As with any new venture, the purchase of an existing business is fraught with risk. Is the business viable? Does it have growth potential? What are its hidden weaknesses? Is the purchaser experienced enough in the company’s business? Is current goodwill and reputation dependent on existing ownership? Is the revenue stream consistent? The list of questions is endless. Ultimately, the decision rests on the purchaser’s due diligent efforts at valuing the business. This article briefly addresses some important considerations:
The Seller is the Seller: Whatever the business and whoever you deal with, whether directly with the seller or a broker, the seller is determined to get the most value for their business. Aside from their financial investment, most sellers have poured their hearts and souls into the business. Either way, you can be sure that the product is going to be pitched in the light most favorable to the seller. Avoid being lured in by “pie in the sky” stories of marketing genius, unlimited revenue and unreported incomes. Take everything at face value and let the professionals (an appraiser and/or a CPA) give you a frank assessment of the stream of earnings you will be purchasing. Even then, it’s wise to assume there are skeletons in the closet. Look for clues. If you have uncovered a minor misrepresentation, it might be a clue that they are hiding bigger secrets. Rely on your common sense and gut feeling about the seller and his or her representatives.
Funding: Marshaling the resources needed to purchase a business is not as prohibitive as many imagine. In fact, it is possible for some, especially those with good credit, to purchase an existing business entirely through seller financing. While the chances of obtaining 100% seller financing might be slim, seller financing of a portion of the sales price is common. Sources of funding include personal savings, asset backed loans, business loans and seller financing. Prospective buyers can expect to pay a 20% to 30% down payment on a business loan and sometimes a higher percentage for seller financing. However, a large cash layout isn’t always necessary. The Small Business Administration (SBA) can assist with loans of all sizes with as little as 10% down, and sellers are often more flexible than expected. Diligently investigate options and shop around for the right deal for you. You might be surprised at how low the sales price is for many businesses. The key is to think creatively about funding the purchase. Explore all options and combine the most attractive and practical sources.
Entity v. Asset Purchase: There are two ways to structure the purchase of an existing business: an entity purchase (purchasing the Corporation, LLC or other formal business entity) or an asset purchase. Purchasing an entity involves taking on the company “as is” and absorbing all of its financial, contractual and legal obligations. Asset purchases are typically the better option for the buyer. With an asset purchase, you buy all of the company’s assets, tangible and intangible including inventory, real estate, equipment, copyrights, patents, trademarks and trade secrets without absorbing any of the company’s liabilities. In some cases, sellers may insist that the buyer in an asset purchase agree to take on some liability such as accounts payable, but this is all part of the negotiation. Prospective buyers should also talk with their CPA or tax attorney regarding the tax consequences of either approach.
Line up Professionals: Prospective purchasers of an existing business benefit from experienced advisors. In addition to diligently investigating the business, buyers should consult with experienced professionals: an appraiser to ensure the business is adequately valued; an accountant to ensure continued economic viability; a broker to expand your options; and a business attorney to protect your interests. Don’t rely on your broker to value the business. His interest is in making the deal.
Continued in Purchasing Existing Businesses In San Diego, Part Two.