How to Buy a Small Business
Whether you’re ready to take charge of your future by becoming a business owner or an established entrepreneur looking to expand through acquisition, you may be considering the purchase of an existing company. Buying a business is one of the most complex, yet potentially rewarding challenges you can undertake. In many ways, buying an existing operation is easier than a startup, but there is also the risk of inheriting unwelcome “baggage” with your purchase. To help you prepare, let’s take a look into the intricacies of how to buy a small business.
You Need Professional Help
Recently we discussed the advantages of using a broker when selling a business. It stands to reason that a broker is equally helpful—if not more so, in fact—when buying a business. A business broker understands how to value companies from a variety of sectors, which can be particularly useful if you are entering or expanding into a new industry. While we expect that you’ll have at least some degree of familiarity with the type of business you’re pursuing, valuation is not always the sort of skill you’ll learn even with many years of experience.
Business valuation techniques vary significantly across industries. Fixed assets are crucial in capital-intensive businesses like manufacturing, for example, whereas in a segment like restaurants, assets are mostly irrelevant because their residual value is minimal. Not only does a broker understand correction valuation metrics, but he or she also knows where valuations currently stand in the marketplace. Returning to restaurants as an example, price as a multiple of EBITDA varies from market to market and from brand to brand in the case of franchised units.
Ditch the Baggage
As mentioned in the introduction, buying an existing business is in many ways easier than a startup. Cash flow is immediate, there is an established customer base, and market demand, trends, and the competitive environment are all known quantities. However, an existing business can also bring with it baggage—heavy, unwelcome baggage.
As a business broker will tell you, when buying a small business you want only the operations, not the current owner’s legal entity or entities. Fortunately, most of the baggage that can accompany a business is tied to the company, not the “business” itself. Federal tax liabilities, for example, follow the legal entity, so if the prior owner wasn’t making payroll tax payments, the IRS will chase him or her, not you.
However, some states impose what is called successor tax liability, meaning that you as the buyer can be held responsible for certain tax liabilities of the prior owner—predominantly sales taxes, though other types may be included. Often, successor tax liability can be avoided by obtaining a tax clearance letter from the state department of revenue, but the exact regulations, timeframes, and other requirements vary from jurisdiction to jurisdiction—another good reason for having professional assistance.
Avoiding Unwelcome Surprises
The due diligence phase of a transaction is the time to uncover any nasty surprises that may await. We have already looked at some of them in the form of “baggage.” However, not every surprise is as easy to reveal as verifying the past three years of sales tax payments or securing a tax clearance letter.
Here’s a real-life example: The buyer of a small self-serve frozen yogurt franchise system discovered shortly after closing the deal that some of the franchisees had left the system, rebranding their stores and changing their product to avoid trademark infringement claims. Since most of the system’s cash flow was derived from franchisee royalty payments, this was a significant blow to the value of the purchase. While better due diligence probably would have uncovered the issue, the assistance of a broker would almost certainly have avoided this unfortunate outcome.
Work with BroadCreek
Our professional business brokers have the knowledge, resources, and experience to guide you through the business purchase process, ensuring that you pay a fair price and actually receive what you are expecting. BroadCreek has access to a network of sellers ready to sell their businesses and the knowledge to steer you safely through the entire process. We’ll be at your side from evaluating opportunities to conducting a comprehensive and thorough due diligence.
If you are ready to buy a small business or interested in exploring your options, contact us today for assistance.