Summary: Are you thinking about buying a small business? The rules of buying a small business are different to the rules of buying a big business, yet a lot of people try to apply big business rules when buying a small business.
Below are some steps to follow specifically when buying a small business:
Step 1: Remember that Sales drives Value
If there are no sales or low sales, that business entity has no value or low value. Sales are the market’s response to that business’ product and/or service. Therefore gross sales helps define the value of the business because the real bottom line of earnings has to come out of the top line of gross sales.
Step 2: Go to a Business Broker
Just as if you are looking for a suit, you go to the clothing store; if you are looking for a car, you go to the car dealer; if you are looking for a house, you go to the real estate broker; if you are looking for a business, go to a business broker. A Business Broker must be registered with the EAAB and have a valid fidelity fund certificate. It is helpful too if they are members of IBBA as they ascribe to a code of conduct.
Step 3: Get an Advisor
An advisor is a very important part of your team in deciding to buy a business. They are there to assist you and will advise you from a very conservative view in order not to advise you incorrectly or have to answer to you later. If you are using advisors remember that the ultimate decision whether to buy or not lies with you, no matter what the advise. The advisor has nothing to gain or loose, you have. If you are using advisors, choose from the following:
- Preferably a chartered accountant. One who will have your best interests at heart and who will give you an honest, un-biased report of the financial aspects of the business you are looking to buy.
- A qualified business consultant or someone who is familiar with the industry you looking at buying a business in entering.
- An attorney (One who specializes in business transactions.)
Get their opinion, sure but be guarded against the advice from your father, mother, brother, sister, uncle, aunt and any other family connection or suspect advisors unless they presently own, or have owned their own business in the past and preferably in the industry you are buying in.
Step 4: Use various Valuation Methods
Use more than one valuation methods, for example: Extra Earning Potential, Return on Investment and the Payback Method. Ultimately though, the value of the business is what the buyer will offer and the seller will accept. Using the various valuation models is meant to get you to an offer as close to the fair value of the business that you believe the seller will accept. Get someone to assist you with these methods.
Step 5: Analyse the Value Drivers of the Business
When buying a small business, it’s not just about the financials of the business, which may even be inaccurate. One needs to take into account all the Value Drivers of the business. The Value Drivers include:
- The LOCATION of the business.
- The FURNITURE, FIXTURES, and EQUIPMENT that help produce the company’s product and/or service.
- The INVENTORY or PRODUCT that the customers buy from the business.
- The TRAINED EMPLOYEES of the business.
- The EXISTING CUSTOMER BASE that buy the company’s products and services.
- The ESTABLISHED CASH FLOW sufficient to pay all of the business expenses and provide for the owner’s lifestyle.
- The business’ FINANCIAL RECORDS.
- The INDUSTRY ITSELF, does it have a shelf life.
- The ESTABLISHED VENDORS – SUPPLIERS RELATIONSHIP.
- The COMPETITION.
- The possibility of SELLER FINANCING. WHAT YOU (the buyer) ARE GOING TO DO WITH THE BUSINESS AFTER THE SALE.
Step 6: Don’t be afraid to Negotiate
You can negotiate the purchase price via your business broker. Don’t just pay the first price the seller asks for.
Step 7: Conduct Due Diligence
Due diligence is designed to both verify information and to look for problems (and there are always some problems and opportunities that come out and present themselves during due diligence). While the buyer is responsible for his own due diligence, I always recommend that he or she put a team together, including himself or herself (the buyer), the seller, any business broker that may be involved, an accountant to review the financials, and an attorney to represent him in the closing (and perhaps to file any needed organizational papers, such as forms for incorporation a partnership or LLC, at the right time).