Buying a business can be an excellent way to kick-start your journey toward having your own business or expanding your existing brand.
But there’s a dark side to selling a business that few people mention to first-time buyers. Sometimes, in order to avoid losses, business owners will put their businesses up for sale when they predict a downward trend in sales.
Many people assume that buying an established business means you’ll already have a foot in the door, making it easier to generate profits. But if you’re unsure about the demand for its products and services, you risk buying a business that’s no longer relevant to your industry or audience.
That’s why you should do your due diligence before purchasing an existing business.
What to ask when buying a business
You should only invest money, effort, and resources into a business after you’ve done the appropriate level of due diligence and research. That’s why, before buying a business, it’s important to ask certain questions — both to identify good deals, as well as to disqualify the bad.
Here are some common, but important, questions to ask the current owner before purchasing their business:
- What’s the financial performance of the business? (Ask them to provide all financial records for at least the last three years, including the balance sheet, cash flow statement, and income statement.)
- How long have you owned the business, and why are you selling it?
- Are there any legal issues or outstanding debts related to the business?
- Are there any existing contracts, agreements, or liabilities connected to the business that you’d need to transfer to me as the new owner?
- Is sufficient staff available with the skills required for success (like sales personnel and technical support)?
Some believe reviewing business assets and financial statements is enough to understand a company’s performance. However, there are some key details you can’t afford to overlook. Let’s go over some of them to help you dig deeper into the business you intend to purchase:
- How much of the business operations depend on the current owner? Will clients leave if you come in?
- How did the seller come up with the asking price?
- How do customers find out about the business? Is the marketing strategy sustainable and effective, especially with a new owner?
- What marketing channels does the company use, and how effective are they?
- How does the business measure the success of its marketing efforts? Is there a system in place to track customer acquisition and retention rates?
- How does the company differentiate itself from competitors? How effective is it at attracting and retaining its customer base?
- What’s the process for handling customer complaints or disputes? Is there a customer service policy? How does the business resolve these disputes?
- How does the company measure customer satisfaction? Does it have a system to train employees on customer service best practices?
- What’s the current state of the business’s technology and systems? Do they need more investments to upgrade or maintain them?
- What technology systems does the company currently use? How are they integrated?
- Are there any pending software or hardware updates you need to complete? What’s the timeline for updating them?
- Is the business compliant with data privacy and security regulations? Are there any potential risks to sensitive data?
- Which assets are included in the asking price? What’s the current value of each physical asset?
- How long has the current owner used the equipment? (This will help you understand the condition, depreciation, and the asset’s remaining value.)
Where to buy a business
The best place to look for a business to purchase depends on several factors, including your budget, industry of interest, location, and expertise in the particular field.
Some options to consider include:
- Online business marketplaces: You can search for businesses for sale based on location, industry, and price on BizBuySell, BusinessBroker.net, and Flippa.
- Networking and referrals: You can reach out to business owners in your industry or local business associations for recommendations.
- Business brokers: Intermediaries who connect buyers with sellers can provide valuable guidance on the buying process. They often have access to a broader range of businesses for sale. Business brokers typically receive compensation as a percentage of whatever deal is made.
- Industry trade associations: Trade associations can be a great source of information on businesses for sale in a particular industry. They often have online directories of member businesses that may be for sale.
- Classified ads: You can check classified ads in local newspapers or online marketplaces like Craigslist.
Chris Hurn, founder and CEO of small-business lender Fountainhead, recommends buyers work with a business broker: “[They] have access to listings you likely won’t, and they have the skills and expertise to make the process much easier for you.”
Using a broker is similar to working with a real estate agent to purchase a house. Although you can buy the house yourself, it’s often much easier to work with a professional who does this often and who is more knowledgeable than you are about that industry.
Buying a business from your employer
If you know that your employer is looking to sell their business, you might consider purchasing the firm directly from them. This can be a good idea if you already have a deep knowledge of the business and its employees and a passion for the company’s work.
However, it also comes with challenges and risks you wouldn’t encounter if buying the business from a stranger. There is always the risk that your feelings for the people involved (i.e., your boss and co-workers) may get the best of you, so you need to be sure you can manage the emotion of the transaction.
Establishing ground rules for how you’ll engage with each other will help minimize the potential strain on the relationship.
Buying a business financing
You’ve done your due diligence, asked the right questions, and found the right business to buy. But how do you get the best financing?
Your financing options will depend on your preference and eligibility. They include bank loans, seller financing, and Small Business Administration (SBA) loans.
Many entrepreneurs opt to seek financing from “traditional” lenders, such as through bank loans or lines of credit. But this can be difficult to secure. When a lender agrees to finance your purchase, they are agreeing to take on a certain level of risk.
If the business doesn’t perform as well as you think it will, and you’re unable to pay back the loan, then the bank or lender risks losing money.
With this in mind, lenders tend to have strict requirements for how they evaluate borrowers. Each bank sets its own loan qualification standards, making it typically hard to qualify for a business acquisition loan.
Seller financing is like a bank loan. But instead of working with a bank, you’re working directly with the seller and paying them over time. This makes it more likely that your deal will go through, but may come with worse terms — such as a higher purchase price, more significant down payment, shorter repayment terms, or higher interest rates.
SBA financing, especially SBA 7(a) loans, is often the best way to get financing to buy a small business (up to the $5m limit). The SBA guarantees these loans, which reduces the lender’s risk in the event of nonpayment. As a result, it may be easier and safer to get an SBA loan.
When getting this type of small-business loan, it’s usually best to work with an SBA lending specialist instead of a bank. Hurn shares that “any bank can make an SBA loan, but that doesn’t mean they do it frequently enough to have the expertise you need.”
Grants for buying a business
Grants offer cash for existing businesses and startups to grow. The effort and time to research and apply for funding can be worthwhile if you secure a grant.
Government agencies offering federal grants can be an excellent place to start.
- Program for Investors in Microentrepreneurs (PRIME)
- USDA Rural Business Development Grants
Is buying a business tax deductible?
According to the Internal Revenue Service (IRS), you can deduct up to $5k if you spend less than $50k acquiring your new business. If you exceed that amount, your reduction threshold reduces pretty fast.
For example, you'll only have a $1k write-off if you spend $54k on a business acquisition. Spend $55k, and you won’t be able to deduct any expenses.
Buying a business contract
It’s best to leave drafting the letter of intent and business purchase contract to a lawyer. Still, you should have a basic understanding of the terms that will be involved.
When creating a business purchase agreement, consider adding some key clauses to protect yourself and the seller. They include:
- A description of all the goods or services the business sells and their value.
- Conditions under which either party can terminate the agreement and how to resolve disputes.
- Intellectual property rights associated with the company, including trademarks, copyrights, and domain names.
- Specifics regarding payment terms and delivery of goods or services.
- Any confidentiality agreements related to customer or pricing information that both parties must abide by.
One important thing to note is the language and terms of the contract. In particular, watch out for the noncompete clause. It prevents the seller from opening the same type of business in the same geographic area for a specified amount of time.
If you’re not keen on the specifics of this clause, the seller could poach old clients. Matt Schmidt, CEO of life insurance agency Diabetes Life Solutions, learned this the hard way.
When purchasing another insurance agent’s business, he inserted a five-year noncompete clause into the contract. However, six months later, he noticed several new clients leaving his agency. After some research, he realized the former agent was working with another agency as an administrative assistant and helping it poach old clients.
So, make sure the agreement states that the seller can’t use the information on confidential business processes like customer lists or trade business secrets with others.
Buying a business checklist
Here’s a summary of what you should do when buying an existing business:
- Ask crucial questions to get deep insights into the business.
- Use a business broker to purchase a business since they’re professionals in that space.
- Work with an SBA lending specialist to secure SBA 7(a) loans if you’re buying a small business costing less than $5m.
- Be keen on the noncompete clause specifics to avoid the seller poaching old clients.
There’s often a lot at stake when purchasing a business, so it’s important to do your due diligence before signing the agreement.