Should You Buy an Existing Business?

Maybe you have your eye on a business in town – either because you love it and know how successful it is, and can predict how profitable it will be for you, or because you see a fixer-upper that you can buy cheap and turn into something amazing. Whatever your motivation, there are lots of benefits to buying a business that’s already up and running. Of course there are risks involved too: check out this episode of The New Entrepreneur to see what the real deal is:

Action Steps for Success

If you’ve found a business you’re interested in, do as much research as you can to find answers to the following questions:

Why is the business for sale?

Is the business in trouble in any way? Are there any lawsuits against it? Is there a new competitor opening? You may not get straight answers to these questions from the seller, so you should do as much research as possible.

 

What is the financial history of the business?

If you’re looking for a bank loan to buy the business, the banks as well as your lawyer and accountant should recommend that you get a copy of previous tax returns for the last 3 years, but the more records you can get, the better. Tax numbers are harder to falsify than other records and they set a benchmark that helps predict the future. You also want to know who prepared the records – was it an accountant, or the manager of the business? Knowing a professional prepared the records can help set your mind at ease.

Has the business been well-maintained?

Ask to see the maintenance records for all equipment- have they been up-kept on a regular schedule? Check the place out thoroughly for hygiene and general cleanliness. Don’t assume that because they’ve passed health or WCB inspections, that you will be satisfied with the condition of the business. There could be hidden problems that may be hard to find and solve.
Figure out how much you can afford to spend on the business, and whatever your budget is, leave room to buy new equipment. Even if it doesn’t look like there’s issues, things can be swept under the rug. You might want to redecorate, or give the place a face-lift. Don’t assume the business is OK as is.

Does employee morale seem high?
Although inheriting trained staff is a major advantage of buying an existing business, you never know what problems you might be walking into. When you’re checking out the business to see if you want to buy it, keep a close eye on the staff to see how well they work together and if they seem to be enjoying their jobs.
There may be low morale due to mismanagement, or you might find the staff don’t want to stay if the business is sold because they are reluctant to adapt to a new owner’s policies. Change can be challenging.

What are you buying?
Are you buying assets, or shares? If you’re only buying assets, there may be tax benefits for the buyer, but before you decide that is the best option talk to a professional and make sure you know exactly what you’re getting and what everything is worth. If you’re buying shares, you’re inheriting everything with the business, including credit history, pending lawsuits, accounts and more.
There are lots of different methods for determining the value of a business. It’s best to talk to your accountant about it. It’s not an exact science – there are different assumptions, and using different financial information can result in different values.

Asset purchase advantages for the buyer:
You decide which assets you wish to purchase
You can choose which liabilities you are willing to take on, such as contracts and leases
You can choose which staff you want to keep employed
You avoid having to deal with any lawsuits against the corporation running the business
You aren’t responsible for the corporation’s unpaid taxes or other bills outstanding

Disadvantages:
You might have to pay sales tax on some of the purchases
It’s generally a more complicated legal transaction
There can be some disruption in business operations

Share Purchase advantages for the buyer:
It’s generally a simpler legal transaction
You don’t pay sales tax when purchasing shares
There’s minimal disruption in business operations
You could pay less corporate tax if there was a loss in the previous year

Disadvantages:
You’re subject to all of the known and unknown liabilities and lawsuits of the business
You take on all contracts and obligations of the business

In most cases the seller will want you to purchase the company’s shares because they will save on tax, but as a buyer it could be in your best interest to purchase the business’s assets unless the seller offers you a great deal on a share purchase.

How much should you pay for the business?

The amount you pay will depend on the valuation method you choose:

Earnings and Cash-Flow Based Methods:
Discounted Cash Flow: this is generally the most effective way to estimate a company’s value from an investor’s perspective, because it is based on future cash flows, which ultimately determine the investor’s return on investment.
Going Concern Value: This method uses the revenues of previous years to project future revenues.

Asset-Based Methods:
Book Value: This is the company’s net worth or shareholders’ equity, as shown in its financial statements (subtracting liabilities from assets).
Liquidation Value: This is the amount you would get from selling all of a company’s assets, including equipment, land, inventory and receivables.

 

In all cases, discuss the details with your accountant, lawyer or financials you trust. Make sure you have experts reviewing the deal thoroughly before you sign on the dotted line! Best case scenario: a big win-win deal for you and the person selling the business. They’ve earned a profit from their hard work, and you have a solid investment.

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