20 Mar Why & How To Buy Your Own Business
by Glen Cooper
Business Broker / Business Coach
Buying a business is the right thing to do . . . for some people.
This article is about what you might want, what you should expect to get, and how you should go about getting it, if you decide this unique “buying-a-business” path is for you.
Those of you who are individual buyer prospects are usually looking for a business that will employ you as owner/operator. Because you are investing your hard-earned money, you want to know that it’s worth it.
You want to “run your own show,” a unique personal growth experience. In Colorado, especially, we buy businesses that improve our lifestyles. In some cases, it’s more than lifestyle—it’s a personal mission! We intend to leave our mark. We want to have more life!
Can you reasonably achieve these objectives with a business purchase?
Yes, you can!
But, things can also go terribly wrong if you are not informed and don’t ask questions.
For most, it’s a once-in-a-lifetime experience. That means you need to study the process! If you think you already know all this, think again!
Every business is different and circumstances are changing rapidly. Businesses also sell differently, depending upon the type and size of business.
Let’s start by exploring what most buyers want.
What You Want
Job: Owning and running a business is usually a full-time job.
It offers unparalleled freedom of action. You may work very hard, but you will enjoy freedom that no salaried position can give. That’s worth a lot.
There is really nothing like being able to start each day by planning your own actions, then seeing what you can do.
Measuring your own performance against your own plan is a way to improve what you can do while, at the same time, lowering your stress. That’s the ideal job.
Investment: Owning a business offers a great return on investment. A purchased business may return in excess of a 15% pre-tax annual return on your cash invested in down payment and working capital.
There are also legitimate expenses which, when paid for by your business, will lower your cost of living. This is often left uncalculated by buyer prospects as well as business owners.
Personal Growth: Owning and running a business makes you smarter! And, who among us doesn’t want to be smarter? Working on, and in, your own business will challenge you in every way you can imagine.
Most of us don’t grow until we have to. Necessity is the mother of invention. Owning and running your own small business requires you to learn “Street Smarts 101.” It puts you on a personal growth regimen.
Lifestyle: In Colorado, owning a small business is “the way life should be.” It really doesn’t matter precisely which service you provide or product you make, distribute or sell.
It’s your chance to use the skills you love. It’s your chance to do the part of the job that you like and hire someone to do the parts you’re not so good at. If your business is located near lake, forest, mountain or open prairie, (as almost all in Colorado are!), it really does allow you to experience a unique “lifestyle.”
Legacy: Making a difference is an everyday experience when you own a business. Your family members, employees, clients and customers are all looking to you to set the pace. Solving business problems always presents an opportunity for deeply touching someone’s spirit.
Who doesn’t remember a teacher in their life that made a difference? Business owners are always teachers. It happens at the workplace, but also in the home. Nothing will instill the “entrepreneurial spirit” in someone else like watching you succeed at running your own show.
What You Get
So, what do you get, specifically, when you buy a business?
Why not just start your own business? Wouldn’t that be more fun? Aren’t you just buying someone else’s problems?
For some, starting their own business is the only way to go. Those start-up years can be exciting. But, it takes more time to get going when you start your own. It’s riskier—the chance to fail is much greater. It also costs more, not just in time, but in lost financial opportunity. I know this from personal experience.
In 1981, a long time ago now when I lived in Maine, I had a chance to buy what was then the Maine’s most successful business brokerage firm – called MAINCO – for just $125,000. Instead, I started my own firm, largely for reasons of ego.
In the first few years after that decision, I made very little, but the firm I DIDN’T buy made a lot. I can say now, that the decision NOT to buy that firm cost me more than $1 million in lost income. My firm, Maine Business Brokers, eventually succeeded, but it took many more dollars and years than it should have.
Buying an existing business gives you a leg up—several, in fact.
Immediate Cash Flow: A going business provides built-in customers and/or clients. No waiting for your first sale. Vendors are frequently willing to extend credit to a proven business more so than to a new one.
A “turn-key” business is what you get. Starting from scratch can chew up mounds of working capital before the first customers and clients even realize you exist. Buying a business provides immediate cash flow.
Known Market Position: “Location, location, location” can be more than just a reference to the right real estate choice. It’s also a position in a business market—an “enterprise to be considered” in potential customers’ purchasing decisions, if you will.
In a purchase, you know where you stand. In a start up, whether or not you will be able to create such a position is a complete unknown.
In selling businesses, there is always major value when a business is “dominant in its market.” Buying a business gives you this known market position.
Working Systems: Don’t underestimate the importance of operating systems that make it all happen. In a successful, established business, these systems are in place.
Remember the last time you did something you never did before?
When it’s your money on the line, you want a business with proven systems, not a first-time-out experience. Buying a business gives you working systems.
Trained Employees: It takes months to train even one employee. Even if the employees aren’t perfect (hint: they NEVER are!), at least existing employees can get from opening to closing each day, probably even without you.
There is an unrealistic fear among buyers that employees will abandon a new owner. In truth, when an existing business is sold, employees often respond with great enthusiasm to a new owner’s arrival.
Employees of a just-sold business are often eager to tell the new owner their ideas. The good ones see it as a second chance for a new start, for them and for the business.
Seller Assistance: After the tensions of the purchase and sale process subside, the seller may very well be a fountain of wisdom, energy and help.
Even if you don’t follow all of their advice (they don’t expect you to, anyway), it is still worth listening to. They know answers to questions you forgot to ask before you bought—ones that it might take you years to learn if you were starting from scratch.
And, did I mention seller financing? Yes, sellers will often even “play bank” for you—becoming a “partner” in your success. There is nearly always a good reason to take advantage of a seller’s assistance.
So, why buy a business?
Buying a business is exciting!
Buying a business offers you a job and an investment all rolled up into one, with an opportunity for personal growth, a unique lifestyle and a chance to establish a rich legacy for yourself and your family.
So, what are the advantages of buying an existing business vs. starting one? They are:
- Immediate cash flow
- Known market position
- Working systems
- Trained employees, and
- Seller assistance
Note that if you start a business from scratch, you get NONE of these!
But, before you start to buy a business, you must get clear about who you are and what you want to do.
Do You Have the Resources?
To buy a business, you need money, skills, energy and time.
Money is an obvious. You at least need borrowing power. How much you need depends, of course, on what you plan to buy.
A quick “rule of thumb” for individuals might be that the cash needed for a down payment is often about 1½ times the annual owner cash flow expected from the business.
Skills required are mostly sales skills, not accounting or even general management skills. If a buyer knows how to sell, everything else is made easier.
Sales skills are toughest to teach. People management skills are more important as the business gets larger, but getting the sales right is THE big deal for most businesses.
Energy is another essential. Buying a business requires as much energy as running a business. It’s not something you do only on the weekends.
If you’re not full of enthusiasm and drive, you just won’t survive the rigors of looking for the right business, dealing with the broker and/or sellers, negotiating the right price and terms, financing your purchase, closing the deal and transitioning to your new role as owner/entrepreneur.
Time, finally, has to be on your side. It has to be the right time in your life.
If you have another major stress event happening in your life, it may not work.
Divorce, getting fired from a job or even just buying a new home—any event that either damages your self esteem and/or otherwise throws you off your usual game plan—can make it the wrong time to buy a business.
You must be flexible enough to survive when things don’t go as planned. And, in a business sale, they never quite do.
Do You Have the
Background & Support?
To successfully buy a business, you need role models and a reservoir of personal knowledge. You also need sources of understanding and support, and the ability to take a calculated risk.
Role models are keys to your life. Have you known a successful business owner in your family? Do you admire a business owner? If not, beware.
If you spend your days dreaming of being someone’s top employee, you may not have the right model for your own future as a business owner.
You have to be dreaming of being a business owner to be one. Motivating day dreams and images are always important predictors of success in anything.
Personal knowledge is a big factor. And, I don’t just mean business knowledge.
How well do you know yourself? How good is your knowledge of others? How well do you know how to advance your ideas? How well do you listen?
These types of questions are just as important as knowing about purchasing, pricing, and how to “brand” or position your product or service in a business.
Support on the home front must exist. Does your mother know where you are?!
Your immediate family members have to “get it.” If your family history is filled with models of employment and of corporate career planning, but not with models of entrepreneurship, that could be a problem.
Those who are not themselves inspired by the idea of running a small business will not understand why you are. Those not in small business often just don’t get it. They may think that you should just climb the corporate ladder and behave yourself in your cubicle!
Risk taking ability – creativity, but with a calculator – is needed. Can you take the investment risk of buying a business?
I’m not talking about gambling in Las Vegas. That’s entertainment, not investment. But, I am talking about taking some risk.
Successful business people, despite the caricatures, are not business gamblers. They’re strategists, carefully weighing odds and only taking those large risks when the odds are in their favor, at least by their own calculation.
You have to have the self-confidence and decisiveness to move forward.
Can You Run With Your Strengths?
Business buyers who learn to run with their strengths are successful.
Your experiences, talents, preferences and passions should all merge in your successful business purchase effort. When you own the business, this will also be a key to success.
Go with what you know. If you have spent years in a specialty field, buy a business that uses that knowledge. If you are skilled at some unique aspect of business, buy one that needs that skill.
Don’t throw past experiences away. Leverage them.
Know your talents. Pay attention to what others admire about you. If you’re good at something, make sure the business you buy puts you in a position to demonstrate that talent.
If you have excelled at some task in the past, make that part of the job you assign yourself in the business you buy.
Know your preferences. If you are an introvert, you’ll need to learn to sell like an introvert, and not follow the usual extrovert model.
If you’re a slow decision-maker, make sure you have a way to make quick decisions when that’s important.
Don’t know what I’m writing about? If you’re not familiar with these preference “types,” there’s a good psychological test (the Myers-Briggs Type Indicator – MBTI) that gives you a language to understand your preferences.
You need to know about it.
The classic book on the subject is David Kiersey’s Please Understand Me, now in its revised Please Understand Me II edition. Buy it. Take the test.
Get passionate about this. Do what you care about.
If you can’t find a business in a field that you care about, buy a business that offers you a challenge you care about.
All businesses are unique and serve unique markets. But, surprisingly, even an everyday business can offer the interesting challenge you desire.
After taking personal inventory of your resources, background, support and your ability to run with your strengths, you are now ready to start contacting sellers and brokers.
5 Questions to Ask Brokers & Sellers
What’s for Sale? As you begin to look for a business for sale and respond to an ad or offering from a broker or seller, the first question you need to ask—on the first contact—is “What’s for sale?”
How this question gets answered tells you how organized the broker or seller is, and whether or not they actually understand what they’re selling.
Every business has tangible and intangible assets to sell. The tangible assets are the “things” that make up the business: furniture, fixtures, equipment, vehicles, inventory and real estate.
The intangible assets are the “goodwill” or “going concern value,” the seller’s agreement not to compete in the future, and/or to consult with the buyer in the business transfer process.
Searching for a business is always about finding the one that works for you. It all starts with getting a clear view of just what you’re being asked to buy.
What’s the Opportunity? Buying a business should create a new opportunity for the buyer. So, that’s your next question: “What’s the opportunity for me if I buy this business?”
Again, the answer tells you something very valuable. Does the seller really understand where the business can go from here?
Many sellers put their business on the market because they are “burned out.” This “burn out” often creates the very opportunity a buyer wants. Sellers are sometimes so tired that they don’t see market opportunities that are right in front of them!
A competent business broker will often be able to make up for the seller’s lack of vision, but not always. If a broker or seller, however, can make a good case for the “upside” opportunity, you are in good shape—ready to go on to the next question.
How was the Price Determined? This is often where the person responding will fail the “sanity check.” It is also the beginning of your negotiation.
The answer that you don’t want to hear is: We added up the losses for the last ten years and that’s how much we want for the business! While this is obviously intended to be a humorous representation of what actually happens, it often seems that this is, indeed, a valuation method commonly used.
The preferred answer always has some relevance to market information—what buyers pay for such businesses, based upon what is actually a fair return on a buyer’s investment.
I have covered this issue in my writings on business valuation. If you don’t have access to these, contact me and I will provide them. Right now, the important point is to find out if the person you’re dealing with has any grasp—at all—of this subject. If they do, you’re in luck! On to the next question!
What Financing is Available? A business owner can’t sell it —and you can’t buy it—if there isn’t a good source of money to do the deal.
Prepared brokers and/or sellers have considered this issue carefully. They should be able to explain how much cash down payment you will need, and perhaps how much working capital they also expect you to provide.
Then, they should know how much seller financing is possible, and how much they expect to be available from a bank or other source. If not, watch out!
Financing a business acquisition is difficult if it requires the use of a third- party lender. Banks and others are not excited about business loans to novices who have never run a business before, even if they have a great credit score. Yes, they make loans to businesses—just not too many acquisition loans to inexperienced business buyers!
The road ahead is much smoother when the seller offers reasonable financing from the beginning. Seller financing is common, seen by buyers and lenders as a seller’s “bond for performance” that the business is healthy.
Why is the Seller Selling? Finally, you need to ask about the seller’s motive for selling. It should be something you can understand.
If you don’t understand, keep asking this question until you get an answer that you do understand.
Seller’s who are “burned out” are often reluctant to disclose this. First, it is often just personally embarrassing. Second, the sellers might assume—perhaps with good reason—that what they say will frighten you away!
Sellers who can’t see a future opportunity are also reluctant to share their lack of vision. Some other reasons to sell—like divorce or health issues—are also very difficult for sellers to talk about.
If you have gotten this far—to the fifth question—because the answers to the other questions were all acceptable to you, then maybe it’s time to begin the bonding process with the seller. Only then, after you begin a relationship which involves mutual trust, will you get the “real reason” the seller is selling.
When you and the seller finally trust each other enough to tell the truth, then a good deal is possible. You’ll begin to see the real opportunity a successful transaction offers each of you. You will get the business you want and it will likely be a good deal for both of you.
So, you ask, what’s a good deal? What, after all, is the business worth?
Rules of Thumb Are Dumb!
Business valuation experts agree: rules of thumb are dumb.
But we use them anyway!
The most common rule of thumb for what a small business is worth is three times owner cash flow. It comes up all the time because it is often a good general measure of what might make sense. It is sometimes used just to explain why more than three times owner cash flow is too much. Owner cash flow, by the way, is just one of many ways to measure the profitability of a small business. Another name for “owner cash flow” that you may hear is “seller’s discretionary earnings.”
But is that this year’s owner cash flow, last year’s owner cash flow, next year’s projected owner cash flow, or what?!
How do you define owner cash flow?
For that matter, how do you define a small business?
Does a value calculated using this rule of thumb apply to all types and sizes of businesses?
Does it include furniture, fixtures and equipment?
Does it include inventory? Does it include real estate?
Besides that, how does any rule of thumb take into account all of the other things that matter besides profit?
Is there any way to measure the attractiveness of a business?
What about location of the business?
What about the stability?
What about the systems and the skilled employees?
What about seller financing?
How do these things impact a rule of thumb?
A rule of thumb, however handy it may seem, is an obvious simplification of a much more complicated reality.
Only Future Benefits Create Value
The truth, of course, is that only future benefits create value. Business value is a function of future benefits a business offers its owner. Future benefits are measured in many ways.
There are cash flow benefits, to be sure. But there are benefits that relate to an owner’s ability to realize his/her dream. The personal growth and lifestyle and legacy benefits are almost always just as important as cash flow. Companies that acquire other companies often experience synergistic benefits.
Who says so? Well, buyers, of course.
There are, at any one time, at least 1,000 active business buyer prospects (individuals, companies and groups) roaming around Colorado with a variety of wishes and needs.
They have their financial limits, of course, but they are almost always looking for a unique business that matches the dream they have in their mind’s eye, or gives them that synergistic fit with the company they already own.
A business buyer might pay three times annual cash flow for a business if his/her goal was purely a 33% pre-tax annual return on investment.
But if another buyer wants it for non-financial reasons of growth, lifestyle, legacy and/or synergy, and can live with only a 20% pre-tax annual return, they might pay five times annual cash flow to get it.
The day-to-day reality of business buying and selling is negotiating all these terms and taking into account the many and varied motives of buyers and sellers.
Because individuals, companies and groups measure and define all of these terms a little differently, the range of what people will pay for a small business is usually pretty broad.
Someone may tell you that these recessionary times have reduced business values. Yes, on an absolute basis, that’s true. But, multiples of earnings, when there are earnings, haven’t changed.
When one can still buy a business and get an annual return on investment which substantially exceeds returns elsewhere, good businesses with predictable profits are still selling at multiples that have been relatively stable for many years.
Nobody Really Knows What It’s Worth
It might shock you to know that no one really knows what a business is worth.
Even those of us who are veteran business appraisers don’t really know. Ultimately, only the person who is making the buying decision can determine value. And the value that they determine is only good in that one moment and may be unique to them.
To really figure out what a business is worth takes in-depth knowledge of that specific business. You can’t “drive by” and figure it out. You can’t just read an Internet ad and know. You can’t judge a business’ worth from its website.
Even if you know some of the data—like annual gross sales and annual cash flow to the owner—you still can’t figure it out.
You must know more than just facts.
You must know the subtle nuances of why the business is what it is. You will even need to make your best judgment about where it is going! Where, indeed, can it go under new ownership?
To understand a business takes in-depth study of its markets. You must know the customers and clients the business serves, and their reasons for buying from this particular business. You must know who the competitors are, and what they offer. You must know how the whole industry works.
To fully understand how a business works, there is a need for long talks with an owner who trusts you. Yes, if the seller of a business does not trust a buyer, the information given to that buyer will never be good enough.
Buyers, don’t bother to buy from people who don’t like you or trust you. Sellers, don’t bother to sell to buyers you don’t like or trust.
I know from more than 30 years as a broker selling hundreds of businesses – and NOT selling hundreds of businesses – that if buyers and sellers don’t like each other and trust each other, it’s really NOT possible to reach an agreement.
If the chemistry is not right between a buyer and a seller, it takes an earthquake to get a good negotiation going!
Finally, AFTER you have figured out how the business works, how the markets work, how the industry works and determined whether or not you can get along with the owner, then—and only then—is it time to get busy with the numbers crunching!
Strategy: You Control the Process!
If you need to value a business—yours or someone else’s—there is a process.
It starts with YOU taking control. You need to read at least a few “how to” articles about small business valuation.
You need to research the business. You need to study the industry and its markets.
If you’re buying a business, this all starts with a long talk with the business owner and seller. Remember though, that if you don’t like the seller—or the seller obviously doesn’t like you—then move on to seek another opportunity. Life is too short—and the odds are too long—to waste your time trying to do the very intimate work of buying or selling with someone on the other side of the table who you don’t like.
Two sources of easy-to-find pricing data arethe annual Business Reference Guide and the various databases available from Business Valuation Reseources:
2018 Business Reference Guide
This annual guide, now in its 28th year, is the essential guide to pricing businesses with updated “rules of thumb” for over 700 types of businesses. It is published by Business Brokerage Press and is the guidebook we brokers use.
Pricing data contains rules of thumb, tips from industry experts, benchmark comparison data, financing facts and industry resources.
Order from www.BBPInc.com.
BVR’s Small Business Sales Databases
Business Valuation Resources offers an online site that has data you can buy from several different databases. The major databases for smaller businesses available on this site are Pratt’s Stats and BizComps. Take your pick.
These are from market data studies based upon thousands of small business sales transactions in the U.S., updated continually.
Order on www.BVMarketData.com.
Make A Contingent Offer
A “contingent” offer is one that is subject to the completion of some step that has not yet been taken. It allows the buyer making the offer to get out of the transaction if something goes wrong.
Before you complete your investigation of a business, you may be asked to make an offer. This is normal. Sellers can’t be expected to give you absolutely everything until you prove that you are serious. Making a contingent offer is an acceptable way to do that.
A startling fact is that only 2% – yes it’s only 2% – of business buyer prospects ever actually buy a business! Sellers want to limit disclosures to someone who will definitely buy their business. They are looking for proof in the form of a serious contingent offer.
Most offers made to business sellers are contingent upon the buyer’s completion of homework. Buyers need to verify that representations made are accurate. Buyers need to investigate. This process is called “due diligence.”
Buyers also need to make offers contingent on getting financing. Sometimes that just means working on a detailed proposal for seller financing. Other times that means making applications to lenders.
Offers can be made in three basic ways: a “purchase and sale” agreement, a “letter of intent” or just a verbal offer. To avoid wasted effort on a proposal that might not be accepted, I usually recommend starting with a verbal offer. Then, if it appears that your verbal offer is acceptable, draft a “letter of intent.” It is simpler than a full purchase and sale agreement. You can find samples on the Internet of both letters of intent and purchase and sale agreements.
A verbal offer is obviously just that: the price and terms with whatever other understandings need to be made clear up-front. Verbal offers are rarely enforceable at any level. But, getting the numbers and terms approximately right can sometimes move a transaction forward quickly.
A letter of intent just spells out the basics: identities of the parties to the agreement, price and terms offered, details of what assets of the business will be acquired, contingencies needed and a timetable for dealing with them, proposals required for training or non-competition, and a deadline for response to the offer.
A letter of intent can often be in a format as simple as a bullet-point term sheet delivered by email. It doesn’t always have to be a formalized document. Some sellers and buyers are quite comfortable dealing with this informally.
Prepare to Negotiate
Offers are usually met with counter offers. There are some things that shouldn’t surprise us. This is one of those things. Don’t fight this process. It is normal.
Just like you, the seller is fearful of making a bad decision! You have that in common. This can be a tense time.
If there is a broker involved, use the broker. Get the advice of the broker. Consider taking any good advice given. Brokers of businesses usually represent the seller, but they also don’t get paid unless there is a meeting of the minds. They want both of you to succeed in putting an agreement together.
Make offers that are reasonable. Make offers you can afford. If you think the seller has overpriced the business, make your case rationally with evidence, not emotion. Decisions in business are made emotionally, but only after they are rationalized with evidence. If you don’t understand what the business is worth, and/or aren’t prepared to present the evidence for the reasonableness of your offer, you are not ready to make an offer.
Sellers often respond to well-reasoned proposals. Sellers normally can be expected to compromise a little. But if you want them to compromise more than a little, be prepared to make your case. Then open your mind to their case. That’s what an effective negotiation involves: listening carefully and reasoning out each little point.
This is good practice. When you own a business, you’ll be doing it every day – with vendors, employees, clients, customers, and – yes – even with your own family members.
Fast Track the Process
After your offer has been accepted, you now enter the real period of verification, investigation and financing, the “due diligence” and lender application phase.
The accuracy of everything you’ve been told about the business needs to be verified. Everything else that’s important to your success needs to be investigated. You really need to take a close look at where the money is coming from and where it will be going.
You may need help here. This is usually the time to get legal and financial advice from professionals.
Form your team now, unless you are very experienced at this already. Lawyers, accountants and even bankers have lists of what you need to do at this time. You can also find checklists on the Internet.
There are usually two processes that have to be completed simultaneously at this point – the business due diligence and the lending applications. You will take too much time if you do them sequentially, one after the other.
Even though it costs money, you won’t be timely unless you proceed down both paths at the same time. Get your facts and financing together in efforts that proceed in tandem.
Arranging the time to go over the business’ accounting records and reviewing them thoroughly takes coordination.
Market research, business plan preparation, lease negotiations, equipment condition inspections, license applications, business entity formation for your new company will take you time.
The lender may also require appraisals, inspections and credit reports that take time to order, receive, verify and correct if needed.
Get to the Closing On Time
As you form your buyer team – lawyer, accountant, banker and maybe another family member or close advisor – make sure they know your wishes and the date you need to finish the transaction. That’s called a “closing.” It needs to happen on time.
Advisors left alone and undirected to manage their own part are likely to slow the process down. Sometimes your advisors slow you down because they don’t know the urgency. Sometimes they slow you down by intent because they don’t want to be held accountable for advising you to take a risk. You should be your own team captain. Set the agenda clearly.
You are the risk-taker, not them. Give them permission NOT to be negative. But, don’t expect them to be cheerleaders.
Attorneys, accountants and bankers make lousy cheerleaders! Their job is to warn you of danger. Your job is to make the business judgment about what business to buy and how to do it.