the marketplace. You will also have access to past financial performance to review prior to making an offer.
In either case, an experienced business broker will have the knowledge to help you make a decision that is right for you – based on your skill set, interests, and financial capacity.
2. Be sure to complete your due diligence
If you are looking to purchase an existing business, it helps to understand why the seller is moving on. Review the value and market opportunities of the business. Look at the last few years of financial statements and use them to project potential revenues and costs. Ask about the business’ customer base, employee situation, and any significant contracts in place that impact revenues. An ethical business broker will provide you with unbiased information to help you make an informed decision. You will also want to understand what is or is not included in the purchase price – real estate, intellectual property (including the business name!), equipment, and how much training the seller will provide for the transition.
3. Enlist the assistance of key professionals
A good business broker will be able to walk you through the purchase process, as that is what they do day in and day out. It is also helpful to work with an accountant and/or attorney with experience in small business transactions (which are very different from larger M&A deals), as they can help you through the due diligence process, and help you be fully prepared when it is time to close. Be sure that you and/or your team review the appropriate documents prior to execution, so that the terms of the purchase agreement are clear. Your future success is dependent on many factors and getting the legal and financial aspects in order is a big one.
4. Determine how you plan to finance the business purchase
There are various ways to structure the purchase transaction, but most require at least a portion of the purchase price to be paid with cash at the time of closing. Both sellers and financial institutions want you to have “skin in the game,” in the form of cash. Most business owners and business brokers will also require a good faith deposit prior to providing detailed information, so be prepared to have some cash available prior to making an offer. Work with your financial adviser to identify accounts or investments you could draw down to make the purchase.
In addition to cash, there are several ways that you can finance the remainder of the transaction. These include traditional bank loans or lines of credit, using a home equity line of credit, a bank SBA loan, and/or the seller financing a portion of the purchase price. Most transactions have a combination of cash, bank lending and seller financing. Another option is to use a portion of your 401(k) as a Rollover as Business Startup (ROBS) account. These are accounts that invest in your business acquisition and should count towards your cash down payment requirements.
5. Have a clear understanding of your current financial position prior to making an offer
If you are leaving a career with a steady stream of income, owning a small business will result less predictable income. Be sure to determine how to handle your living expenses with your partner or spouse, while keeping in mind important financial goals such as a child’s college fund or saving for retirement. There are also tax implications to consider with this move. Finally, if you are quitting your job, or your partner doesn’t have benefits, explore your options for health, life and disability insurance to make sure that you and your family maintain adequate coverage.
There are so many factors that come into play when you are looking to purchase a business or a franchise, so have a plan in place to move forward. And consult with your trusted professionals – including financial, legal and tax experts. A key partner in the process is an experienced business broker, who will be there to help you every step of the way!