You’ve found a business model that you’re so intrigued by; you can’t help but want to be a bigger part of it. You consult your resources and find you have the financial clout to get involved, so you decide you want to make an offer to assume ownership of the business and start running things yourself. But before you move forward, how do you decide if buying a small business is a worthwhile investment?
We’re here to help anybody considering making the big financial step of buying out another business. Keep these tips in mind when you’re preparing to get involved in running a new business so that you can be confident you’re making a sound investment that will provide you with a rewarding journey for years to come.
How Do You Determine If Buying a Small Business Is Worth It?
Consider Why the Business Is Being Sold
Evaluating why the current business owner is interested in selling to you will give you some insight into the value of the business you’re appraising. Sometimes, the reasons are simply age or lifestyle related, such as the current business owner looking to retire. They may also be interested in a career change and don’t have the time to worry about administering their business as they pursue their new goals.
However, there are warning flags to look out for at these early stages of the deal. If the seller is putting undue pressure on you to finalize a deal and buy the business, there might be something they’re hiding that makes them desperate to get out of the business. If the current owner is unclear at all about why they’re looking to sell, it may be a sign to take a step back and look for a better deal.
Understand the Business’ Market
It’s important you understand what drive’s a business’ profitability before you take the helm yourself, and the first step in that is understanding the business’ customer base. Find out the demographics of their current customer base. Determine if there are any important large clients that make up for a good portion of the business’ income and start to assess that client’s specific needs.
Once you understand the current customer base, take some time to research the industry that this business operates in as a whole. How many customers are competitors in the same field reaching? You’ll want to see that there’s room for continued growth in the industry you’re investing in, and start thinking of ways to expand the business and reach more customers. Always look for room for growth and have a clear plan on how to get there when you’re deciding on buying a small business or not.
Research from a Customer’s Perspective
You shouldn’t buy a business that you wouldn’t give your patronage to as a customer. After all, if you don’t want to take advantage of the products or services the business is offering, why would any of the potential customers you’ll be marketing to want to? Understanding the customer experience will help you determine the long-term viability of the business you’re involving yourself in.
Take time to do some research checking out the business’s online presence. If they have a storefront, check out their inventory and the ease of use. Take a look at customer reviews to see how past transactions have occurred, and if there are any obvious points of discontent. If the business offers customer support, consider contacting them to see how well set-up their support structure is. Doing all the due diligence can help you be confident in your investment.
Look at Recent and Long-Term Finances
As with any business matter, the real story of a business is told by its numbers. Ideally, you’ll want the entirety of the last five years of financial history for the business so that you can get a comprehensive view of the financial outlook. Ideally, you’ll want these financial records to be audited by a professional so that any disparities the untrained eye might overlook can be detected and investigated.
Not only will you only want to understand the recent transactions the business has carried out, but you’ll want to understand any debts that the business holds. Depending on the terms of the deal you negotiate with the current owner, these debts will most likely become yours. Make sure you’re ready to take on the debts associated with the business along with the revenue it brings.
Evaluate the Business’ Assets
No matter what you’re purchasing, you’ll want to understand everything you’re getting for your money, and purchasing a business is no different. Take some time to evaluate the property that the business owns and any other assets involved in its operations. In what condition is the equipment that is critical for the day-to-day functions of the business?
Don’t overlook another type of asset that the business you’re acquiring has: its human assets. Determine who the key employees are and what they bring to the team that you’ll be running. Developing a good relationship with these vital members of your future team can help make the transition process from one owner to another as smooth as possible, helping you hit the ground running with your newly acquired business.
Make Sure Legal Bases are Covered
Once you’ve got the financial side of things covered, take time to consider the potential acquisition from a legal perspective as well. Consult a legal expert for assistance in reviewing the contracts and legal agreements a business has so you’ll know exactly what you’re getting when you make the business your own.
Some legal documents you’ll want to review include leases for any property the business uses and agreements they have with existing employees. Find out whether or not these leases are transferable to you so that you know what steps you need to take to ensure a smooth transition once the deal to purchase the business is finalized. Consultation from a trusted legal advisor can help make you aware of the details of any necessary legal processes during the transition.
Prepare for the Transition Period
Once you’re almost ready to agree upon a deal, you’ll also want to make sure you determine with the current owner how the transition between their ownership and yours will be handled. One common practice during a transition in ownership is for the previous owner contracted for a period of time under the new ownership, to help with maintaining relationships with providers and otherwise ensuring the transition is smooth.
There is also a legal factor to consider when determining the details of this transition period. One thing you’ll want to avoid is the old owner using their experience in the industry to open up a new business that will compete with the one you’re buying. Having them sign a noncompetition agreement is a common practice that will prevent this difficult situation from arising, making sure that you and the previous owner remain on good terms.
Understand if You’re Buying Shares or Assets
One final step before you strike a deal is to make sure you know exactly what you’re buying. The current owner will likely want to sell their shares of the business, while it may be more beneficial for you to buy the business’ assets instead. The distinction here can be important when it comes time to file your taxes, so make sure you clearly understand the terms of the deal before you finalize buying the business in question.
Buying a small business is a big step, so make sure that you go into any potential purchase agreement well-informed. If you want more advice, the in-depth discussion and expert commentary on our podcast is a great place to start. Tune in to the David vs Goliath Podcast for more information about how to succeed in the world of small business!