Start Your Own Business (8 page)

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Authors: Inc The Staff of Entrepreneur Media

BOOK: Start Your Own Business
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chapter 5
 
BUILD IT OR BUY IT?
 
Starting a Business vs. Buying One
 
 
 
 
 
W
hen most people think of starting a business, they think of beginning from scratch—developing your own idea and building the company from the ground up. But starting from scratch presents some distinct disadvantages, including the difficulty of building a customer base, marketing the new business, hiring employees and establishing cash flow ... all without a track record or reputation to go on.
Some people know they want to own their own businesses but aren’t sure exactly what type of business to choose. If you fall into this category, or if you are worried about the difficulties involved in starting a business from the ground up, the good news is that there are other options: buying an existing business, buying a franchise or buying a business opportunity. Depending on your personality, skills and resources, these three methods of getting into business may offer significant advantages over starting from scratch.
 
e-FYI
 
If you’re looking for a business to buy or a broker to help you in your purchase, stop by
bizbuysell.com
. In addition to searching 47,000 businesses for sale and broker listings, you can order business valuation reports or research franchises.
Buying an Existing Business
 
In most cases, buying an existing business is less risky than starting from scratch. When you buy a business, you take over an operation that’s already generating cash flow and profits. You have an established customer base and reputation as well as employees who are familiar with all aspects of the business. And you do not have to reinvent the wheel—setting up new procedures, systems and policies—since a successful formula for running the business has already been put in place.
On the downside, buying a business is often more costly than starting from scratch. However, it’s often easier to get financing to buy an existing business than to start a new one. Bankers and investors generally feel more comfortable dealing with a business that already has a proven track record. In addition, buying a business may give you valuable legal rights, such as patents or copyrights, which can prove very profitable.
Of course, there’s no such thing as a sure thing—and buying an existing business is no exception. If you’re not careful, you could get stuck with obsolete inventory, uncooperative employees or outdated distribution methods. To make sure you get the best deal when buying an existing business, take the following steps.
The Right Choice
 
Buying the perfect business starts with choosing the right type of business for you. The best place to start is by looking in an industry you are familiar with and understand. Think long and hard about the types of businesses you are interested in and which are the best matches with your skills and experience. Also consider the size of business you are looking for, in terms of employees, number of locations and sales.
Next, pinpoint the geographical area where you want to own a business. Assess the labor pool and costs of doing business in that area, including wages and taxes, to make sure they’re acceptable to you. Once you’ve cho sen a region and an industry to focus on, investigate every business in the area that meets your requirements. Start by looking in the local newspaper’s classified ad section under “Business Opportunities” or “Businesses for Sale.”
“Play by the rules. But
be ferocious.”
-PHILIP KNIGHT,
CO-FOUNDER OF NIKE
 
 
You can also run your own “Wanted to Buy” ad describing what you are looking for.
TAXING MATTERS
 
Y
ou are investigating a business you like, and the seller hands you income tax returns that show a $50,000 profit. “Of course,” he says with a wink and a nudge, “I really made $150,000.” What do you do?
 
 
There may be perfectly legal reasons for the lower reported income. For instance, if the seller gave his nephew a nonessential job for $25,000 a year, you can just eliminate the job and keep the cash. Same goes for a fancy leased car. One-time costs of construction or equipment may have legitimately lowered net profits, too.
 
What to watch for: a situation where a seller claims he or she made money but just didn’t report it to the IRS. If this happens, either walk away from the deal ... or make an offer based on the proven income.
Remember, just because a business isn’t listed doesn’t mean it isn’t for sale. Talk to business owners in the industry; many of them might not have their businesses up for sale but would consider selling if you made them an offer. Put your networking abilities and business contacts to use, and you’re likely to hear of other businesses that might be good prospects.
Contacting a business broker is another way to find businesses for sale. Most brokers are hired by sellers to find buyers and help negotiate deals. If you hire a broker, he or she will charge you a commission—typically 5 to 10 percent of the purchase price. The assistance brokers can offer, especially for first-time buyers, is often worth the cost. However, if you are really trying to save money, consider hiring a broker only when you are near the final negotiating phase. Brokers can offer assistance in several ways:
•
Prescreening businesses for you.
Good brokers turn down many of the businesses they are asked to sell, either because the seller won’t provide full financial disclosure or because the business is overpriced. Going through a broker helps you avoid these bad risks.
•
Helping you pinpoint your interests.
A good broker starts by finding out about your skills and interests, then helps you select the right business for you. With the help of a broker, you may discover that an industry you had never considered is the ideal one for you.
•
Negotiating.
During the negotiating process is when brokers really earn their keep. They help both parties stay focused on the ultimate goal and smooth over problems.
“Pretend that every
single person you meet
has a sign around his
or her neck that says
‘Make Me Feel
Important.’ Not only
will you succeed in
business, but you will
succeed in life.”
-MARY KAY ASH, FOUNDER
OF MARY KAY COSMETICS
 
 
•
Assisting with paperwork.
Brokers know the latest laws and regulations affecting everything from licenses and permits to financing and escrow. They also know the most efficient ways to cut through red tape, which can slash months off the purchase process. Working with a broker reduces the risk that you’ll neglect some crucial form, fee or step in the process.
A Closer Look
 
Whether you use a broker or go it alone, you will definitely want to put together an “acquisition team”—your banker, accountant and attorney—to help you. (For more on choosing these advisors, see Chapter 11.) These advisors are essential to what is called “due diligence,” which means reviewing and verifying all the relevant information about the business you are considering. When due diligence is done, you will know just what you are buying and from whom.
The preliminary analysis starts with some basic questions. Why is this business for sale? What is the general perception of the industry and the particular business, and what is the outlook for the future? Does—or can—the business control enough market share to stay profitable? Are the raw materials needed in abundant supply? How have the company’s product or service lines changed over time?
You also need to assess the company’s reputation and the strength of its business relationships. Talk to existing customers, suppliers and vendors about their relationships with the business. Contact the Better Business Bureau, industry associations and licensing and credit-reporting agencies to make sure there are no complaints against the business. (For more questions to ask before purchasing an existing business, refer to the checklist starting on page 44.)
If the business still looks promising after your preliminary analysis, your acquisition team should start examining the business’s potential returns and its asking price. Whatever method you use to determine the fair market price of the business, your assessment of the business’s value should take into account such issues as the business’s financial health, earnings history, growth potential, and intangible assets (for example, brand name and market position).
Business Evaluation Checklist
 
If you find a business that you would like to buy, you will need to consider a number of points before you decide whether to purchase it. Take a good, close look at the business and answer the following questions. They will help you determine whether the business is a sound investment.
• Why does the current owner want to sell the business?
• Does the business have potential for future growth, or will its sales decline?
• If the business is in decline, can you save it and make it successful?
• Is the business in sound financial condition? Have you seen audited year-end financial statements for the business? Have you reviewed the most recent statements? Have you reviewed the tax returns for the past five years?
• Have you seen copies of all the business’s current contracts?
• Is the business now, or has it ever been, under investigation by any governmental agency? If so, what is the status of any current investigation? What were the results of any past investigation?
• Is the business currently involved in a lawsuit, or has it ever been involved in one? If so, what is the status or result?
• Does the business have any debts or liens against it? If so, what are they for and in what amounts?
• What percentage of the business’s accounts are past due? How much does the business write off each year for bad debts?
• How many customers does the business serve on a regular basis?
• Who makes up the market for this business? Where are your customers located? (Do they all come from your community or from across the state or are they spread across the globe?)
• Does the amount of business vary from season to season?
• Does any single customer account for a large portion of the sales volume? If so, would the business be able to survive without this customer? (The larger your customer base is, the more easily you will be able to survive the loss of any customers. If, on the other hand, you exist mainly to serve a single client, the loss of that client could finish your business.)
• How does the business market its products or services? Does its competition use the same methods? If not, what methods does the competition use? How successful are they?
• Does the business have exclusive rights to market any particular products or services? If so, how has it obtained this exclusivity? Do you have written proof that the current business owner can transfer this exclusivity to you?
• Does the business hold patents for any of its products? Which ones? What percentage of gross sales do they represent? Would the sale of the business include the sale of any patents?
• Are the business’ supplies, merchandise and other materials available from many suppliers, or are there only a handful who can meet your needs? If you lost the business’s current supplier, what impact would that loss have on your business? Would you be able to find substitute goods of the appropriate quality and price?
• Are any of the business’s products in danger of becoming obsolete or of going out of style? Is this a “fad” business?
• What is the business’s market share?
• What competition does the business face? How can the business compete successfully? Have the business’s competitors changed recently? Have any of them gone out of business, for instance?
• Does the business have all the equipment you think is necessary? Will you need to add or update any equipment?
• What is the business’s current inventory worth? Will you be able to use any of this inventory, or is it inconsistent with your intended product line?
• How many employees does the business have? What positions do they hold?
• Does the business pay its employees high wages, or are the wages average or low?
• Does the business experience high employee turnover? If so, why?
• What benefits does the business offer its employees?
• How long have the company’s top managers been with the company?
• Will the change of ownership cause any changes in personnel?
• Which employees are the most important to the company?
• Do any of the business’s employees belong to any unions?

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