When you buy an existing business, you are assuming responsibility to an existing customer base. Buying a business this way, you are most concerned with the ability of the business to continue to earn profits.
The price you choose to pay for this business, therefore, is more related to the business’ past profit earning record. One commonly accepted way of evaluating this business is projecting its profits for the next three years based on its last three years and discounting the present value (using present value tables) to this year. This suggests that you expect to get your investment back within three years.
You may also choose to buy a business that is not doing well, believing that you can use your knowledge and talents to make it succeed.
Then the value you would place on it would have more to do with the replacement value of the assets of the business (plant, equipment & inventory) taken against what is shown on a current balance sheet, to be the book value of the assets and liabilities.
In some cases, you may wish to buy a business and resell it quickly; your success here would depend on your ability to identify businesses which can be turned around quickly and resold at a profit. You are particularly concerned with the balance sheet and the specific liquidity aspects revealed by it. This is what happens when the assets of a business are purchased from a receiver or a bankruptcy. Then you can either do a sort and a further liquidation sale, or you can pick up the pieces and attempt to build a new business from them.
Most people negotiating a buy/sell agreement for a business use the above methods in some combination. You negotiate for assets based on their worth to you. Beyond the asset value, you pay for inventory against cost figures (not retail dollars) and according to how current that inventory has been kept. You sort the inventory into current stock, slow sellers and dead stock. You shouldn’t pay for someone else’s mistakes, i.e. “dead stock.” “Slow sellers” stock you might offer 50 cents on the dollar on cost, and for current stock, you pay near cost.
How to Do It
1. As a first step, learn about the process by seeking out books which explain how to buy a business. Pay special attention to the reason why the person is selling the business.
2. To find businesses available for purchase:
—check newspapers for classified ads under Business Opportunities or similar headings;
—contact commercial real estate agents;
—visit businesses which interest you, to observe their operations; and
—talk to business professionals (lawyers, accountants and bankers) to see if they know of any firms which might be for sale.
3. Check out businesses you would like to operate looking for owners who want to retire or sell for other reasons such as boredom, partnership disagreements, divorce or poor health.
4. Look for businesses which are not doing well, and which your talents, knowledge and energy could make successful. Beware of businesses which are in a shrinking marketplace (e.g. typesetting printer businesses).
5. Identify and talk with potential customers to determine their need for your product.
6. Before entering into negotiations to purchase a business, talk to your banker, accountant and lawyer.
Key Questions to Ask:
What existing businesses could I buy and operate?
What types of businesses am I interested in?
What types of businesses would I enjoy operating?
What businesses could I run, based on my previous experience?
What funds are available to me for the purchase of a business?
John Thompson is a freelance writer based in San Francisco.
