Purchasing an existing small business can be less risky than setting up a new business, but only when you take these precautions.
Here are a few key aspects that you need to be on the lookout for when buying someone else’s small business.
Positive cash flow
There’s a high chance you’ll experience positive cash flow from the outset after buying an existing business, but only if it has the necessary infrastructure in place and an established customer base.
‘Infrastructure’ can include everything from a shop front to an established website, social media branding and all legal and licensing requirements already in place. Provided the customers remain loyal and your business plan has allowed for it, the cash flow should cover any borrowing costs that were incurred in buying the business too.
Once you go through all your checks and balances and decide on a price for the business to be bought, you will note that part of the price will include equipment and part will constitute goodwill. This amount is basically covering the price of the business’s good reputation and customer base.
The whole point of buying an existing business is to avoid the need to source and set up equipment and attract a loyal customer base. But don’t just rely on the business numbers; do some footwork in the local area and conduct online searches to ensure the business comes with a good reputation and the location or target area doesn’t have a glut of competitors. If it does, the business may be overvalued.
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Taking on an existing business with staff that have been there for at least a few months and know the ropes can be a great advantage. This team needs to know you’re the new boss and to respect your thoughts and opinions and management style. At the same time, be careful not to drive them away. Take time to get to know them, their knowledge of the business and what customers they deal with. Customers may well be loyal to a particular employee as in the case of personal services such as hairdressers.
Ideally, you need to spend time with a trusted accountant to analyse the financial statements for at least the past three years. Check that financial ratios all make sense and that the numbers align with what your gut is telling you about the business. Ask for an accountant’s report to show that the business has lodged its BAS forms and tax returns on time; if not it can be a sign of a struggling business. Remember, it will always be in the seller’s best interests to make the numbers look as good as possible to get the best price for their business. The business’s net position needs to cover your personal wages as well as enough cash flow to pay off any borrowings you’ve made to buy the business.
Issues you need to look out for that may not be readily apparent include outstanding debtors and the average payment times for major customers. Poor relationships with key suppliers will affect your ability to access favourable discounts and payment terms as well as access to special offers. If possible, spend time with the current staff to gain insight into what it’s like to work for the business and the quality of the team you’ll be employing. Any vendor unwilling to let you talk to current staff may well be hiding something from you. If that’s the case, try spending time in and around the business or have friends investigate the business anonymously.
Buying an existing business can be an exciting time in your life; just be sure the business ticks all the boxes and “fits” into your ideal lifestyle. Remember, the business is there for you to run and grow, don’t let the business run you.
What are your tips for buying an existing business?