Doing your homework before buying a business will help prevent buyer’s remorse and help you do a better job in running the business should you decide to go through with the purchase. This article covers some of the crucial questions you should ask the seller and yourself in order to make a well informed decision. We’ve ordered the questions in a convenient step-by-step format, so if you decide at any stage that you don’t want to purchase the business, you won’t waste time gathering information you don’t need.

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Step 1. Determine if You Are Interested in Buying the Business.

Here are some initial questions you should ask yourself and the seller to gauge your level of interest in buying a particular business and whether you can afford to purchase it.

Questions to Ask the Seller:

The Basics:

• 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?

These are the most basic questions you should start your search with. If the business does something that you have no interest or experience in, or the business is for sale because it hasn’t been performing well financially, then you may want to think twice before purchasing it.

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?

Get some preliminary numbers on how the business has been doing financially for the last few years. If you are interested in buying the business, then you will later get financial documents to verify this information.

Price of the Business

• What is the purchase price, and what assets are included in that price?
• Is the purchase price supported by the profits of the business?
• Is seller financing available? If so, how much?

There will be time for negotiations later, but you should get a price estimate for the business from the seller. A good rule of thumb for most businesses is that the valuation should be no higher than 3 times annual net profits. However, this varies based on things like industry and geographical location.

Often, what the buyer thinks of as “the business” is not what the seller thinks of as “the business,” so it’s important to ask what assets and liabilities are included in the purchase price. Specific assets may include real estate, customer lists, contracts, equipment, etc. The sale may also pass debts and liabilities of the business on to you.

Lastly, you should ask if the owner is offering seller financing because, unless you’re planning to do an all-cash deal, this could be an important tool for buying the business.

Questions to Ask Yourself:

• Why buy this business and not just start one from scratch?
• 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?
• Do I plan to buy and run the business on my own or with a partner(s)?
• Can I afford to buy the business, given personal and family constraints?
  Note: Various financing options are available to fund a business acquisition, including seller financing and bank and SBA loans.
• What parts of the business do you want to buy? What is the owner actually selling? (e.g. contracts, customer lists, land/real estate, equipment, inventory, debts/liabilities, etc.).

These are some gut-check questions to ask yourself to make sure you are buying a business which meshes well with your interests, financial ability, and goals. If you’re planning to have a business partner, make sure that you and your partner are on the same page on the important decisions in the acquisition process.

Another question which you should ask is “What Is My Credit Score?” Your credit score will be critical in securing financing for buying a business. You can check your credit score for free here.

Step 2. Find Out How the Business is Valued.

Valuation is often the most challenging part of the business acquisition process but also one of the most important. Asking these questions will help you evaluate if the price is fair and reasonable.

Questions to Ask the Seller

• How was the business’ purchase price determined?
  • Is the valuation based on internal calculations or an independent appraisal?
• Is there room to negotiate the purchase price?
• What is the goodwill value of the business?
  Note: Goodwill value is the value associated with certain non-tangible business assets, such as reputation and any patents or trademarks the business holds.
• How is the sale structured–is this an asset sale, stock sale, or a sale of membership or partnership interests?

There is more than one way to value a business. Valuation may be based on revenues, profits, or goodwill value or on a combination of these things. The most objective valuation will typically be determined by an independent appraisal.

While most business acquisitions are asset transfers, some are treated as stock sales or mergers. How the sale is structured has legal and tax consequences, so make sure to discuss this with the seller fairly early in the process.

Step 3. Think About Financing Options.

Once you and the seller decide on a fair price for the business, it’s time to think about how you will come up with the money. Some buyers are able to do all-cash deals. In most cases, however, you’ll need some of type of financing.

Questions to Ask the Seller

• Is seller financing available? How much?
  • If you’re also planning to get a bank loan or SBA loan to buy the business, is the seller willing to take a standby position? For how long?
    Note: Most lenders require the seller to take a standby position for 2 years, which means the seller won’t receive any payments for 2 years.
  • Is the seller willing to subordinate to a bank or SBA loan?
    Note: Most lenders require the seller to subordinate to a bank or SBA loan, which means that the bank gets first rights to any proceeds of collateral if the buyer is unable to pay back the loan.
  • What are the terms and conditions of seller financing? Interest rate? Length of loan? What happens if you’re unable to pay back the loan?
• Will the seller wait for you to find external financing if no seller financing is offered?

The first thing to consider is whether the owner offers seller financing. Seller financing is an attractive aspect of any business acquisition because it shows that the owner believes in the business and the new owner-to-be. Seller financing usually covers about 10-25 % of the purchase price of a business, but it may cover more. If you’re getting a bank or SBA loan and don’t have enough cash for a down payment, seller financing can sometimes be used to supplement a down payment.

Questions to Ask Yourself

• Do I really need financing, or can I afford an all-cash deal?
• Do I have personal assets, such as retirement funds or home equity, that I can use to finance the purchase?
• Do I have enough money for a down payment?
  Note: Bank or SBA loans require a down payment that’s 10-30 % of the total asking price.
• Have I written out a business plan with financial projections to provide to lenders?
• Do I have a resume to provide to lenders which highlights relevant industry experience and/or business management experience?
• Do I have a good credit score (650+) that will allow me to qualify for bank financing?
• Is there collateral, such as equity in a home, that I can bring to the table?

Few buyers can afford all-cash deals, but you do need to bring some cash to the deal. Lenders want you to have some “skin in the game” when it comes to your business acquisition. If you don’t have cash in the bank, you can get funds by utilizing your retirement account or home equity. Remember, if you’re relying on bank financing, your credit score will play a big role, as will the comprehensiveness of your business plan and the collateral you can bring to the table. Collateral can be a combination of personal and business assets.

Step 4. Gather All Necessary Documentation.

If you’re a serious buyer, you should work with the seller and the seller’s broker to see financial and other documents for the business. Use these documents as a window into the business and to verify information that the seller has already given you.  

• What documents should be examined before buying the business?
  • Organizational documents for the business (e.g. incorporation docs, certificates of good standing, business licenses, etc.)
  • Previous 3 years of business tax returns
  • Current year income statements, balance sheets, and cash flow statements
  • Information on existing business liabilities
  • Customer lists with proprietary information blocked out as necessary
  • Existing contracts – can these be assigned to the new owner?
  • Lease or other property documents
  • Rent rolls if the property has tenants
  • Uniform franchise disclosure document (if the business is a franchise)
  • Employee and manager information
  • Marketing and advertising materials
• Do financial documents show volatility in the business’ financial condition?
  • If so, what explanation(s) does the seller provide?
• Will the owner sign a non-compete agreement to prevent interference with the business?
• What documents are needed at closing? (click on links for templates)
  • 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

We recommend hiring a qualified attorney to review the legal and organizational documents of the business you are planning to purchase. All agreements about the acquisition should be put down in writing.  If you don’t want to spend a small fortune on legal services, Avvo offers fixed rated legal help. An accountant can help you evaluate the financial condition of the business. You and the seller will both have to bring certain documents to closing.

Step 5. Learn As Much As Possible About the Day-to-Day Management of the Business.

Before signing the purchase agreement, you should find out as much detail as you can about how the business makes money and how it is run on a daily basis.

Questions to Ask the Seller

• Does the business currently lease space?
  • If so, will the lease end soon and need to be renegotiated?
    • How will this impact cash flow?
• What licenses or permits will I need to operate the business?
• Are business ratings, such as Better Business Bureau ratings, transferable with the purchase of 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?
  • Does the business have a concentrated client base? Note: Proceed cautiously if the business is reliant on just one or two customers or on one specific industry.
  • How quickly does the business get paid for goods and services?

• Will the seller stay for some period of time after the sale to ensure a smooth transition?

Businesses with a steady stream of revenue or contracts in place are generally a safer bet than businesses that make one-time revenues per transaction. However, you should find out if any contracts that are currently in place can be assigned to you as the new owner. You should also find out if other things, such as licenses and ratings, will transfer over to you as the new owner or will need to be obtained anew.

Questions to Ask Yourself

• How will I be paid once I start running the business?
  • Will I take a salary from the business right away?
  • How will I afford my personal living expenses?
  • Does my household have additional income independent from the business that will help support personal living expenses if the business has a slow season or is slow to generate revenues?
• Is the business highly dependent on the personality of the owner, or is it fairly independent from the owner?
• Is there a good management team in place?
• Have I talked to employees, suppliers, and other third parties to get their perspective on the business and verify information that I’ve learned from the seller?

Ask yourself the above questions to make sure you’re personally ready for the transition to business ownership. As you experiment and try new things in the first few months of running the business, there may be some ups and downs in revenue, particularly if the business is highly dependent on the personality of the current owner. You should make sure you have enough runway to support yourself until the business makes a steady profit and a good team of managers and employees to help you achieve profitability.

Bottom Line

The key to buying a good business is to ask the right questions and uncover the right information about the business. By asking the questions included in this article, you’re well on  your way to a rewarding and lucrative business acquisition.  

Looking to buy a business? Click here to get our FREE Guide: How to Buy a Business.