Owning a business can be very exciting but it can also be quite risky, especially if you are starting it from ground zero. One way to reduce some of that risk is to buy an existing successful business; one that already has products/services and customers. This reduction in risk does come at a price, a substantial price in some cases. However, if you have the funds, it can be an excellent option to consider.
Due Diligence
Because buying a business will involve a fair amount of money and time, it is critical to do your homework. It is important to thoroughly check out the business. This includes reviewing its products or services offered, historical and projected financial performance, assets, liabilities, contracts, employees, customers and vendors. There are also a number of other items to consider when purchasing a business, including what type of deal will it be – a purchase of the assets of the business or a purchase of the company stock. The tax consequences of this decision can be very different for the buyer and the seller. You will also want to determine if the seller will share confidential information about the business such as legal or audit issues. Many times the seller will require the buyer to sign a non-disclosure agreement before information is shared.
Verify the Seller’s Financial Information
Verifying the historical financial performance of the business is a very important part of the process. The buyer will want to review internally prepared financial statements for the business as well as externally prepared/filed tax returns for the past three years. If tax returns are not available, a buyer may request audited financial statements as part of the review process. They may also request validating information from third party sources such as lenders, external accountants, and/or CPAs.
Business Valuation
A good business valuation is a very important part of the purchase. Both the buyer and seller will need to know what the business is worth in order to determine if each of them is getting a fair price for the business. Additionally, if the purchase will be financed, there will likely be a requirement by the bank to get a business valuation as part of the loan application. If real estate is involved in the business, a real estate appraisal will be needed to value the real estate, especially if the real estate will be used to collateralize any new loans financing the purchase.
Financing the Purchase
Financing the business purchase may be done through traditional lenders. Some financing may even qualify for the Small Business Administration’s loan guarantee program. When financing the business purchase, the lender will need to obtain financial information on the business. This information is critical, and will help to establish the viability of the project, ability to repay the loan, and determine if the purchase agreement meets the lender’s requirements. If the historical financial information is unavailable, you may need to prepare a comprehensive business plan to show the lender you can repay the loan.
The information the lender will require includes: interim financial statements for the last three years, the purchase agreement, documents to support the valuation of the business assets, and a business valuation. You will also need to provide specific information on exactly what the loan funds will be used for (i.e. inventory, equipment, and leasehold improvements). The lender will also want to know how much the borrower is putting into the project. Most lenders will require 10% to 50% based on the industry and the borrower’s overall credit risk. Finally, the lender will want to see cash flow projections based on the historical financial data to assure the business will provide sufficient cash flow to service the debt needed to acquire the business. In many cases, the lender will be looking for periodic cash flow generated by the business to be 1.5 times the periodic debt payments.
Get Professional Assistance
A good business attorney should be considered for all acquisitions, since they can represent you, review legal documents and provide business advice. They can also act as the escrow agent or recommend a company to handle the exchange of money. It is also a good idea to engage the services of a qualified CPA, since some attorneys and business brokers are not familiar with the tax, accounting and financing impact of business transfers.
Owning a business can be very exciting as well as risky. One way to reduce some of that risk is to buy an existing successful business. This reduction in risk does come at a price, but if you have the funds it can be an excellent option to consider. Furthermore, if you do your homework and enlist the help of a few experts it can also be a very profitable experience!
Please let us know if you have questions concerning these buying or selling a business or any related topics, we can be reached at (480) 980-3977!
