How to Buy a Business: The Ultimate Guide

Here at Fit Small Business we have written over a dozen articles on how to buy a business. In this ultimate guide, we bring together all the resources on buying and valuing a business into one place. This guide covers the following:

• Where to Find Businesses for Sale
• Questions to Ask When Buying a Business
• How to Value a Business
• Documents That Need to Be Exchanged When Buying a Business
• How to Set Your Budget For Buying a Business
• Financing Options for Buying a Business
• Your Allies in Buying a Business: Lawyers, Accountants, and Brokers

(Be sure to read the section on Rollover for Business Startups (ROBS). A ROBS lets you tap into your retirement funds to buy a business without having to pay taxes or early withdrawal penalties. For more information, contact Guidant, our recommended ROBS provider).

Where to Find Businesses For Sale

Businesses are available for sale in many places. Often times, the best opportunities aren’t advertised, so it’s a good idea to begin your search by asking fellow business owners or contacts in the industry for leads.

Other sources include the following:

• Online business-for-sale sites – We recommend BizBuySell.com because it’s the largest online database of businesses for sale.
• Newspaper classifieds and industry publications – Sometimes, the traditional route works best. While some small businesses no longer advertise in newspapers and publications, many still do.
• Franchises –  Most franchisors list franchising information online and will list phone numbers to call to get further information.
• Business brokers – Business brokers represent the seller and are paid by the seller. However, they can help you find businesses for sale that you might not find on your own and have a wealth of knowledge about what’s on the market and how much businesses are going for.

Looking to buy a small business? Murphy Business & Financial Corporation is a nationwide business broker a large inventory of small businesses for sale. Let them do the work of finding you a business in your industry and price range. Set up a free consultation with a highly trained Murphy business broker today.

Visit Murphy  

Questions to Ask When Buying a Business

When buying a small business, there’s a lot of information to uncover. You should know which questions to ask the seller so that you get all the necessary details and avoid buyer’s remorse. Below, I’ve listed some of the most important questions to ask. For a full list of questions to ask, see our article Questions to Ask When Buying a Business.

Questions to Ask Yourself:

• Why buy this business and not just start one from scratch? Are there benefits to buying, such as a great location, existing customer base, etc.?
• Do I have interest and experience in what the business does?
• Is there a positive outlook for this type of business? What’s the competition like?
• Can I afford to buy the business?
  • Do I need a loan? If so, can I qualify for a bank loan?
  • Do I have personal assets, such as retirement funds or home equity, that I can use to buy the business?

Basic Questions to Ask the Seller:

• What does the business do?
• Why is the business for sale?
• How old is the business, and how long has it been operating under the current owner?

Financial Performance of the Business:

• What have been the annual gross revenues of the business for the past two years and to date?
• What have been the annual net profits of the business for the past two years and to date?

Price of the Business:

• What is the purchase price, and what assets are included in that price? (Most small business sales are structured like a sale of assets)
• How was the purchase price determined?
• Is seller financing available? If so, how much?

Day-to-Day Management of the Business:

• Does the business currently lease space? If so, will the lease end soon and need to be renegotiated?
• What licenses or permits will I need to operate the business?
• How does the business generate revenue?
  • One-time payments for goods and services? Subscription model? Long-term or short-term contracts?
    • If there are existing contracts, can they be assigned to the new owner?

In general, talk to as many different people as you can about the business’ history and prospects for future success. What do employees have to say about the business currently? What about customers and vendors? You should also try to find out how dependent the business is on the current owner? If a business is highly dependent on the current owner, it may not survive a transition of ownership.

How to Value a Business

The seller will give you a purchase price for the business, but how do you know if the price is accurate? It’s important to do a valuation of the business.

At the very beginning, you should get a good ballpark estimate of how much the business is worth. To get a rough estimate of a business’ valuation, use our Business Valuation Calculator. This calculator tells you the approximate worth of a small business based on its annual revenues and profits.

After getting a rough estimate, but before it’s time to sit down with the seller and negotiate a price, you’ll need to finetune the valuation. To do that, you can get a professional valuation from an expert such as BizEquity. Alternatively, you can do it yourself by calculating the seller discretionary earnings (SDE) for the business. Seller discretionary earnings are the earnings for the business with certain expenses added back in to give a true picture of the business’ earnings. Once you get the SDE, you multiply that by an industry multiple to get the business’ valuation. Click here to read How to Value a Business, which tells you step-by-step instructions on how to calculate SDE and make a business valuation.

Documents That Need to Be Exchanged When Buying a Business

Buying a business is a paperwork intensive endeavor. In order to avoid legal and financial troubles down the line, it’s important to exchange all the necessary paperwork and have it reviewed by an attorney and accountant.

As soon as you’re serious about buying a business, you should gather financial documents for the business, including the following:

• Last 3 years of the business’ tax returns
• Last 2 years and year-to-date income statement
• Last 2 years and year-to-date balance sheet
• Organizational documents (e.g. articles of incorporation, certificate of good standing from the Secretary of State, etc.)
• Existing contracts
• Commercial lease for the office building or business space
• Franchise Disclosure Document (if the business is a franchise)

Finally, at closing, you’ll need to exchange the following documents:

• Purchase Agreement (deal contract)
• Promissory Notes and collateral agreements for any financing that you’ll be using.
• Commercial lease (if applicable)
• Transfer documents for any vehicles that may be part of the purchase
• Bill of sale – transfers ownership of tangible business assets
• Non-compete agreement from the seller (if applicable)
• Bulk sale documents – these govern the sale of inventory
• IRS Form 8594 – shows how assets are allocated during the purchase
• Consultation/employment agreement – this is necessary if the owner will be staying on for some time to aid with the transition of the business

To access free templates of the documents above, see our article Questions to Ask When Buying a Business.

Determining Your Budget for Buying a Business

Most people who think about how to buy a business forget the most important thing: setting a budget! Here are a few steps to help you figure out how much you can afford:

1. Add up your liquid assets – Liquid assets are assets like cash, checkings and savings accounts, and investments that you can easily convert to cash. Your liquid assets tell you how much you can invest up front in the business. In most cases, you’ll have to make at least a 20 % equity injection into the business upfront. For example, if you have $50,000 in liquid assets, you would have a sufficient down payment on a business that’s worth $250,000 or less.
2. Consider other debt that you have – Do you have a mortgage? A student loan? Credit card debt? If so, you’ll need to factor in those obligations when deciding how much you can spend on a business acquisition. Calculate your Debt-to-Income (DTI) Ratio by dividing your monthly debt payments by your pre-tax monthly income. You can include your spouse’s income if you’re married. Ideally, your DTI should be below 40 %.
3. Evaluate the business’ cash flow – If you have a particular business in mind that you’d like to buy, divide its monthly net operating income by your monthly loan payments. This is your Debt Service Coverage Ratio (DSCR). Ideally, your DSCR should be at least 1.25. Anything less, and you’ll have difficulty paying back your loan with the business’ current cash flow.

Doing these things should give you a good estimate of what you can afford. As you find businesses for sale and work with sellers and lenders, you might refine this initial estimate.

Financing Options for Buying a Business

If you’re planning to buy a business, then more likely than not, you’ll need some kind of financing to make it happen. There are several financing options for buying a business, chief among them the following:

1. Seller financing
2. SBA loan or bank loan
3. Rollover for Business Startups (ROBS)
4. Other types of financing

Seller financing is a loan provided by the current owner of the business. Usually, seller financing covers 30-60 % of the purchase price of a business. Banks and other lenders look more favorably upon deals that include seller financing versus those that don’t because it shows that the seller is invested in the business’ success. Read more about seller financing by clicking here.

Seller financing is often used in conjunction with a bank loan or SBA loan. To qualify for a bank or SBA loan, however, you generally need to have a credit score above 680 (check here for free) and some experience in the industry or in running a business. Also, the business should have a history of strong revenues and profits. If that sounds like you, schedule a call with our preferred loan provider for business acquisitions, South End Capital.

If you’re not able to qualify for an SBA loan or bank loan, or just don’t want to pay a bank interest, another good option can be to invest your own retirement money in the purchase of the business.  A Rollover for Business Startups (ROBS) lets you do this without paying early withdrawal fees or income taxes. To do a ROBS, you should have at least $50,000 in a 401(k), traditional IRA, or other eligible retirement account (Roth IRAs aren’t eligible). Setting up a ROBS can be complicated though. We advise getting professional assistance from a company such as Guidant, our recommended ROBS provider.

Finally, consider other alternatives such as getting a consumer loan, borrowing from family and friends, or getting a home equity loan. If you’re buying a franchise, the franchisor may offer some amount of in-house financing. We cover the range of options in our article How to Get a Loan to Buy a Business.

Your Allies in Buying a Business: Accountant, Lawyer, and Broker

If you’ve read all the way through this guide and are feeling overwhelmed at the amount of work involved in buying a business, don’t worry because you don’t have to do it alone. There are three people that can be immensely helpful to you throughout your journey of buying a business:

• Your accountant – An accountant is useful primarily for evaluating the financial condition of the businesses that you are prospecting. When buying a business, you’re going to exchange a lot of paperwork with the seller, and a lot of this paperwork will be financial in nature. It will include the business’ recent tax returns, income statements, balance sheets, and cash flow statements. Without a qualified accountant to review these, it be difficult to know if a business is a good investment.
• Your lawyer – A lawyer will be necessary for the nuts-and-bolts of the deal. He or she can help you draft a purchase agreement, obtain any permits that you’ll need for the business, review existing contracts of the business that you’ll be responsible for, and more. In addition to that, a lawyer can help you uncover any problems with the business early on. For example, if the business is currently operating in violation of zoning laws, that could come back to haunt the new owner.
• Your business broker – Lastly, consider working with a business broker. A business broker represents the seller and has a fiduciary duty to the seller. The seller pays the broker’s commission. However, a broker can be very valuable to you as a buyer in sending you listings for sale, negotiating with the seller, and bringing some structure to the process of exchanging information and documents. To find a business broker, a good place to start is the International Business Brokers Association, or ask a fellow business owner for a referral.

Consider hiring each of these three people to make the process of buying a business a little less stressful for yourself.

Bottom Line

Buying a business is an exciting time! However, there is a lot to consider. You should be ready to devote a significant amount of time and effort into finding the best business to purchase, valuing the business, exchanging paperwork, and financing the purchase. Good luck!

Looking to buy a small business? Murphy Business & Financial Corporation is a nationwide business broker a large inventory of small businesses for sale. Let them do the work of finding you a business in your industry and price range. Set up a free consultation with a highly trained Murphy business broker today.

Visit Murphy