Buying a business | Making a business purchase | 11 min read

The ultimate guide to buying a business

Last updated: July 26, 2019

So you’ve decided to take the leap into business ownership and you’re excited about what the future holds. The sky’s the limit and you’re raring to go.

Buying an existing business is a great way to become a business owner, but it’s not without its challenges. That’s why to make it easier, we’ve created the ultimate guide on how to buy a business. Your new life as a business owner awaits.

This guide will cover:

1. How to tell if you’re ready to buy a business
2. Independent businesses vs franchises
3. Researching a business
4. Performing due diligence
5. Valuing a business
6. Making an offer
7. Purchase contracts
8. Financing a business purchase

 

How to tell if you’re ready to buy a business

Before you even start your business search, you first need to fully understand if small business ownership is right for you.

Ask yourself whether you’re ready to be responsible for every decision on a daily basis and whether you have sufficient time management skills and self-discipline.

You also need to be willing to hustle, especially in the early days, and to wear the many hats that all small business owners must wear, from sales and customer service through to financial administration and people management.

Independent businesses vs franchises

Deciding which type of business is right for you is a personal decision that you have to make for yourself, depending upon your personality, preferences and financial situation.

There are generally two options available:

  1. Buy an independent business: A business that’s free from outside control. These are privately owned establishments as opposed to publicly listed companies.
  2. Buy a franchise: A business where franchisees (people like you) are granted the right to use the business name and practices of a franchisor (the owner of the business providing the product or service).

When it comes to deciding whether to buy an independent business or a franchise, there are no hard and fast rules.

One of the main benefits of purchasing an independent business is that you have greater control to take your business in the direction you choose.

Unlike franchise owners, you have the freedom to implement new ideas or to change your products and services based on your own personal interests or changing market conditions. You’re also not bound by specific catchment areas or terms and conditions, giving you greater flexibility to market your products to a broader audience.

On the other hand, franchise owners enjoy the security that comes from belonging to a much larger organisation. Other benefits include strong brand recognition, bulk purchasing power, group marketing support and training.

Researching a business

In the same way that you’d take a look under the bonnet if you were buying a new car, you need to give your potential new business a thorough inspection before you decide to buy it.

This research is all about finding a suitable business among the many that are available, exploring the costs involved in buying the business and getting a feel for your chosen business’ strengths and weaknesses.

Finding a suitable business

Successful business owners find companies that tap into their personal interests, so take the time to think about what you’re passionate about. Steve Jobs was passionate about consumer technology, Mark Zuckerberg is passionate about connecting the world and Elon Musk is passionate about putting a man on Mars.

Once you’re sure of the type of business that you’re interested in buying, you can start looking for opportunities in your chosen industry.

Exploring the costs involved

Buying a business is rarely a straightforward financial transaction, so make sure you understand all of the costs involved beyond just the asking price. Costs can generally be divided into set-up costs (i.e. the initial investment you’ll need to establish the business) and running costs (i.e. the expenses you’ll incur running the business day-to-day).

Getting insight into a business’ strengths and weaknesses

It’s essential to know which questions to ask the current owner. The most important question of all is, “Why is the business for sale?” If you can discover the current owner’s motivations for selling, you’ll be in a stronger position to negotiate.

As well as asking the current owner the right questions, there are other things you can do during the research phase:

  • Find out the business’ legal structure by performing a search with the Australian Securities and Investments Commission (ASIC).
  • Perform a credit check with Equifax (as endorsed by ASIC).
  • Ask friends and family to visit the business and provide you with feedback.
  • Talk to staff and find out if they enjoy working there and if they’d stay if a new owner took over.
  • Talk to customers about what they like about the business and its products or services.
  • Talk to suppliers and find out their impressions of dealing with the business.
  • Research the business’s competitors and see how they compare to the business you want to purchase.
  • Identify industry trends, market trends, risks and opportunities.
  • Visit the business at different times to get an overall feel for how it’s performing.
  • Analyse the business’s reputation by checking social media for reviews, discussions and customer feedback.
  • Find out what the current and future demand is for the business’s products or services.
  • Review potential costs involved in buying the business and consider your financial position, including how much you might need to borrow.

Performing due diligence

Due diligence is the process of examining a business in detail to assess whether it’s a good investment.

It’s generally conducted after the buyer and seller have agreed to a deal in principle, but before a legally binding contract is signed. You’ll likely need to sign a confidentiality agreement before you can access this important information.

You should always perform due diligence with the help of your lawyer, accountant or business advisor and will often need to complete this activity within a specified time period.

While conducting due diligence, you’ll need to carefully review all financial matters including:

  • Income statements
  • Balance sheets
  • Tax returns
  • Profit and loss statements
  • Stock levels and details about plants, equipment, fixtures, and vehicles

You’ll also need to review all legal matters such as:

  • Intellectual property
  • Trademarks
  • Registered patents
  • Existing contracts and contractual obligations with staff and third parties such as customers and suppliers
  • Any past, current or unsettled lawsuits

Valuing the business

You don’t always get what you pay for. Most of us have paid more than something was worth at some point or another and it always leaves a sour taste in the mouth. Now imagine what it feels like if you over-pay for a business.

Your first step is to take a look at what was paid for similar businesses on the market. While this benchmarking is no substitute for a formal valuation, it does offer a guide to the likely market price.

The valuation should take into account both tangible assets (such as property, machinery, equipment and furniture) and intangible assets (such as intellectual property and goodwill). Goodwill represents the features of a business that aren’t easily valued, such as an established brand, an existing customer base, quality staff, a good location or supportive suppliers.

A combination of methods is usually used to value a business. The two most common are:

  1. Calculating a business’s net worth – Essentially the difference between its assets and liabilities. While this is a relatively straightforward method for valuing a business, it doesn’t take into account any intangible assets including future earnings.
  2. Calculating a business’s value based on its capitalised future earnings – When you buy a business, you’re buying both its assets and any profits it might generate in the future, which are known as future earnings. This method ‘capitalises’ the business’s future earnings by giving them an expected value today.

Making an offer

It’s time to start thinking like a negotiator, so get ready to haggle and enter into business negotiations. Negotiations can be either simple or complex, depending upon the business that you’re purchasing and who needs to sign off on the deal.

Negotiating is both an art and a science, so you’ll want to study up on master negotiators while simultaneously getting as much practice as you can.

Negotiation tips and strategies

  • Before you start negotiations, know the highest price you’re prepared to pay for the business and stick to it.
  • Allow yourself some wriggle room by starting negotiations at the lowest price possible (but make sure it’s reasonable and that you’re able to justify it). Making a lower offer and increasing it if required is always a better strategy than going in high at the start.
  • Never agree to the seller’s first price.
  • Make a list of items for negotiation, placing them in two separate categories based on ‘non-negotiables’ and ‘nice to haves’.
  • Never show how desperately you want the business.
  • Never rush negotiations – it can take time to achieve a beneficial outcome for both parties.
  • Get advice from your accountant on the best way to deal with intangible assets such as goodwill. For example, it may be better to pay more for tangible assets such as stock and equipment than for goodwill because these assets can be depreciated over time.
  • If you’re comfortable with the price then go ahead and strike a deal, but be prepared to walk away if you’re not.

Above all, make sure you temper your emotions. If you’re unable to stay calm during negotiations, ask a professional adviser to negotiate on your behalf.

Purchase contracts

Ready to get the ball rolling and to make your purchase official? The next step is to draw up a purchase contract to make your agreement legally binding. This written document ensures that both parties clearly understand the terms and conditions of the sale.

As the buyer, you should always get legal advice and seek the guidance of an accountant on any legal and tax implications before signing the contract.

Your lawyer will generally prepare the first draft of the purchase contract. If you’re purchasing the assets of a business, your purchase contract should describe exactly which assets are being bought, such as machinery, stock, customer/supplier contracts, premises and intellectual property. You’ll also need to list any assets that are not being purchased.

 

What to include in the purchase contract:

  1. The price
  2. The payment method
  3. The seller’s involvement after purchase
  4. A restraint of trade covenant. This is to protect you, the new owner, from any loss of business should the seller open a competing business within close proximity.
  5. Any other conditions. The purchase contract should also include contingencies for different scenarios such as what happens if the seller provides inaccurate or false financial information or if they have more liabilities than were known at the time of purchase. Most of these contingencies will help to limit your risk as the new owner.

Financing a business purchase

While you’re working on the final drafts of the purchase contracts, you should also be looking into financing options. It’s much more common (and best practice) for buyers to know how they’re going to finance the purchase before they’re ready to sign on the dotted line.

There are a variety of loans available including secured loans (where the loan is secured against the assets of the business) and unsecured loans (where a business owner borrows money that isn’t associated with any assets).

The bank/lender usually won’t give you a business loan without a clear business plan, a good credit history and consistent positive cash flow. You’ll need to be able to show them that you’ll be able to turn a profit, so put together plenty of evidence based on the existing financial records. You’ll also need to demonstrate the security you can provide for the loan.

Interest rates and terms vary depending on the bank, so contact a finance broker who specialises in business lending or use an online loan comparison tool to check out all of your options.

If you can afford to buy the business outright without borrowing or taking on outside investment, even better – then you won’t need to share the profits with investors or use the profits to make loan repayments.

Conclusion

There’s a lot for you to think about when it comes to buying a small business. The good news is that now you should know everything you need to know to get started.

While we’re not going to pretend that it isn’t a challenge, purchasing a business is a rewarding process in itself that will help to set you up for the future.

So if you think you’re ready to take on the challenge of buying and running a small business, be sure to begin your search on SEEK Business. Your future is just a couple of clicks away.