Buying a Business in 8 Steps + Free Check List

Buying a business and starting a business are two opportunities that budding entrepreneurs may want to consider. In the case of buying a business, you’re taking slightly less risk than starting a business from scratch. Bear in mind that you’re buying the business for its value at that time. Also, know that purchasing a business, even a successful one, requires just as much work, if not more work, than starting a new one. Let’s review the important steps on how to buy a business and to keep track of what to keep in mind, download our free checklist.

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1. Make Key Considerations

Mindset and motivation are the first factors in any small business decision, whether it’s buying one or starting one. Evaluate where you stand from the following viewpoints to consider what business type makes sense for you and why you want to buy one in the first place:

• Why do I want to buy an existing business?
  • Why don’t I want to start from scratch?
  • What are my skill sets, experience, education, and expertise as they relate to different businesses and industries?
• What businesses and industries interest me or are a hobby or passion of mine?
• Which industries pose growth potential in the marketplace?
• What kind of time do I have available to give to this process?
• Do I have the money or credit to make this happen?
• Do I have the entrepreneurial spirit?
• Do I have a mindset for owning a small business?

The above questions to ask when buying a business force you to take an inventory of yourself as a potential small business owner. It will also guide you in choosing a business that suits your wants, expertise, and capabilities. This information then helps ensure that buying an existing business is the right approach for you.

2. Set an Investment Budget

How much can you afford to put into a business investment? Just like you wouldn’t start shopping for a home without knowing what kind of mortgage fits your budget, you don’t want to start looking into businesses without knowing your financial capacity for buying.

If you’re self-funding this purchase, there are a few pieces of information worth calculating for a helpful reality check:

• Net worth: This is basically a report card of your personal financial health, all said. The calculation is relatively simple: Add up your assets and liabilities. Then, subtract liabilities from assets. Check out Kiplinger’s easy calculator for finding your net worth—  and don’t let the number bog you down. It’s just worth knowing so that you can improve your financial situation, if it applies, and become a more attractive loan candidate.
• Credit: Another piece of your financial portrait is your credit report. This includes your overall score, collections, inquiries, payment history, and credit utilization. A bank will pass judgements based on this, so knowledge is power. If your score isn’t adequate for a bank loan, work to improve it.
• Debt-to-Income Ratio (DTI): A final key indicator to be aware of is your DTI. Your attractiveness as a loan candidate may come down to a ratio of 40% or higher, which defines your ability to repay the debt you’re asking for, among your other debts and obligations.

If you are planning on taking out a loan for this business, a great next step is to crunch the numbers using our SBA Loan Calculator, which will help determine how much money you need to buy a business. Before going much further in this process, it’s helpful to know if you’re a good candidate for a small business loan in the first place, along with what you qualify for and where you stand financially.

3. Explore Your Business Opportunities

Buying a business typically presents two options: purchasing a franchise (existing business model) or purchasing an existing business (existing business and business model). Both are proven in some capacity and, in the right environment, mean comparable price tags for the buyer. Because franchising is a slightly different process, in this article, we’re going to focus on buying an existing business.

Once you’ve targeted your industries, conduct research on what’s available. It may end up changing your mind, but it’s important to start somewhere. Here are two accessible online resources for finding businesses, real estate, franchises, and business brokers:

• BizBuySell (recommended)
  • Search for businesses, franchises, and brokers
  • Filter by industry, starting bid, keyword, gross revenue, year established, and more
  • Trends more toward main street businesses
  • Produced 127 results in my state for sale from $10,000 to $100,000
• Business Broker Network
  • Search for businesses, franchises, and brokers
  • Filter by location, industry category, Hot and Trending, investment level, and more
  • Trends more toward franchised businesses and business ideas
  • Produced 105 results in my state for sale from $10,000 to $100,000, but many of these were a duplicate listing

Another great feature of these sites is that many of the listings show Cash Flow, Revenue, or both, so you can learn pretty quickly which businesses are thriving and appropriately valued and which are overpriced. A brief visit to these sites will make you a much more informed buyer and will give you plenty of options, even if you don’t opt to hire a business broker.

4. Research Your Options

Once you’ve found one or two businesses that seem viable, feasible and attractive, it’s time to do some real homework to protect and inform yourself.

• Retain a Business Broker: Deciding whether to hire a business broker when buying a business is comparable to deciding whether to get a real estate agent when buying a home. The access and guidance a business broker provides can be a real asset throughout your search, negotiation, and purchase of an existing business. However, just as people manage to buy homes without a real estate agent, so can you buy a business without a business broker. It’ll cost less in the short run but can definitely make the process bumpier and maybe even more expensive in the long run.
• Retain a Small Business Attorney: A major part of the research on the businesses you’re evaluating is doing your “due diligence,” or obtaining all the necessary documentation and information to make an informed decision about the business purchase. A Business Broker or a Small Business Attorney can aid in the due diligence process, the back-and-forth communication between you and the seller, pulling and researching documentation and filings, and more.
• Learn the Legalities: It is your responsibility to understand all of the legalities of taking over ownership of an existing enterprise. Not only do you need to abide by all federal, state, and local requirements, you need to make sure the business is set up to do so under new ownership. These are all things that your business broker or attorney can help with, including filing or updating:
  • Permits and Licenses: The business may already have all the necessary permits and licenses, but you’d do well not to assume this. Plus, they may need to be updated, renewed, or transferred to new ownership.
  • Business Registration: Even if you don’t change the business name or business structure, you’ll need to update the business information on the Secretary of State website to reflect the name of the new owner.
  • Employer Identification Number (EIN): Depending on what you would like to do (change the business structure, name, ownership), a new EIN will likely be required upon transfer of business ownership. Investigate how the details of your purchase plan will affect this filing.
  • Zoning: Even if the business is zoned appropriately, research and understand your local zoning laws to see if or how this might be affected in the future.

5. Conduct a Business Valuation

Confirming the value ascribed to the business in question is an extension of the due diligence process. It’s important to make sure you’re paying a fair price for the business, and there are a couple of ways to do so.

• Retain an Accountant: Not only can a good accountant help you find your own capacity for purchasing a business, they can also help you evaluate the business you’re seeking to buy.

Depending on how much you know about the business, try running the numbers yourself for a preliminary valuation of the business. If the selling price and your own business valuation are worlds apart, it may be time to find an accountant.

• Apply The Business Opportunity Rule: This is another scenario in which a Small Business Attorney comes in handy. The FTC has a protective series of regulations in the business purchase process called the Business Opportunity Rule. An attorney can tell you if and when these circumstances apply to your potential purchase, but you can also arm yourself with the information ahead of time.
  • Disclosure Document: Part of the business opportunity includes a disclosure document outlining the following overview items, which serve as a preliminary legal and informational document for you as the buyer:
    • Basic Identifying Information
    • Earnings Claims [see below]
    • Legal Actions
    • Cancellation or Refund Policy
    • References
  • Earnings Claim Statement: One of the most important components of buying a business is knowing its earning potential. Or in the case of an existing business, knowing its actual earnings, documented on an Earnings Claim Statement, which is another legal document in which the current owner certifies their earnings claims in writing.

6. Make a Business Plan

If you’re lucky, the business seller will already have a business plan. Many franchises have a guiding plan for new franchisees, while others, like the highly desirable and discerning franchise Chick-Fil-A, require new owners and franchisees to write a business plan that fits into their business model.

It doesn’t really matter, though. Any good business owner, buyer, coach, and investor should write a business plan suitable to their capacity, skills, and investment. Even for an existing business, a new owner means change, and a good business plan will illustrate this plan of up to three years down the road. Infusing your plan with the existing business model is fine, but different folks run businesses with different strokes, and any bank will require a business plan for a sizable loan.

In fact, buying a business means your plan is the best of both worlds: reality and optimistic speculation. The best thing you can do in writing a business plan for your takeover is to infuse existing information and assets furnished by the seller (e.g., marketing strategy, staff, market research, branding, earnings, pricing strategy, financial statements, and customer segments) with your own big-picture plans, ideas, and application.

It just so happens we offer expertise on starting a business, so follow our guide on how to start a business and how to write an adequate how to write a business plan for any kind of idea on your radar.

7. Compute the Needed Investment

If you’re following our advice, early on in the process you used the SBA Loan Calculator to see how much you can afford to borrow or invest in the business acquisition. Additionally, your accountant ran the sale price of the business through a valuation process to ensure it’s priced fairly. In a nutshell, let’s go through the investment process in two parts: valuation and funding.

Determine Valuation

Valuation is determining the fair market value of the business in question to see what it should be purchased for. Never assume that the seller’s price is appropriate. It’s up to you to research and ensure a fair and profitable purchase price, and there are a few ways to valuate a business for sale.

In the case that you chose not to retain an accountant, review our business valuation calculator and guide for valuing a business, which also includes a worksheet to help you plug through a DIY valuation. Next, it may be wise to tap into a resource like Guidant Financial, which, for less than $500, will provide a detailed valuation and financing assessment, complemented by an industry analysis. You really can’t go wrong here. The obvious, full-service solution here is hiring an accountant for the full-service process of assisting with valuation, financing, and helping you determine what kind of investment you can realistically afford based on your own financial condition.

Determine ROI

Determine a Return on Investment (ROI). A key part of the investment calculation process is determining your ROI. No matter how passionate you may be about a business you’re considering, if it’s not a smart and reasonably safe investment, it’s something you may need to walk away from. That being said, small business is inherently risky, which is why bank loans aren’t easier to come by. Your accountant can help you determine whether this is a sound investment as far as small businesses go but also bear in mind that ROI simply demonstrates whether a business can pay for itself at a return rate or profit of at least 15%, according to Entrepreneur. There are actually lots of ways to determine the savviness of a financial investment in an existing business, and that’s where an accountant or broker can be immensely helpful in navigating this process.

Funding Options

There are many options for funding available and funding to purchase your target business can come in many forms. Depending on the price tag, an entrepreneur should consider a variety of financing opportunities, including:

• • • Loans: The word “loan” tends to make aspiring business owners bristle, but it tends to be unavoidable in the business acquisition world. Some funding avenues that are suitable for a from-scratch passion project (like Friends and Family, Crowdfunding, and Grants) aren’t feasible for a business purchase. There are, however, a few different types of business and personal loans to choose from:
    • Banks: A traditional bank loan from a big-box bank. One place to start is where you currently do your business banking and where there is hopefully an established relationship. Some large banking institutions that tend to be SMB-friendly and offer a wide variety of flexible financing products include Wells Fargo, Bank of America, Chase Bank, and US Bank.
    • Credit Unions: Just as you might first approach a bank you have a relationship with, it makes sense to approach a local credit union, especially one with which you already bank. Credit unions are nonprofits with very low interest rates.
    • SBA: Not only is the Small Business Administration a font of information and resources, but it’s also a great option for small businesses (or aspiring small business owners) seeking financing. Click on “SBA” above to review the six different types of SBA loans to see what you qualify for.
    • HELOC/HEL: A Home Equity Line of Credit (HELOC) and Home Equity Loan (HEL) are options for qualified homeowners to leverage the equity in their home to start/buy and grow a business. Read more on how to use a Home Equity Loan to start a business.

Investing and Financing Options

Depending on the nature of the business you’re looking to buy, investors may see enough ROI that they want to get in on the action. Sometimes known as Private or Angel Investors, this is an appealing way to obtain interest-free startup funding for your business purchase. Don’t count on this as Plan A, though. Unless you’ve got a trail-blazing or bank-busting small business on your hands, this is a lofty financing method.

In some circumstances, the business owner/seller will finance the purchase. That is, the seller agrees to accept monthly payments from the buyer directly for the purchase of the business and/or real estate in lieu or as a supplement to a bank or SBA loan.

Otherwise known as Rollovers for Business Startups (ROBS), 401(k) business financing is exactly as it sounds: you tap into your retirement funds tax- and penalty-free to finance your business. This option may be appealing for individuals with lower credit scores or who are not homeowners with equity to spare. Guidant Financial offers a comprehensive guide to exploring ROBS for your business purchase.

Unconventional Financing Alternatives

Limited cash doesn’t have to limit your purchasing power of that dream business. There are some unconventional ways around conventional financing such as lease to own, co-op partnerships, collateral, and factoring.

Lease-to-own is a function of cars and houses, so why not businesses? Also known as a Lease-purchase, this agreement (documented early on paper) is executed over an agreed-upon period of time during which the lessee operates the business and pays an up-front down payment and monthly payments to the lessor in anticipation of purchasing at lease-end.

Co-ops are a variation of a partnership, you could consider buying the business cooperatively with a person or business that has more buying power than you do up-front. Involve a Real Estate or Small Business Attorney here to execute a safe contract for all parties involved.

In some cases, you may be purchasing real estate along with equipment, inventory, vehicles, and other assets. These are assets you can borrow against as collateral, so be sure to factor them into your business plan and loan applications.

Factoring is an option that depends heavily on the type of business in question, but consider a factoring company to finance your activities before they’re executed. Factoring companies loan against Accounts Receivable, or money coming in that hasn’t been paid yet. So, if you’re in the situation of needing capital to fund activities and services before they’re rendered, a factoring company could be a short-term financing solution.

8. Begin the Paperwork

Once again, enter a Business Broker or Real Estate Attorney to help execute the final purchase and legal documents between seller and buyer. The stack of documents of business information and purchase documentation can include:

• Leases and other Real Estate Contracts, including Leasehold Improvements
• Inventory Appraisal
• Assets Appraisal
• Confidentiality Agreements and/or Nondisclosure Agreements
• Distribution Agreements
• Financial Statements
• Employment Contracts
• Proof of Insurance
• Tax Returns
• Sales Agreement
• Purchase Agreement
• Financing Documents
• Escrow

Remember That You’re Still Starting a Business

Because it’s new to you, even with a proven business model, a business can still fail under your new ownership. You’re technically a startup business and a new small business owner. So, all the rules of starting a business should be followed, including that business plan you wrote.

FAQs

Still have some questions? Here are a few one-offs we want to address.

What am I buying when I buy an existing business?

Other than the business model, reputation, branding, and other intellectual assets, the rest depends on what’s agreed upon. Your real estate attorney or business broker can help negotiate what’s included in the purchase; everything from a storefront or vehicle, to employees, to trade secrets and hands-on guidance.

How do I know if I’m getting a good price?

That’s the whole point of valuation. Just like I could price a $200,000 home for sale at $2 million, the seller can technically list the business for whatever they like. A DIY valuation, a Guidant valuation, or a valuation conducted with an accountant can help determine the financial combination of your worth, the business’s worth, and the return of that investment over time to determine if it’s a smart move.

How much money do I need to buy a business?

Based on all of the criteria and checklist items listed above, you’ll probably notice that this will depend pretty significantly. How much money you need to buy a business can vary greatly depending on how much you have to spend, what kind, size, age, and location of the business, and much more.

That being said, and taken with a grain of salt, here are some of BizBuySell’s 2020 Insights and Figures:

• Median 2020 Business Sale Price: $279,950
• Median 2020 Sold Business Cash Flow: $135,990
• Median 2020 Sold Business Revenue: $613,341
• Lowest Median Asking Price by Geography: $75,000 in Fresno, CA
• Highest Median Asking Price by Geography: $1.5 million in Greensboro – Highpoint, NC
• Median 2020 Sale Price by sample industries:
  • Car Wash: $900,000
  • Home Health Care: $375,000
  • Auto Repair Service: $295,000
  • Bars and Taverns: $200,000
  • Convenience Stores: $185,000
  • Restaurants: $180,000
  • Hair Salons and Barbers: $79,750
• Franchise Fee Range: $10,000 – $50,000*
  • *This fee doesn’t include all of the upfront investments, though. It’s just the price of buying into the franchise. Expect your upfront investment to near the median business sales price of $200,000+ when all is said and done.

How do I know which documents to collect from the seller?

This is what business brokers and real estate attorneys specialize in, which is why we recommend securing a team that will make this process as painless as possible. But for starters, you’ll want to collect everything you can about the business, including business plans, permits, licenses, registrations and certificates, existing contracts, inventory, software platforms, tax returns, earnings claims, any legal actions or pending legal actions against the business, and financial statements (which typically, at a minimum, include a Cash Flow Statement, Income Statement, and Balance Sheet).

If my DTI Ratio is less than 40%, should I opt against purchasing or starting a business?

Not necessarily. The DTI is only a portion of your full financial condition. Think of it as only one of the grades on your report card. It shapes the bigger picture, but it might not be a deal-breaker. If you’ve got savings, inheritance, investments, or some other means of self-funding the business, you and your DTI don’t have to answer to anyone. Your financial picture comes into sharper focus only when you need to get money from a bank or other lender. If you find yourself declined for a bank loan, you can work to improve your credit, your DTI, and/or opt for a less expensive startup.

What are some common mistakes to avoid when buying a business?

The whole idea to this guide is to show what to do, so as to avoid what not to do. The major mistake aspiring business owners make is neglecting to research and plan. The flip-side of the coin of this guide are some of the mistakes people make, such as by forgetting, neglecting, or failing to:

• Valuate – again, do not trust the listed sale price, especially of an independent business not held to franchise standards. As a smart business investor, it’s your responsibility to ensure that you’re making an intelligent investment in a business.
• Do Due Diligence – part of valuation is collecting all of the necessary paperwork and learning everything you can about the business you’re investigating. For every detail left uncovered, you’re putting yourself and this investment at significant risk.
• Build a Team – in buying businesses, starting businesses, and even selling businesses, strong-minded entrepreneurs tend to try going solo. But this may be the direst mistake of all. No one knows everything, and any good business owner knows what they know and acknowledges what they don’t know. Building a team of real estate brokers, accountants, attorneys, and more, will act as a force field of added protection and padding in buying and running a business.

What is the benefit of buying an existing business?

Here’s the big picture of three options. One is no better than the others—they’re just things that appeal to different people for different reasons.

Bottom Line

Buying a business is tricky work, but purchasing a proven business model and existing infrastructure has definite merit. The choice depends on how much expertise, investment, and flexibility you’re bringing to the table, and how much risk you’re willing to withstand. Not only do you need to do your due diligence as you would starting up, but you also need to make sure you’re investing in a profitable, scalable, and proven business model. Follow this guide to apply best practices, avoid pitfalls, and make a savvy and sustainable business buy.

Related: Internet Businesses for Sale