Business Buyers FAQs
Most of the buyers FAQs are answered here for taking informed decision in an acquisition.
What are the key steps to a successful business search process?
Buying a business is a process that takes time. It can sometimes take years to find the right opportunity. There are some key steps to follow in the business search process:
Start with a self-assessment:
Ask yourself why you want to buy a business. What types of work activities do you like and what kind of lifestyle do you want to pursue? It is important to understand that there may be more work and longer hours for an owner in some industries. Be sure to include your family in the assessment.
Establish financial expectations:
Determine how much money you need and want to earn. Make sure your expectations are in line with the types of businesses you are targeting and the return they can produce.
Put together a personal financial statement:
Outline your assets and liabilities. Identify what you can use for your initial investment. The personal financial statement serves as proof of your financial wherewithal, so be prepared to share this document with a seller’s intermediary.
Update your résumé:
Sellers want to be sure that their business will continue to be a success. They are looking for someone with the experience necessary to continue their legacy and take care of the staff. Ultimately, you are selling yourself to the current owner(s), the lender, and the professionals representing them.
Outline your acquisition criteria:
Define the parameters of your search. Ideally, it should include your targeted industries, geographic area, and transaction size. Your motivation, lifestyle, expectations, financial statement and résumé will help you develop your acquisition criteria.
Search multiple sources and enlist help:
Let your professional advisors (e.g. attorney, accountant, financial planner) know you are looking for a business. Most importantly, contact business intermediaries who represent businesses within your targeted market. They will notify you of available companies that meet your criteria and qualifications. Most business brokers or intermediaries work for the seller and are paid by the seller. That means you can enjoy the luxury of their services at no cost. The intermediary is looking out for the seller’s best interests, so you should have experienced council to represent you in any transaction.
What is the due diligence process?
Merriam-Webster Dictionary defines due diligence as “research and analysis of a company or organization done in preparation for a business transaction.” Ultimately, due diligence is the process of being sure that things are as they appear before a deal is sealed. For someone considering a merger or the purchase of an existing business, the review of documentation and the answers to your due diligence questions are critical. There is no doubt it is a complex process that can be time-consuming, but with so much on the line with any merger or acquisition, you do not want to make a decision without all of the information. You want to be sure, everything is reviewed and all questions are answered to your satisfaction.
During the due diligence process, an often lengthy list of documents should be provided. The list of documents should cover a range of areas, including:
- Legal structure and incorporation of the company
- Internal Revenue Service (IRS) records
- Insurance policy information
- Organizational structure
- Personnel policies
- Capital and real estate
- Contracts, licenses, agreements and affiliations
- Technology and Intellectual Property
- Current or potential legal liabilities
- Marketing materials
Today more than ever, buyers are putting more emphasis on the due diligence process, and while the financial aspect is a key component, the due diligence process should also consider organizational items. Be sure to seek documentation and ask important questions about the company’s culture, strategy, leadership and competencies.
Although the due diligence process may take considerable time, it is a critical part of any transaction and should be considered the foundation of the entire deal.
What are some creative financing options?
The evaporation of small business capital markets and other economic factors have made creative financing the norm for today’s business buyer. There are a number of creative financing options that you can consider.
- Seller Financing – Increasingly, buyers and lenders are looking to the seller for financing as they try to put a transaction together. In such a scenario, the seller will hold a note at an agreed upon interest rate for a specific term or amortization – generally ranging from five to 10 years. The terms of the sale may include a balloon payment three to five years after the purchase date. It is a way of giving the buyer time to get up and running and to establish a successful track record with the business. Seller financing makes the bank more comfortable with the transaction. Lenders know they have a seller who has a vested interest in the success of the business rather than one who will take their money and run. There are a number of benefits for business owners who are considering seller financing:
- Fast sale
- Tax Breaks
- SBA Loans – In business sales, conventional bank loans may not be available, so a buyer may want to consider going to a Small Business Administration (SBA) lender, which has a number of loan options. The SBA guarantees a portion of the loan. The buyer pays an SBA loan fee that allows him or her to get funding for a loan the bank could not do conventionally. If an SBA guaranteed loan goes into default, the SBA will pay the lending institution up to 75 percent of any deficit left after liquidating the collateral. There have been several changes to the Small Business Administration’s lending guidelines and standard operating procedures. You will want to speak with an advisor who is familiar with these recent changes.
- Earn outs – Earn out financing involves a certain dollar amount agreed on by the buyer and seller to be paid to the seller based on the performance of the company after the transaction is completed. Earn outs can be structured in a variety of ways and can be based on different financial benchmarks such as a company’s revenues, gross profits or net income. Earn out financing is often used for companies that are in a turnaround situation or when buyers are purchasing on potential, rather than on historical cash flow.
- Mezzanine Financing – In mergers and acquisitions, mezzanine financing is another alternative for a buyer looking for capital where the financing package may include interest rates of 20 to 30 percent. The lenders in this situation are typically high net worth individuals who are expecting a larger return on their investment. They are lending in a junior lien or a position behind the bank and seller financing. The loans are typically made with limited sources of collateral, thus the request for higher interest rates. Again, this financing is often used in funding goodwill or reputation in an acquisition.
- Funding Scenario – In a million dollar transaction, the buyer would be expected to have a 20 percent down payment. The seller may hold an additional 10 to 20 percent in seller financing, and the lending institution would offer a combination of conventional or SBA financing to cover the difference, depending on collateral available. A buyer and the lending institution must evaluate a company’s cash flow and determine if it is adequate to cover their debt service and provide a reasonable return on their investment. Lending institutions will also be examining whether a buyer’s coverage ratio or excess cash flow after all debt is paid, is adequate to cover their needs.
What are the benefits of buying a business instead of starting one?
So you want to be your own boss. There are certainly pros and cons to both buying and starting a business. If you do a careful analysis, you will learn what many seasoned entrepreneurs have discovered…the risk-to-reward ratio is tipped in your favor when you purchase an existing business. Starting a business of your own can pay great dividends, but it is important to understand that the risks are significant. Most start-up businesses will falter and eventually die. According to Michael Gerber, author of The E-Myth Revisited, 40 percent of new businesses fail in the first year and 80 percent fail within five years. On the other hand, purchasing an existing business reduces an entrepreneur’s risk while creating opportunities for tremendous profit. There are a number of reasons to consider the purchase of an existing business rather that starting one:
- Proven Concept. Buying an established business is less risky – as a buyer, you already know the process or concept works. Financing a purchase is often easier than securing funding for a start-up business for that very reason—the business has a track record.
- Brand. You are buying a brand name. The on-going benefits of any marketing or networking the prior owner has done will transfer to you. When you have an established name in the business community, it is easier to place cold calls and attract new business than with an unproven start up.
- Relationships. With the purchase of an existing business, you will also be buying an existing customer base and vendor base that took years to build. It is very common for the seller to stay on and transition with the business for a short time to transfer those relationships to the buyer.
- Focus. When you buy a business, you can start working immediately and focus on improving and growing the business immediately. The seller has already laid the foundation and taken care of the time-consuming, tedious start up work. Starting a new business means spending a lot of time and money on basic items like computers, telephones, furniture and policies that do not directly generate cash flow.
- People. In an acquisition, one of the most valuable and important assets you are buying is the people. It took the seller time to find those employees, develop them and assimilate them into the company culture. With the right team in place, just about anything is possible and you will have an easier time implementing growth strategies. In addition, with trained people in place you will have more liberty to take vacation, spend time with family, or work on other business ventures. When start-up owners and independent contractors go on vacation, the business goes too.
- Cash Flow. Typically, a sale is structured so you can cover the debt service, take a reasonable salary, and have some left over to take the business to the next level. Start up owners, on the other hand, often “starve” at first. Some experts say start-ups are not expected to make money for the first three years.
- Risk. Even with all these advantages, some entrepreneurs believe it is cheaper, and therefore less risky, to start a business than to buy one. However, risk is relative. A buyer may pay $1 million, for example, for an established business with strong cash flows of approximately $200,000 to $300,000. A lending institution funds the transaction because historical revenues show the cash flow can support the purchase price. For many people, however, that is far less risky than taking out a $300,000 loan with an unproven concept and projections that may or may not be realized.
Becoming your own boss always involves a risk. When you buy a business, you take a calculated risk that eliminates a lot of the pitfalls and potential for failure that come with a start up.