To buy or to build?

The next thing to consider is how you will go about acquiring or creating your new business. Will you set up a local franchise of a larger, established brand? Will you purchase an existing business and take over where the previous owners left off? Or will you start completely from scratch and build a business that is uniquely yours?

All three options have their merits and their drawbacks. Take a look at the following descriptions and see which one resonates best with you and your list of niches, business models, and location preferences.

Buy an existing business

Purchasing an existing business can be quite costly compared to starting one from scratch. Despite the cost, many entrepreneurs consider purchasing an existing business to be less risky than starting a new one. It can save a lot of time and energy since all the complex work has already been done for you, and it is believed to have a lesser risk of failure.

There are many advantages as well as disadvantages associated with the acquisition of an existing business.

Advantages of purchasing an existing business include:

  • Established customer relationships
  • Proven business methods and concepts
  • Qualified and trained employees
  • Proven cash flow
  • Established supplier relationships
  • Established infrastructure
  • Lenders are more willing to finance a loan to an existing business
  • Goodwill of the business already established

Goodwill is defined as the value assigned to the reputation of the business. An established business that has been in existence for several years, has a solid and loyal customer base, and is well respected in the community will have a higher goodwill value than one that is not yet established, with no solid customer base and no standing in the community.

In most cases, goodwill increases the value and purchase price of the company, beyond the actual monetary value of its facilities, inventory, and other assets. However, a company that has been maligned may have negative goodwill, meaning that the reputation of the company actually detracts from its value, resulting in a purchase price that can be lower than the monetary value of its physical assets. It’s like buying a house that’s rumored to be haunted. You can scoop it up at a discount because the goodwill of the home has been compromised.

Disadvantages of purchasing an existing business include:

  • Staffing problems and/or resignations of current employees due to resentment of change to a new owner
  • Loss of customers due to loyalty to former owner
  • Obsolete or defective facilities and equipment
  • Past financial performance does not guarantee future performance
  • There may be operational and logistics concerns that are not readily apparent
  • Existing staff and infrastructure may not support new ownership’s desired changes in systems and processes
  • Goodwill acquisition may drive the purchase price up too high

Similar to purchasing a franchise, acquiring an existing business may lessen the amount of work you need to put into your business planning, product selection, and marketing strategy, but you still need to do your due diligence in order to ensure that the business is being represented accurately by the seller.

It is for this reason that I highly recommend working with a broker to facilitate the purchase. However, you must remember that most brokers are hired to work on the seller’s behalf, so be careful in choosing one. Never work with the seller’s broker directly; they will always have the seller’s best interests in mind, not yours. You need to have your own representation.

A business broker typically acts as the middleman between the seller and buyer. They help in the transfer of ownership from seller to buyer. Your broker’s main role will be to guide you by providing all the essential information and advice needed in the purchase of the business.

The process of purchasing a business through a business broker is very similar to purchasing a house through a real estate agent.

Brokers can assist buyers in many ways including:

  • Help in providing research and information for the buyer that is essential for making a decision
  • Present the buyer with relevant facts about the business
  • Serve as a bridge of communication and negotiation between the buyer and seller
  • Help to determine the buyer’s interests, and help to decide on what kind of business best suits them
  • Aid in handling paperwork; buying a business is a complicated process which involves a great deal of paperwork
  • Assist buyers with the policies and laws governing the purchase

Your broker’s job during the purchase process involves the following:

  • Know what the buyer’s investment objectives are
  • Seek the right opportunities
  • Prepare a business valuation to determine offering price, or order a third party appraisal
  • Perform a thorough examination of the business before acquisition
  • Supervise and negotiate the purchase
  • Close the deal

Steps in the buying process with involvement of a business broker:

  • Meeting between buyer and broker wherein broker assists in deciding on what type of business best meets buyer’s needs
  • Detailed information on viable purchase opportunities are presented by the broker to the buyer
  • Buyer identifies business(es) of interest; visits the premises of each business with the broker
  • Buyer decides and selects the business to be acquired
  • A Purchase Offer in writing will be made by the buyer with the assistance of the broker. A Purchase Offer would include the following:
    • A clear identity of the buyer and seller
    • Sales price/purchase price
    • Closing date
    • Legal description of the assets which are the subject matter of the offer
    • Down payment or earnest money
    • Financing terms
    • Required fees associated with the offer
    • Contingencies
    • Inclusion of a non-compete clause, which prohibits the seller from opening a competing business near the premises for a specified period
    • Request for information and documentation on the business
    • Other terms agreed upon by the buyer and seller
    • The Purchase Offer is still for further review and not yet binding
    • Presentation of the established Purchase Offer by the broker to the seller
    • Acceptance of Purchase Offer by the seller with signature affixed on the contract
    • An escrow account will be opened consisting of the down payment for the acquisition of the business
    • Thorough investigation of the business done by the buyer
    • A final draft of the Purchase Offer contract will be made with the aid of a lawyer
    • Final fixed selling price is established by both buyer and seller
    • Determination of whether there will be retention of staff
    • Pending debts will be paid by the seller, unless covered in the Purchase Offer by buyer
    • Signing of the final Purchase Offer in the presence of a notary with the full payment paid to the seller
    • Seller turns over the business to the buyer

Legal and Tax Concerns

Be sure to also look into any legal or tax consequences involved in purchasing this particular business. Your broker can’t help you here; only a business lawyer and a CPA that specializes in these types of transactions can provide legal or financial advice, so it is in your best interest to spend the extra money and make sure your proverbial butt is covered.

Excerpted from:

Starting A Business 1-2-3
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Module 1: Research and Development