What is the best way to start a business?
If you dream of becoming your own boss, you have two options: buy a business or start a business. You can start a business with no money, or you can start one with a sizable investment. If you have a lot of money, you might be able to buy a business. If you are part of the 9% percent of Americans who will take the plunge to become an entrepreneur, you have a decision to make.
Will you start a business from nothing or buy one?
But, which one is the better option for you and why?
Each option has its pros and cons.
Advantages of buying a business
- Easier – Starting a business from zero is a lot more difficult than buying an existing business and run with it.
- Safer – The failure rate of brand new businesses is much higher than established businesses. According to Bloomberg, 8 out of 10 entrepreneurs who start a business fail within the first 18 months. That is an 80 failure rate. The U.S. Bureau of Labor Statistics reports a 38.8 – 45.1% and the U.S. Census Data shows a 51.2% failure within the first four-five years. Regardless of which numbers you believe, we can agree that business failure rate is very high. Buying an existing business greatly increases your chances of success.
- Requires less creativity – When you buy a business, you are paying for a system with customers and revenue. You don’t have to struggle to go from zero customers with no revenue to a business that is up and running. The first couple of years is the most vulnerable time in the life of a business.
- Many options – At any given time there are about 1 million businesses for sale in the United States.
Disadvantages of buying a business
- Expensive – Buying a business is much more expensive than starting a business from scratch. In the long run, it might save you money, but it is an expensive thing to do.
- Risky – Many businesses in the market are in a downward spiral. They might have been mismanaged or neglected.
- Investment – The business might require additional investment for additional staff, equipment, improvements, or inventory.
- Location – You might buy a business that is in a bad location.
- Staff – When you start a business, you hire the staff, but when you buy a business, the employees come with the business. You might be buying into a business with untrained or under-performing staff.
- Trends – There might be industry trends that could reduce your market share and increase your competition.
- Seller – Most businesses rely too much on the entrepreneur – seller – which could result in the decline of the business under new ownership.
What kind of businesses can you buy? different size maturity full-time, part-time franchise
- Established business – If you can afford it, you can buy a well-established business with customers and healthy revenue.
- Full time or part time – If you are not ready to buy a full-time business, you might want to look into buying a small part-time one. It will be less expensive, and it will be lower risk.
- Early stage business – Many people start businesses that are listed for sale for a variety of reasons. The person who started the business might have lost interest. S/he might not have the cash or time to stick with it. You might be able to buy an early stage business at a bargain price.
- Franchise business – There are turnkey franchise opportunities in every industry you can imagine. It is a great option if you want to buy into a system. If you are happy plugging into an existing business model with little flexibility, it might be the right option for you.
- Asset sale – Unfortunately, there are businesses that can’t make it, but there are valuable assets. This might be a viable option if all you need are assets. For example, a machine shop might no longer operate a business but the owner would be willing to sell you tools, machines, and inventory.
How to find a business to buy?
- Business classified sites – There are many business opportunity classified sites such as bizbuysell.com and businessesforsale.com. You can also search niche classified sites that focus on verticals like health and medical.
- Newspaper – I know it’s old school, but many people still sell and buy stuff through printed media. This is an especially effective option if you are looking for low tech businesses.
- Business brokers – Finding experienced business brokers is a good idea. Look for brokers who are members of the International Business Brokers Association (IBBA).
- Reach out to accountants and attorneys – CPAs, accountants, bookkeepers, business, and bankruptcy attorneys are some of the first people to know when a business is for sale. This way you might snatch up a business before it even hits the market.
- Cold call – If you find a business you are interested in, call and speak with the owner.
Ways to buy a business
- Complete buyout – This option is the riskiest to the buyer. Sellers prefer a cash sale because it is the best deal for them. If you are the buyer the best deal for you is if you demand as much of the sale amount as an earn-out.
- Seller financing – In a tough economy when it is difficult to secure a bank loan, entrepreneurs are motivated to do to seller financing. They usually require a hefty down payment. Seller financing shares the risk between the seller and buyer.
- Earn-out – This option is the lowest risk for the buyer and the best possible option. If you can get a full earn-out deal, you can buy a business with minimum risk. It is the lowest risk option for buyers and the highest risk for sellers.
- Hybrid – Many deals end up being hybrids. They include a down payment and offer an earn-out option. Realistically, if you end up buying a business, you will end up with a hybrid deal.
What to consider when buying a business?
- Size – The size of the business will determine several things such as the amount of capital you need, and the management skills required to run the business.
- Financials – Before you even consider buying a business you must see the financials of the past three years. If the seller is not willing to share, you should walk away from the deal. Obtain actual tax returns.
- Debts – Is there any bank or private debt?
- Liabilities – Are there any outstanding legal liabilities?
- Litigation – Is there any current or past litigation? Are there any judgments?
- Time in business – Especially, with a brick-and-mortar business, there is a real value in longevity. Long-term reputation is precious.
- Duration of ownership – Is the owner the founder or s/he bought the business?
- Reasons for selling – Don’t expect to hear the truth, but you should consider the story they tell you. Common reasons for selling are health, lack of success, burnout, divorce, and death. It is unlikely that the business owner will share the real reason(s) for selling.
- Revenue – Even more important than revenue is profitability. Regardless of revenue, you have to know that you will be able to generate a profit. Are sales increasing or decreasing, and why?
- Value of business – It is important to get a third part unbiased valuation. One of the most common reasons businesses fail to sell is that the seller overvalues the business.
- Target customer – What is the size of the market? Who are the current and past customers?
- Customer acquisition cost – How much does it cost to get a new customer?
- Real estate – Is there a lease or mortgage included with the business? If there is a lease, what are the terms?
- Vendors and suppliers – Who are the key vendors and suppliers? Are there any disputes?
- Inventory – What is the value of the current inventory? Make sure “dead” inventory is excluded from this list. Many businesses hang on to unsaleable inventory the same way people hang on to declining stocks. You not only want to know about the inventory but how long it takes to sell each different SKU in the inventory.
- Assets – Most assets fall under the tangible or intangible asset category. Tangible assets are building, vehicles, equipment, etc. Intangible assets are brands, name recognition; they are usually not listed on the balance sheet. Intangible assets are not considered liquid.
- Intellectual Property (IP) – Patents and trademarks are a form of intangible assets.
- Sales and Marketing – What is the sales and marketing strategy?
- Systems – Are there systems in place employees use daily to perform their tasks?
- Training – How long will current owner stay to provide support and training?
- Time commitment – How much time does the current owner spends working in the business? Ask questions like when was the last time you went on vacation?
- Reviews – Online and offline reputation should be a key factor in your buying decision. There are many review sites like Yelp where you can get a feel for how people feel about the business. Do your homework and find reviews about the company.
- Gut feeling – Do you trust the owner of the business? Does it feel like you were given an accurate picture of the business?
- Legal – Consult with a legal professional before you make a buying decision. Even if you only pay an attorney for a few hours of time, you will talk away with a wealth of knowledge.
- Transition time – You should have a sales transition timeline to know how long it will take to transition the business from the seller to you.
The reality of buying a business
There are thousands of businesses for sale, yet most of them will never sell. Go to BizBuySell or one of the many other sites showing businesses for sale. Only about 10% of businesses for sale will ever sell.
Here are some of the biggest reasons most businesses are unsaleable:
- Unrealistic pricing – Unfortunately, many entrepreneurs think that their own business is worth more than comparable businesses.
- Too late to sell – Often, by the time a business is listed it is already operating in the red. It might have been neglected for too long to make for an attractive investment.
- Inherited – Many businesses are inherited by the wrong people. A parent dreams of leaving the family business to the children, but they are only interested in the money or lack the skills necessary to run the business.
- Owner irreplaceable – Many entrepreneurs become the business. The end result is a business that will die once the owner is removed from the equation.
Despite all that could go wrong with buying a business, it is a viable option for many.
Negotiating is an art form. Often, the difference between a good deal and a bad one is the negotiation. Leave the negotiation to later in the process. Before you buy a business, you should have a negotiation strategy. Educate yourself on all the potential pitfalls of buying a business.
Consider the following during negotiations:
- Understand the market. How much are similar businesses sell for? Disregard how much businesses are listed for, research actual sale prices.
- How long has the business for sale? You can usually negotiate more with a business that has been for sale longer.
- Consult a business broker. There is a huge value in working with a professional on your side. Not all business brokers are equal, so you have to do your homework to find an exceptional professional.
- Focus on the reasons the seller is selling the business.
- Are there other offers on the table? Don’t believe the seller or broker that there are other interested buyers unless it can be verified.
- Make an offer. You would use a Letter of Intent (LOI). The LOI is the document that outlines information known and understood by the buyer and seller to date. The LOI is not a binding contract. Never offer the full asking price.
- Be ready to walk away. Don’t fall in love with the business. Act like you are ready to walk away from the deal at any time.
Put it in writing
Don’t assume anything. Ask many questions. Put everything that is important in writing.
Closing the deal
After you have investigated the business, made your offer, and completed due diligence you are ready to close the deal. The due diligence is the longest step in buying a business. It is also one of the most stressful for both parties. Your interpersonal skills will be tested during this process, but don’t give up. Take it one day at a time.
You’ll need a written sales agreement. Have your attorney review it before you sign.
You own it, now run with it
It is a long process to find and buy the right business. Do everything in your power to prepare for the transition.
In the comments section below discuss what you think of buying a business.
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