The ultimate guide to buying a business

Many people dream of owning a business someday, but building one from scratch can be difficult. Some entrepreneurs prefer to buy an existing business instead. Every year, half a million businesses are sold to new owners. As millions of baby boomers begin to retire and sell their businesses, that number is expected to grow.

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Buying an existing business allows you to generate profits without having to get a business off the ground yourself. However, acquiring a business isn’t necessarily a walk in the park. In this article, we’ll discuss everything you need to know about buying a business.

How to buy a business

1. Find a business you're interested in buying

Buying a business that aligns with your passions, skillsets, or previous experience increases your chances of success. Not only will you be able to understand current business challenges and opportunities, but you’ll also be able to better predict future trends. 

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Once you’ve identified the kind of business you’d like to acquire, you’ll need to start shopping around. Here are ways to find available businesses:

• Find businesses online: Websites such as BizQuest and BizBuySell connect small businesses up for sale with potential buyers. These sites allow you to filter businesses by price, industry, and location. 
• Hire a business broker: Buyers sometimes work with brokers to help them purchase a business. Business brokers often have specialized knowledge in certain industries or locations, which can help inform a buyer’s decision. 
• Network with small business owners: A more casual way to find businesses that are up for sale is to attend business meetups and industry conferences in your area. Sometimes, owners attend these events in hopes of either growing their business or selling it to the right buyer.  

2. Investigate the reason behind the decision to sell

Before buying a business, you should understand the motivation behind the sale. An owner may want to sell their business to retire or accommodate a lifestyle change, such as caring for an elderly parent. However, some owners put their businesses up for sale after a major setback, such as an expensive lawsuit or public scandal. If it’s the latter, you could face obstacles trying to get the business up and running. 

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In addition to asking the owner about their decision to sell, ask existing customers, employees, and neighboring businesses how the business has been running the last few months. This will give you a comprehensive view of the business’s perception.

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While no business is perfect, certain problems require more capital, creativity, or sweat equity to fix. Whether or not these problems are worth solving will depend on your capacity as a new business owner. 

3. Evaluate the business earnings 

Once you’ve determined whether a business is worth acquiring, you’ll need to decide whether its purchase price is worth it. It’s always best to consult an appraiser or financial advisor. 

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There are many ways to value a business based on earnings, future projections, and current balance sheets. Here are three of the most common business valuation methods:

Asset-based valuation

An asset-based company valuation involves adding up the total fair market value of a business’s assets. This includes real estate, furniture, equipment, and other intangibles such as patents and customer lists. You would then subtract the total liabilities, which include mortgage payments, equipment loans, and lines of credit, from its total assets to get a value. 

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Asset-based valuation makes sense when a business’s assets are the main factor in income production, such as with a rental business. 

Market-based valuation

A market-based valuation involves looking at similar companies that have recently sold and determining a price based on comparable sales in the industry. This type of valuation is only possible when a business in an established industry is up for sale. If the business is very niche, a market-based valuation may not make sense. 

Income-based valuation

An income-based valuation involves estimating a business’s future cash flow over a certain amount of time. The current value of that future cash flow is also factored into the valuation. This kind of business valuation makes sense when a profitable company can reasonably forecast future earnings. 

4. Issue a letter of intent

A letter of intent expresses your interest in purchasing the business. One advantage it offers is the "right of refusal," granting you priority in buying the business should another potential buyer emerge.

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Additionally, a letter of intent helps you do your due diligence. Typically, sellers are reluctant to disclose comprehensive financial, tax, and legal information unless they are assured of a buyer's genuine interest.

5. Do your due diligence

Due diligence is the process of gathering and reviewing necessary financial and legal documentation before making a major purchase. Understanding the ins and outs of a business’s financial viability and daily operations is key to determining if the business is right for you.  

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Consider hiring a business accountant and lawyer to help you review and record the following documents:

• Founding paperwork: If you’re buying a sole proprietorship or partnership, the owner may not have official “founding” paperwork. However, a registered business entity, such as an LLC, will have an article of organization on file with the state. A corporation should have an article of incorporation. These documents are often referred to as certificates of formation. 
• Certificate of good standing: A certificate of good standing ensures that the business you are eyeing operates legally and follows local zoning and environmental laws. Obtaining this documentation from your state’s secretary of state is especially important if the business you plan to buy is consumer-facing, such as a restaurant or mechanic shop.
• Status of inventory, equipment, furniture, and building: Depending on the type of business you acquire, you may need to inspect its inventory and other tangible assets. Buying a brick-and-mortar business, such as a clothing store, requires you to quality-check product inventory and physical space. You can also estimate how much it would cost to repair or replace critical business assets, such as furniture and equipment when assessing inventory status. 
• Organizational chart:  Organizational charts reveal how certain employees rank in relation to one another, as well as how employee compensation, benefit plans, vacation policies, and insurance are structured.
• Business licenses and permits: Certain businesses require business licenses and permits to stay open. Daycare, nail salons, and restaurants are a few examples of small businesses that need to renew their permits regularly. Make sure the company you plan to buy has all licenses and permits active to avoid fines in the future.
• Contracts and leases: Monthly leases and other contractual obligations heavily influence the cost of operating a business. As the new owner, you should know all the necessary expenses to keep the business running. Make sure the current owner can transfer contracts and leases to your name. If not, you may need to renegotiate these agreements, which could significantly increase your expenses. 
• Business financials:  Understanding a company’s financials is one of the most important aspects of acquiring a new business. Look specifically for positive cash flow, diversity of customers, and outstanding debts. No one client should be responsible for more than 20% of a business’s revenue, and no debt should be outstanding for more than 90 days.  

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You should also double-check that tax returns and financial statements have passed a formal audit by a certified public accountant (CPA). Here is a list of financial documents you should examine up to three years back, if possible:

• Cash flow statements
• Balance sheets
• Tax returns
• Accounts receivable
• Accounts payable
• Sales records 
• Debt disclosures

6.  Secure capital 

Once you’ve decided that a business is worth acquiring, you’ll need to come up with the funds to buy it. While it’s always possible to buy a business in cash, it’s not always feasible. Here are six finance options to explore even if you’re wondering how to buy a business with no money:

• Small Business Administration (SBA) loans: The SBA 7(a) loan program backed by the federal government allows small businesses to borrow up to $5 million to start or acquire a business through SBA-approved lenders.
• Bank loans: Local banks and credit unions offer small business loans that you can use to fund your venture. These loans can be difficult to qualify for unless you have excellent credit, experience buying and selling businesses, or are buying a company with substantial assets. 
• Find a business partner: Another way to purchase a business is to find a partner who can provide funding. Business partnerships can be structured in different ways. You can take on a silent partner who stays out of the decision-making process but provides financing in exchange for partial ownership. You could also partner with a venture capitalist who provides a mix of funding, industry expertise, and access to their network. 
• Seller financing: In some cases, the seller is willing to loan you the money needed to buy the business. This may be the case if the seller is highly motivated or if you have an existing relationship with the seller. You’ll likely be on the hook for some form of interest payments. 
• Home equity financing: Homeowners have the added option of tapping home equity to finance the purchase of a business. Home equity financing uses a property as collateral, resulting in better rates and easier eligibility requirements than SBA loans. You can take out a home equity loan, line of credit, or Home Equity Investment. 

7. Get the right paperwork in order

In addition to funds, you’ll also need the right documentation to purchase a business. Here’s a list of documents to have prepared for  the closing process:

• Bill of sale: The document outlines the transfer of ownership from the seller to you. 
• Patents, trademarks, and copyrights: This is a record of the transfer of ownership of all patents, trademarks, and copyrights from the seller to you.
• Asset acquisition statement: An IRS Form 8594 that lists each business asset you’ve acquired and for how much. 
• Non-compete agreement: An official document preventing the previous owner from setting up a competing shop within proximity to the business. 

8. Close the deal

When you acquire a business, you do so through either an asset purchase or a stock purchase. In a stock purchase, the buyer takes over the entirety of the business's ownership, assuming all its assets and liabilities. In an asset purchase, the buyer selects which assets and liabilities they'll own, giving them greater flexibility in tax responsibility.

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Both methods have advantages and disadvantages, as well as legal and tax considerations. Consult with the relevant professionals, including an attorney, to determine what’s best for you. 

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Hiring a business lawyer to help finalize the purchase agreement is always a good idea. Once you and the seller sign off, you can set a closing date and ask your lender to put the funds in escrow. After all necessary paperwork is submitted, the money is then transferred to the seller, and business ownership is transferred to you.

Final thoughts on buying a business

Buying a business can be an exciting venture for those looking to step into entrepreneurship without starting from scratch. However, aspiring business owners need to put in a certain amount of work before they can enjoy the benefits of owning a business. Conduct thorough due diligence, carefully evaluating the business's financial health, and securing funding for the purchase are some of the hurdles aspiring business owners may face.

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Fund your business venture with a Home Equity Investment from Point. Homeowners benefit from no monthly payments, flexible credit evaluations, and the ability to use the funds as they need. Explore Point’s HEIs here.