5 Important Things to Know About Buying a Small Business

buying a small business, the owner
5 Important Things to Know About Buying a Small Business

 

By Barry Rickert and Mike McDermott

Joe Gieger, author of Entrepreneurial Success, said today in our monthly SCORE meeting, "You have three options when you buy a business: Sell it, Liquidate it or Operate it."

While there are many entrepreneuraial choices, let's assume you wish to buy and operate a business.

Price is important but not as much as you think.
Most people are worried about price right off the bat. How much are you asking? That is the last question you should ask and as I will explain why later.


The first thing you need to know is 'what are you about to buy'? No, this is not a stupid question. You might think you are buying a business but that would be wrong. You are buying a vehicle that generates cash or you are buying assets. It is that simple. Sure, there are exceptions but most of those are found when you are buying stock as an angel investor, not when you are buying a small business.

1) Lets talk about cash generation.
A business has value if it generates profit/cash profit. Intangibles, goodwill and such are ways people have to try to embellish the value of their company. They may help the sale but you cannot eat them or sell them so they are of little value when it comes to computing the value of the business.

Assume I have a business that generates $100,000 of cash per year. That is a good business and worth further investigation. Now assume the business has a negative cash flow.  The business may still have value but, truthfully, it will be hard to sell. Would you buy a sick dog? OK, maybe but it would have to be a real heart warmer right? Emotion always plays a part in business decisions so don't think that a bad business cannot be sold.

2) Now lets talk about assets.

What are you buying? Is there equipment, a store location, a lease, products, inventory, recipes or secret formulas, debt and such are all things you need to evaluate. Do yourself a favor and assume you are doing an asset purchase  where you do not accept responsibility for any debts. Your attorney can draft up such an agreement.

3) OK now lets talk about price.

One of the best pieces of advice I got from my long time accountant was this:  “I will pay whatever you ask, as long as I can define the terms”.  Buying a business is like a game of poker. You have a hand, they have a hand. Your job is to get a look at their cards but you know that there are still two cards left to be dealt. That is the fun of buying; the cards that are not yet dealt.  Neither party knows what they are but neither can win until they are played.

As a buyer, you should assume that these cards are going to be losers and adjust your price based upon that risk. But you can work a deal in the contract terms to make it worthwhile for the seller to take part of the risk with you. If both parties are honest, the final deal will be a “mirror deal”. Mirror deals are Win-Win. You can put a mirror to it and no matter what side of the deal you have it still looks like a good deal.

Avoid rushing into buying a business. Due-diligence is critical. It takes time and don't believe anything until you see it in writing. Don't become emotionally involved; you’re buying a used car. There is always another in the lot.


4) Do not rush or be rushed.
Avoid rushing into this. Due-diligence is critical. It takes time and don't believe anything until you see it in writing. Don't become emotionally involved your buying a used car. There is always another in the lot. 

5) Arbitration

Make sure your contract has an arbitration clause. You should not do any deal without one.


Barry Rickert is marketing director for SCORE Richmond and owner of richmond.ThinkShopBuy.com an online local retail shopping mall, emailmarketingguru.us and ecommerceguru.us. Barry is a software developer and has been self-employed for more than 30 years and has started and operated more than a half dozen small businesses.

Mike McDermott is the owner of Enterprise Tune-Up and author of the Recession Survival Guide