Buying an existing business is a complicated process. I’ve done it
on my own and learned some painful lessons. Learning the business and
buying it at the same time is usually a bad idea. If you have worked
in the business, specifically this one, you have some idea what you
are getting into.
Long before you need a lawyer, you will need a good accountant to
help you thru the fine points. Following are some of the questions
you need to ask.
What are you buying?
Inventory? Inventory is not usually valued at its purchase price,
rather at its disposal price - melt or auction price. If it is more
than that, why would you spend more to buy inventory that hasn’t
sold? Your money would usually better be spent purchasing new items.
Equipment - what is its value - used. Get a list of everything.
Fixtures and sales equipment - used.
Obligations of the business - lease - how long, protection from
cancellation, is the cost in proportion to the income of the
business? Other obligations.
Customer list. Who, what they bought and when, address, phone,
Vendor list - what they supply, how often.
Employee records - salaries paid, health care expense, travel paid.
Have the state and federal obligations been paid? Proof of same in
Obligations - what does the business owe to whom and how is it
financed? Are the obligations transferrable to you or are they due
and payable on the date you take the business?
Is the location appropriate for the business? Traffic and adjacent
businesses impact the value. What is the economy in the area?
How is the business valued? Is it on the past income and its future
expectations? The number should have some basis in history. You need
tax returns, bank records, the business records of sales and
expenses. All of this for the past three years at a minimum. These
records should exist, not be generated for purposes of the sale - you
can tell if this is history or recent fiction. Is the customer list
and the business name a major part of the value? Can you even keep
the name and do you want to keep it? If not, why would you pay for
I don’t know what sort of business you are looking at - my guess is
a retail jewelry store. Find out how your potential industry is
valued. Is it a multiple of cash flow over years plus the tangibles?
Do you have an exit strategy? Can you make your numbers work so that
you can sell the business in the future?
If you want to be in this business, would you be better off to start
a new business rather than pick up the untidy parts of this existing
Prospects - is the business up or down? Why is it on the market? Is
the owner going to compete with a new business?
Will the business history support paying the loan to purchase the
business and to pay you a salary going forward? With a loan to pay,
it isn’t the same business model as what you are purchasing. You need
more money coming in because you have all the ongoing expenses, plus
the loan obligations.
Are you going to buy it with no further obligation or participation
on the part of the seller? This would be a red flag to me. You want
your seller to have skin in the game long time. Your price should be
paid over several years, and it should depend on the business making
money going forward. The seller should have financial incentive to
make this work for you.
You say that you would finance the purchase by a home equity loan.
Talk to a banker. Would he loan you the money to buy the business?
Economy be damned, the bank makes money loaning to businesses. If he
says no, is it because you are a bad risk, lacking experience, the
market has collapsed for the business or what? Then go and talk to
the SBA - small business administration - same questions. If they
won’t lend to you, why do you think your money from your home should
be at risk? Your house is not a cash register, it is where you live.
Are you prepared to lose your entire investment? How long do you have
to pay back the home equity loan? You are gambling your future, and
retail is just that - a gamble. Do you have other means of support
while this doesn’t make money?
Now that you have done the homework above, it is time to see a
lawyer. This is not buying a car, it involves a lot more than the
little list I have suggested. Friendship should have no influence on
the purchase. If anything, it is an unneeded distraction. Business is
business, friends are friends and they need to remain separate.
For what it is worth, I spent several years of my life evaluating
and executing mergers and acquisitions of small companies. It is a
little less complicated than rocket science, but not much less. The
list above is a small part of the evaluation.
And much earlier in my career, I bought a small business. That was an
expensive lesson. I didn’t know the business well. There was a gas
shortage and the business was in a resort area accessible only by
automobile. There were two sets of books and I relied on the owner
to tell me that his version of the books was how to value the
business, not what he told the feds. The only good thing was that the
price of the business was to be paid over several years. When the
business lost money the first year, the owner took it back. I was
only out the sizable down payment and a year of my life. It could
have been much worse.