How To Buy A Business

StartUp vs. New Franchise vs. Existing Business
Identify Your Requirements
Get Your Helpers In Place
Decide On A Budget
Research The Industry
Find Out What's For Sale
Analyse the Target Business
Do Your Own Valuation
Settle On A Price
Preparing the Basic Agreements
Perform The Due Diligence
Closing The Deal
The Hand Over

This article assumes that you are a prospective business owner, probably acquiring your first business, and looking at a small to medium priced purchase below the R5 million level. Bigger businesses, and corporate acquisitions, use somewhat different parameters.

StartUp vs. New Franchise vs. Existing Businesss

A grass roots startup means addressing the unknowns of finding customers, pricing, marketing, training staff, setting policies, developing procedures and establishing plant and premises. Will the sales estimates be met.? What will competitors do.? How long will it take to build cashflow and get to break-even.? It may cost less than buying a going concern, but the risks are much higher and finance is harder to secure.

It is generally accepted that your chances of failure will be higher with a start up.

An existing business has a measurable history and almost every variable can be observed and assessed. What has happened before is, for now, likely to keep happening. The personality, risk profile, skills and attitudes needed by the startup entrepreneur are different to those of the owner manager. The startup type would have to morph at a later stage which is exceptionally difficult. This may even be a turnaround operation where you believe you can bring the right skills to make the difference. You are probably more the builder/consolidator than the risk taking experimentalist. You will also be taking over staff who are experienced in the business and have dealt with all the problems and new challenges associated with a start up.

A new franchise start up has some of the same disadvantages that a business start up would face, but the general risk is lower as you implement the franchisor's structured plans. The franchisor also takes care of the market research, shopfitting, staff training, suppliers and providing consulting backup. But then you have to consider franchise fees, royalties and constraints in how you do business and expand. Potential earnings would be lower and you have to stay with the boilerplate business model. And it is not unusual to see franchise chains collapse or franchise holders defranchise. Some franchisors also have a right of first refusal when you want to sell which puts your capital growth return at risk.

Recommended Article - Why Buy An Existing Business

How To Buy A Good Business At A Great Price © is "the mostly widely used strategy guide for buying a business."

This is not a simple generic introductory book on the subject. It combines critical knowledge and proven strategies for each stage of the process and every situation you'll encounter, along with expert ongoing consulting. The guide is based upon countless business investigations and successful transactions in every field including manufacturing, retail, a huge array of service sector companies, the food industry and wholesale and distribution businesses.

The material contains over 500 pages of easy to follow strategies, legal agreements, interactive resources, sample letters, case studies, financial spreadsheets, worksheets, and business plan templates.

Identify Your Requirements

Look for work you enjoy. There's an old saying that goes "if you love what you do, you'll never have to work another day in your life." True words, and one could add to that "... and you'll do very at it too." Passion and your perceived enjoyment works wonders with customers, staff and your own motivation. Whatever you do, don't pick a business that you dislike.

Geographic location is important to most. You probably don't want to move home but may not mind a move to a different side of town. This could limit your choices, but some business aquisitions, and the subsequent move, could improve your lifestyle.

Consider your skill sets and experience. Are they that unique in that having them is a big advantage as the seller has a restricted number of available buyers. Do you have strong managerial and financial skills to work at that level in a business so you save on some heavy salaries and have good hands-on control.

How do you feel about a large labour force and the attendant problems? Do you manage people well and at what level? You might want to avoid certain labour structures. How organised is labour generally in the industries you are targeting and does it have militant unions?

Lifestyle needs defining, especially if this is a smaller business. What sort of hours would you want to work and does the business activities for well with your moral values and cultural background? This would also apply to your immediate family members as they may often be called on to help with running things and there may even be the issue of succession to consider at some time.

The cash income generated by the business is another factor which should be specified. If you are not drawing a salary, then is usually a minimum amount and is defined by your income requirements and a reasonable return on investment where the capital figure would be the purchase price plus the value of your own labour.

Would you want to own the premises from where the business operates? This could insulate you from difficult landlords and unfair rent increases and would give you secure tenure. Unused space could provide some rental income and reduce the risk of having no expansion space for when you grow.

The business will need working capital to finance the operating expenses (such as buying stock and paying for utilities and salaries) once you get going. Remember to reserve hard cash for that when estimating your purchase funds.

Get Your Helpers In Place

At some point in the process you will be needing the help of a lawyer, and probably an accountant. The lawyer will assist with drawing various agreements and the accountant would assist with valuations and the due diligence process. If you are considering a smaller purchase, perhaps below R500 000, then a business broker might be able to handle most of these issues but you may still want your trusted tax and legal people in at the end.At some point in the process you will be needing the help of a lawyer, and probably an accountant. The lawyer will assist with drawing various agreements and the accountant would assist with valuations and the due diligence process.

Recommended Article - Business Brokers - Do You Need One?

If funding is required for the purchase and more funding for the business operations (such as in international trade or selling leased vehicles) then you may also need to have a good working relationship and clean record with your banker. Move away from the electronic reliance and seek out your relationship manager and work on building that rapport. In your planning you should also be getting a list together of people you know in your personal and business networks who would have inside knowledge of your target industry. Ask around in social media and don't forget about usine LinkedIn for this.

In your planning you should also be getting a list together of people you know in your personal and business networks who would have inside knowledge of your target industry. Ask around in social media and don't forget about using LinkedIn for this.

Decide On A Budget

You will need to determine how much ready cash (referred to as unencumbered cash funding) you will have available for the purchase. Additional funding could come from a traditional lender (such as a bank or a private lender) but that will require interest and capital repayments which may effect the income you are expecting to receive from the business.

Be aware that banks will lend up to 50% of the purchase price if you are putting up hard cash for the remainder and if you can give them good collateral by way of sureties. That percentage can be lower based on their assessment of the risk involved and it is also effected by their investment portfolio balances and availability of funds.

The seller of the business is almost always a potential source of funding. If not, they will always say upfront that this is a "cash transaction only" and that would be mentioned whenever price is discussed. The legal terms are "deferred payment" and "vendor financed" and they refer simply to the arrangement (usually written into the sale agreement) which defines when payments will be made. These mayments may be linked to issues such as turnover milestones, staff and customer retention, and/or a major contract being renewed. This exposes the seller to additional uncontrollable risk and may relign the price upwards or require more upfront cash.

The sale contract will also define your penalties for any missed payments and these could be harsh. Repossession of the business would be a common sanction and you could even forfeit payments made to date. The seller would be reluctant to reverse plans to execute repossession and could be taking back a damaged operation.

The seller may be interested in retaining a small stake in the business and, with the prior experience, this would be a good partner to have. You can't really work this into your budget strategy at this time as the possibility is low and you have partner compatibility to yet assess.

A business partner might be able to introduce more capital to enable you to set a higher price figure. Ideally this should be a sleeping partner who will not give negative interference but it could also be an active participant who brings special skills to the new venture. See our article on : Choosing a Business Partner.

Research The Industry

This is where you need to start getting up to speed on the industry you have targeted and specifically the general environment and state of the industry. Is it in a slump or a growth phase. Are there coming technology changes and could there be changes on the horizon in terms of legislation and labour issues. There will be industry representative organisations, associations, lobby groups and trade groups. Each will hve their own publications and you should be able to track them down on the internet. Learn all you can at this stage about the state of the industry.

Try to get some introductions to people who are working in similar type businesses, preferably at the owner level. They would probably need to see you as a non-threatening entrant and not a source of competition. People are often surprisingly candid when asked for assitance and you could find valuable information here. The worst that can happen is that they say No !

If the business type has a retail or public activity then visit as many as possible as a browsing customer or interested prospective client. Try to sample the service and ask the staff how they enjoy their jobs.

Find Out What's For Sale

So, you have decided on what you want from the aquisition, you have your professional people ready, you know how much you can spend and you are happy with the state of the industry. But there don't seem to be any businesses like that advertised in the local newspaper. Truth is that very few businesses of substance get sold through newspaper ads. You have to go do some finding.

Realise from the outset that almost EVERY business is for sale. Sure, some will need a ridiculous price to make that happen but the entrepreneurial streak in business owners will mean that they generally will be receptive to interested buyers. And in nearly all circumstances you are better off in being represented by an intermediary for the initial approach.

Newspaper Classifieds: Consider running a "business wanted" ad. Brokers will be watching these columns and this could be your first broad attempt to get the attention of the deal makers.

Auditors and accountants, where you have an existing relationship, would normally be contacted next. Remember that they have a very intimate knowledge of their clients and their businesses and, as a brokering party, are held to very high ethical standards. They are less likely to have a suitable introduction as this is not their core activity. They can also use their other national offices to make enquiries on your behalf.

Business brokers located in the geographic areas you prefer would be the next group to address. You can use the local press, internet searches and referrals to identify who you want to work with. It is usually a good idea to start with a phone call as that will give you a rough idea of the personality you are dealing with. That can be followed up with an email which specifies your requirements, preferences and dislikes.

Business brokers will assist in many major major areas.

They are commission driven and sales need to happen for them to earn income. They will therefore evaluate any business they take onto their books to ensure it is fairly priced and that the financials, tax returns and other paperwork is in order. Effectively, any business they present to you is pre-screened.

They usually have good networking links to other brokers and will use these links to help hunt down businesses on a commission split basis with other brokers. This can present a wider set of purchase options for you.

A broker's prior client experiences also enables them to help you identify other businesses that would suit your skill sets and interests.

They are usually very familiar with the valuation and price determination process and can help with assessing the fairness of the asking price when one reaches the negotiation stage. As deal makers, brokers are very focussed on bringing negotiations to a conclusion and they provide a buffer between personalities. They have had bitter experience of what kills a sale and should be able to identify vulnerable situations and know when to counter offer and compromise.

The administrative and documentation processes wil be familiar to the broker and they have precedents and teplates to handle most of the low level agreements. They should also be able to advise on your compliance and adherence to local laws, licence requirements, permits and regulations.

With those agents and brokers out there looking for you, you could then try your own broad internet seraches linking the industry and/or business type to "for sale" and the locations of your preference.

Analyse the Target Business

So you have turned up the first potential business that has your interest. You now need to make sure that it passes basic tests before you proceed to working out an offer price and start the due diligence process. There may be a final list of five businesses and you have now narrowed that down to two - and are ready to start looking much closer at the choices.

- Why is the business up for sale ?
- Have you got enough financials and tax returns for basic checks ?
- Is the price reasonable at first assessment ?
- What negatives, liabilities and contingencies are lurking?
- Is the tenure over the trading premises reasonably secure ?

Does the present owner have a genuine and clear reason for selling and does the situation appear to support that. You want to make sure that the true reason for the sale, especially for what appears to be a profitable business, is not one that is going to make you a seller in the near future. Pending technology and competition could be unknown to you. There will be local people, such as suppliers customers, other business people and even staff, who could provide valuable information. You may however be constrained in this by non-disclosure obligations.

The seller is sometimes not only concerned about realising the maximum sale price and being paid. There may be obligations to make sure that the family business name endures and there may also be personal obligations to staff and suppliers. In other words - the seller may want to be sure that the business will continue to exist and will be more interested in your capacity to achieve that that in getting top dolar in the deal.

You would require the most recent audited financial statements, and preferably be able to view the last five years. These should be backed up with the tax returns and assessments as well as the VAT records. Management accounts should also be available. This should give you and idea of longer term trends and you should look closely at trhe last year and the last quarter in particular. Adjust for seasonality and make sure there are no alarming downtrends anywhere.

At this stage the seller would normally ask you to sign a confidentialy agreement, also know as a non-disclosure agreement (or NDA) at this point. This is standard practice and it protects the seller's business secrets such as formulations, access to customers, and revealing supplier sources.

There will be an advertised price which will rarely ever be the price that the business sells for. Usually, the seller would have set a top price and then added margin for negotiation so offers, negotiation and counter offers will always be the order of the day. Finally, it boils down to negotiating between what the seller wants and what you can pay.

If you are buying a services business, you may want to test the quality of those services and pretend to be a customer. Walk around a get a feel of what customers are saying and how staff are behaving.

The business appears to be genuinely profitable so now you can turn to examining the negatives, liabilities and threats.

Liabilities: Compile as full a list as possible. Are any of the firm's assets being used for security to fund loans.? Are there any pending legal cases or other claims. Have any prepayments been made for work or goods not yet executed or supplied.? Are there uncompleted contracts, and if so find out why. Are all local taxes paid.? Is there a large amount of accrued leave owed to staff and/or are the staff benefit funds (pension, medical, etc) all paid and up to date.

Market risks: Is the business exposed to a norrow client base.? Could the sudden loss of two or three major clients cripple the turnover.?

Could the seller become a competitor. Consider asking the seller to sign a restraint of trade and make sure that the period of restraint is of sufficient duration to break customer relationships.

The payment of creditors should be the responsibility of the seller but for practical reasons it is often best left for the buyer to settle. The suppliers will always revert to sueing the business anyway if the seller does not settle them. So make sure this sum is not inordinately large as it could become contingent.

Customer loyalties: Are there special relationships between the seller and the customers.? These could be family or personl links which collapse when the seller leaves. Test this against the critical major customers.

Staff loyalties: If critical staff leave after the owner departs, that could spell disaster. This is especially important when technology levels are high. There may also be overpaid staff who had special owner relationships or were in employ past retirement date in lieu of poor retirement funding.

Accounts receivable: The owner may not want to separate these from the sale and it is an item that is usually negotiated separately. You could take up to 60 days at book value, 50% of 90 to 120 days overdue and refuse and debtors at over 120 days. The difficult debtors could claim all sorts of non-delivery without the owner present and legal remedies in these cases would be exceptionally difficult. A receivables book of many small debtors is much more expensive to collect than one made up of mainly large debtors.

Premises: The right to occupy the premises can be a risk. Does the current lease have a right of renewal at a predetermined rate. Was there a special relationship between the landlord and the owner. You will need to see the lease agreement and should look for any trading restraints that may be in conflict with your plans for the business. As you will be taking over the lease payments you will need the landlord's consent so this might be an opportunity to fix a good term for a new lease.

This could also be a good time to look at the location and premises and, if the lease allowed you, to think about moving. Is the area suitable in terms of customers and access, what is the local outlook and where is population growth going.? Competition, new trends, and public transportation are all factors here. If the business is located in a shopping mall talk or business precinct then you need to talk with the other business owners about mall management, future plans, security and rates. tenants, etc. The loss of a major anchor tenant could be disasterous for foot traffic and turnover in the retail and service sectors.

Price increase capacity: Have there recently been price increases which reduces your capacity to increase margin in the short term. Would this effect medium term profitability.

Product warranty and liability: You may need insurance for damage caused by your product, and you may also have quality warranties to customers stretching far into the future. These would become your liabilities and need to be evaluated.

Insurances: The real danger here is that the operation may be under insured. This is especially commn when the business is in distress and cost cutting has been taking place. Getting insurances back in place would be an extra expense. Remaining under insured could be courting disaster if there was to be a major fire or storm damage. Get your insurance broker to check the situation.

Staff policies: Identify who the key personnel are and figure out if they are on reasonable salaries. Are any under employment contract and is the business unionised and under union settlements. What benefit plans are in place for health, accident insurance and retirement planning.? Ask for the organisationl charts, vacation policies and retirement rules. Do employees receive appointment letters which are updated and do they have functional job descriptions.?

Do Your Own Valuation

Before you make an opening offer you need to know what the business is worth to you, and how far you are prepared to go in terms of the selling price.

There may be synergies that you will get from your other operations and business contacts, and perhaps you will be able to add extra revenues due to what you can contribute with special skills and raw energy. All of this should give you an idea of the income you can generate as opposed to what it now earns. What will be the risk to income introduced by the change in ownership.? You will also need to estimate the change in expenses when under your control. You may be able to reduce some expenses by utilising other resources you already own such as staff, premises, equipment and distribution channels. You can then work back to a price based on your requirement for return on investment (ROI) which may also be expressed as a payback period in years.

That's to establish the highest price you will be willing to pay. You need next to look at some common valuation techniques to see if you can justify and then propose a lower price. This you can use in negotiation with the seller to explain why you feel his price is too high. You can get an idea of the different pricing methods at our resource section : How To Value a Business and Set a Price where we cover many aspects of the pricing subject.

No matter how technical one gets with the valuation, there is always that annoying truism that a business is worth what someone is willing to pay for it, and that person may not be you. The seller will know that and may be prepared to hold out to wait for that person.

Settle On A Price

Begin negotiating the price and the terms of payment. Once you are satisfied that the business you have targeted is what it seems to be and that you have done as much as you possibly can to understand what it is you are going to buy you can then start to talk about actually buying the business. And inevitably this will mean a conversation or dialogue with the business owner or intermediary (agent, broker, accountant) about the price of the business.

As the acquiring party, you should make the first offer.

Leave yourself some room to negotiate, so your first offer should generally be around 75 to 90 percent of what you actually think the firm is worth (to you). Be especially careful that your initial offer is not seen as an insult as that may terminate all negotiations.

Be prepared for a final deal which has several conditions attached, the most common of which would be the payment terms and the security of certain staff positions. This has the capability of being an emotional experience for the buyer and especially the seller and it takes patience, persistence and creative thinking to achieve your goal here.

Knowing why the seller wants out becomes important at this stage. Personal, health, emigration, financial and retirement plans could all be putting pressure on the seller who could see a collapsed sale as the start of another long selling cycle.

It would be advisable to consult with your accountant to use several pricing methods methods to calculate alternate prices to then compare to the seller's asking price.

But what if the price is too high and exceeds your budget. This could now exceed your budget if other business parts were included and maybe profitability has even been increased.

View our pages on Financing Your Business Purchase for ideas and suggestions.

A word of caution on payment schedules. In your zeal to make the deal you could agree on repayments that place a heavy burden on cashflow. It would be reasonable to assume you will iniially make mistakes and have extra expenses in staffing, production stoppages and equipment issues. Customer issues could also depress income and suddenly you can't make the repayments.

Recommended Article - Negotiating Your Way To A Great Deal

Preparing the Basic Agreements

There are three major agreements which are needed in all sales and which protect both the buyer and seller. Your lawyer will be instrumental in drafting these although the first, the NDA, can probably be sourced in an internet search.

The NON-DISCLOSURE AGREEMENT (known as the NDA)

This is also known as a Confidentiality Agreement. In the legal context these cover all sorts of business relationships but we are obviously concened only with the narrower NDAs related to the sale of a business where the agreement is largely structured around protecting the business secrets and rights of the seller.

The seller, being the discloser with rights to protect, would usually be the compiler of this document and you would not have much interest in contesting points raised unless your interest in the sale was less than honourable. You, or your lawyer, would need to scan it to ensure that.

The MEMORANDUM OF UNDERSTANDING (known as the MOU)

In the American context, this is also known as the Heads of Agreement.

One a deal has been agreed there will be a period of time before the sale agreement is prepared, accepted and signed. During this time there will be opportunities for remorse by both parties and the points agreed may become disputed. It is therefore important to make sure that the points agreed are recorded and accepted in writing. This document can then also be the data basis for the drafting of the sale agreement. The sooner it is signed, the higher the probability of a concluded sale. It does not have the same binding compliance as a sale agreement but can still form the basis of confirming what was the intent of the parties at the time. Generally the seller would arrange for the MoU to be drawn, but there is no reason why the buyer could not do so.

You will generally not be bound by the MoU to conclude the deal and there is still wiggle room to negotiate the price and payment conditions before the sale agreement is drawn and concluded. The purpose is to create a climate in which the seller and buyer can comfortably move towards preparing the binding sale agreement.

The MoU usually covers enforcable issues that could occur in the period between the deal time and the sale agreement signing. These could include:

the buyer will be bound to more non-disclosure requirements
the buyer will be compensated for specified costs if the seller withdraws the sale
the buyer has sole right to purchase for a specified period
the buyer might be required to identify the sources of finance and the intended schedule of payments
the seller may not promote the sale to any other buyer for a specified period
the seller might have to give access to financial documentation and tax records
the seller may need to give physical access to premises and staff for the performance of due diligence
a time schedule of tasks is often included in the MoU

The SALE AGREEMENT (known as the MOU)

This would nearly always be drawn by the seller's lawyers at the seller's cost.

As the buyer you should be concerned with your liabilities and performance requirements in the contract and making sure that the sale agreement is in line with the agreed points of the sale.

Make sure that you understand what happens if you miss any payment deadlines and what the situation will be if the deal unwravels.

Have you catered for hand-over assistance and client introductions.?

Have you dealt with the seller's possible re-entry to the market and posing a competitor threat.? This can be handled with a Restraint of Trade agreement.

It is vitally important to understand that you need the assistance of your laywer at this stage - who should have your interests to protect.

Perform The Due Diligence

The Due Diligence refers refers to you making sure that everything is pretty much as it is represented to be by the seller. A common definition would be : "a comprehensive appraisal of a business undertaken by a prospective buyer, especially to establish its assets and liabilities and evaluate its commercial potential." Wikipedia defines it as : "an investigation of a business or person prior to signing a contract. A common example of due diligence in various industries is the process through which a potential acquirer evaluates a target company or its assets for an acquisition.The theory behind due diligence holds that performing this type of investigation contributes significantly to informed decision making by enhancing the amount and quality of information available to decision makers"

This is a critically important process and we have accordingly devoted a separate section to this subject. Please refer to : Conducting a Due Diligence on Buying a Business

Closing The Deal

This is really all about the Sale Agreement and ensuring that it is a comprehensive document that details the intentions and duties of both parties in all aspects of the sale. This would include defining exactly what is for sale, the conditions of payment, the liabilities that will (and will not) transfer and the situation regarding past and present tax obligations. The higher the transaction price, the more the need for a good lawyer with suitable experience to be guiding you in this aspect.

Some areas that you must be certain are well covered include:

The seller did not report known critical negative information or gave false information.
Such issues constitute misrepresentation and, if serious enough, should allow you to cancel the deal with restitutive damages.
Non-payment, or late payment, of agreed installments.
This will always be a major issue and must be accommodated. Most deals include part payments that may be part of a self funding arrangement (such as 12 monthly installments) or they may be dependant on a third party completing a financing loan. Your agreement must define the sanctions for missing these deadlines and cover how the material nature of these events will be determined.
Restraint of trade.
You do not want the seller to launch a competing business in your trading area and immediately be approaching all your customers. Lawyers will be familiar with such agreements and this would usually be included in the sale agreement. It needs to be fair and reasonable and you need to remember that you can't really bar someone from their ability to earn a living.

The Hand Over

The sale agreement has been signed, the deposit has been paid and on the first of next month you are taking possession of the business.

Be aware that the business is vulnerable during and after the transition process to you, the new owner. The employees, your customers and your suppliers are all going to be sensitive to the coming changes - and that is not an unreasonable expectation. It will be very much up to you to allay fears and ensure that everyone is confident about the future.

A well prepared seller would have prepared an "operating manual" to ensure that you have a reference for processes and a recurring timetable for tasks, renewals, registrations, maintenance checks, etc. There should also be a "policies manual" containing guidlines for how decisions are made. If you do not have this documentation, then this is a good time to start assembling manuals for your future reference.

Unless you have bought a distressed business or from an owner with serious health issues (and maybe even from a deceased estate) you should have negotiated with the seller to have the seller's assistance during a specified hand over period. That should be specified in detail in the sale agreement, along with the appropriate sanctions for non-performance in this regard. But generally a happy and helpful seller should be mentoring you for the first month or few.

Although not technically part of the hand over, the employees themselves are a critical part of the institutional memory in terms of how the business operates. Because of their hands on experience they will often know more about the finer details of how things work. So the last thing you want is a hostile, suspicious and fearful work force. Get the staff on your side by being open about expansion plans and project yourself as a progressive and fair employer. Make sure that communication is open and your management style is transparent and respectful. Involve senior staff in your plans. If you have any plans to slash costs with staff retrenchments or salary increase postponements then it would be wiser to delay these until after the transition period. This is a bad time to lose key staff - and the better staff are usually the more employable who could easily fine alternate employment.

Control that "new broom" syndrome and concentrate on not rocking the takeover boat. Taking the extra time to really understand how the business operates, especially with you now running it, will make your forthcoming changes more likely to succeed.

Recommended Article - Buying A Business - What You Need To Know

Related Resources :

Buying a Business

How to Buy a Business
Restaurant Internet or Online Retail Manufacturing Service
Wholesale / Distribution Service Station / Convenience Store Liquors
Conducting a Due Diligence on Buying a Business

Selling a Business
Preparing Your Business for a Future Sale
How to Sell Your Business
Determining a Realistic Selling Price for Your Business

General Topics
Financing Sources for your Business Purchase
How to Choose a Business Partner

Anything we left out, stuff you don't agree with.?
Good article, bad article.?
Please give us your comments and suggestions.