Buying an existing business can be an excellent alternative to starting a new one from scratch. There are advantages to this approach. Clearly, you’ll first need to have the capital (or access to the capital) required to buy a business. By using your capital, buying a business will let you focus on building or adding value to the business more quickly because the startup steps have already been taken care of.
In this section, we’ll outline some steps necessary for a successful buyout.
1) Self Evaluation
The first step should be to determine your goals, expectations, motives, risk profile and how serious you are about your search. Self assessment is even more crucial if you’re buying a business together with someone else. It’s important for everyone involved to be on the same page when searching for a business. Otherwise, your asking for problems and headaches.
Ask yourself:
- How committed you are to the search. your expectations should be consistent with your commitment
- How much you are willing to risk personally in terms of wealth and security
- How thorough will you be with your research
- How patient and willing to wait for the right opportunity you are
- Whether you’re willing to move quickly and decisively as needed
- Whether you’re willing to pursue the search full-time
It’s fine to be more casual with your search, but then you should make sure your expectations match your efforts. A causal searcher should also expect a longer time horizon for the search to bear fruit.
An unrealistic search involves waiting for a great deal to somehow fall into place and looking for shortcuts and bargains. That’s not to say that bargains can’t be had by casually looking around, just that it will take longer.
Importantly, when you have a clear sense of what you’re looking for, you’ll have an easier time persuading sellers and their intermediaries to take you seriously and work productively with you.
2) Define Target Company Profile
In order to define the desired target company profile, at a minimum you should consider the:
- Desired size or purchase price of the deal.
- Preferred industry
- Main factors for success (marketing, information technology, inventory management, etc.)
- Customer type (business vs. consumer, local vs. regional vs. international, etc)
- Preferred geographical location of the business
- Profile of the business’s current owners (how many owners, their reputation and willingness to sell)
Besides considering the “standard” dimensions listed above, you’ll have to filter the good deals from the bad. As a rule of thumb, an ideal target company should have:
- Potential for increasing sales and earnings
- Minimal debt
- Predictable cash flow
- Enough assets to allow for more borrowing
During your search, you’re unlikely to find many (if any at all) buyout candidates that fit exactly the criteria you’ve outlined. You’ll have to be flexible and probably reassess your criteria on a case by case basis depending on the target company.
3) Finding Good Places to Search
Finding a buyout company that’s a good fit with your criteria is one of the biggest challenges you’ll face when buying a business. There are a lot of bad deals out there and you might feel as though there’s an endless amount of legwork to get a deal initiated. Knowing where to start looking will help facilitate your research. Here are some sources to get you started.
Personal Contacts: Using your social networks might help you find people who have themselves bought businesses which can be a valuable source of information and support. They can often help you avoid common mistakes.
The Internet: There are many websites acting as intermediaries to put business buyers and sellers together. Using the World Wide Web is a cost-effective and relatively speedy way of looking for leads. You’ll find listings of all kinds in many industries. You’ll find websites specializing in certain regions while others try to tackle a broader geographical area. For example, http://www.bizben.com/ serves the California region while http://www.bizbuysell.com has listings for businesses in various countries.
Magazines, publications and Newspapers: There’s a lot of printed media out there that can be useful for finding buyout leads. Commercial investment magazines can often be found on magazine racks. These are geared for finding retail businesses. Trade publications are great for industry specific searches, and your local newspapers have classified sections that may generate some leads.
Business brokers: Business brokers attempt to find appropriate buyers for business sellers and keep a percentage if the purchase price if a deal is made. Brokers are often listed in various directories such as the Yellow Pages and in the business or classified sections of many newspapers. A good broker can be an excellent source of leads but care should be taken when choosing one.
There are both professional and independent brokers. Independent brokers may be completely unregulated and because a license is often not required, anyone can claim to be a broker. Use only trustworthy brokers and be sure to check references. Ask people you trust if they can refer you to someone appropriate. In the United Sates, one of the largest network of independent brokers is VR Business Brokers (http://www.vrbusinessbrokers.com) operating in dozens of cities.
Venture Capital Firms, Investment Banks: These organizations typically only involve themselves with deals in the multimillion dollar range. If you’re thinking of “starting small” and growing, approaching these types of firms is probably not worth your time. On the other hand, if you are looking to put together a multimillion dollar deal then VCs, investment banks and professional brokers are areas to investigate.
4) Cash, Credibility, Contacts
Besides your patience and thoroughness, the deal you end up putting together will primarily depend on your resources. These resources essential to the buyout are cash, credibility and contacts. How much of these resources you need will depend on the size of the deal. The pricier the deal, the more sophisticated the potential buyers. Sellers will also require more in terms of credentials from potential buyers as the value of the deal goes up. Rightfully so, nobody should spend time on obvious mismatches. Importantly, if you’re depending on your contacts to put up cash, ensure that they’re committed to backing the project. Try to find out as early as possible whether or not your backers are committed to any given project so that you can start looking for another buyout deal if necessary.
5) Evaluate the Business
Evaluating the potential buyout company is vital. Don’t worry about passing up on a potential deal if you’re not comfortable with it because it’s early in your search. You’ll very likely come up with another potential buyout shortly after. You probably won’t have many different buyout prospects at the same time which makes comparing deals side by side rare. You should nevertheless compare the different business deals that you encounter.
Evaluate the business along multiple dimensions including:
Financial performance: Looking at a potential company’s financial statements is a must to get an idea about its performance. You’ll see if the company has been shrinking or growing and at what rate. You can also use these documents when making comparisons with other firms in the same industry and help gauge its potential. Ask for professional help if you’re not comfortable with balance sheets, income and cash flow statements. Signing a nondisclosure agreement (NDA) with the current owners in order to get this type of information is commonplace.
Riskiness: The more stable the company’s cash flow the better.
Company maturity: Is the company established in its market or is it a new player?
Competition: Is the market for the company’s products full of ferocious competitors?
Industry: Is the industry growing, shrinking or roughly stable?
Management: A competent management team is essential for the success of any business.
Exit strategies: How easy would it be to resell or liquidate the company?
Finally, make sure that you’re confident that you’ll be able to add value to any business you buy out. This is the key to improving the business’s performance. The previous owners will probably already have tried many of the basic things to improve performance so try to find out what has already been attempted. You’ll likely have to get creative or use different techniques or technologies when making operational changes.
6) Cover Yourself
Be sure you have access to professionals who can help you through the process. Investing in an experienced lawyer is worth your while. A lawyer will help you steer clear from pitfalls and help you put together a deal that minimizes your exposure. A good accountant can give you advice about analyzing the target company’s financials and help you weed out bad deals. Finally, use common sense and try to stay emotionally neutral. Try not to be too cynical, but be skeptical of offerings that seem too good to be true.