Buying an existing business can often be exciting but also quite daunting. In most cases, buying an existing business can be considered to be less risky than starting from scratch. When you buy a business, you take over an operation that’s (hopefully) already generating cash flow and profits. You will have an established customer base, reputation and employees who are familiar with all aspects of the business. Buying an existing business means immediate cash flow. The business will have a financial history, which gives you an idea of what to expect and can make it easier to secure loans and attract investors. One way to make the process easier is to go through the process in a methodical step by step manner. In this article, steps in buying an existing business, we take a look at the process involved and the options available to you.
Free Initial Telephone Discussion
For a free initial discussion on how we can help you deal with the legal implications of buying an existing business, get in touch with us today. We are experienced in dealing with all forms of corporate negotiations and we will review your situation and discuss the options open to you in a clear and approachable manner. Early expert legal assistance can help ensure you avoid the stress of dealing with these issues on your own. Simply call us on 0345 901 0445 or click here to make a free enquiry and a member of the team will get back to you.
What are the Advantages of buying an existing business?
There are a number of good reasons why buying an existing business might be advantageous over starting a new venture. These can include:
- Obtaining finance should be easier as the business should already have a proven track record.
- The business will be operating in a market segment where demand for its products or services has already been demonstrated.
- Existing staff and management will be a source of industry experience.
- The business will hopefully have a sound customer base and suppliers.
- The business should have a reliable income stream.
- A business plan and marketing method should already be in place.
- Many of the problems associated with the business will have been discovered and solved already.
What are the disadvantages of buying an existing business?
There can be a number of drawbacks associated with buying an existing business and these can include:
- It is likely that you will need a large lump sum of money to buy a business. You will also need to factor in the professional fees associated with the acquisition.
- Your expenditure will not stop there as you will also need cash reserves to help with initial cashflow.
- If the business was purchased because it had potential as opposed to offering an immediate source of revenue, you will need even more money to iron out the problems.
- Keeping existing staff happy is not without its challenges. The staff will inevitably be apprehensive about a change of ownership and what the implications are for their jobs. Will they have a job? Will the nature of their role change? These are all questions that must be considered to maintain staff morale.
- There may be existing liabilities attached to the business that you may legally be obliged to honour. You should hopefully have picked this up when carrying out your due diligence before buying the business.
- The previous owner may be selling because they have reputational problems. Be very mindful of this.
What are the steps involved?
If you have decided that buying an existing business is more attractive to you than starting one from scratch, there are a number of things to consider. Attention to detail is key and the more thorough your initial work, the more likely you are to find a business that will work well for you.
- Carry out research on what type of business you would like to buy.
The business must be a good fit for you. There is no point in buying into a business if you have no industry experience, no desire to operate in that space or the business is located a long way from home.
Consider how the business will impact upon your home life. Will you have the time to commit to it if you have existing family obligations such as very young children? A long journey to work after the first few months of acquisition may not bother you but consider how you would feel being stuck in traffic on a dark rainy November night.
Start by gathering the information about the business before you move on to getting more in-depth records and information from the business owner. Get a brief history of the business, and analyse carefully major events in the history of the business, such as changes in ownership, major downturns, or major upswings.
Get the owner to give you a description of the how business actually works, how many employees work at the business, and how the business operates on a day-to-day basis.
Find out from the owner exactly why they are choosing to sell their business and try and establish how the change in ownership will affect the existing workforce. Also, ensure all required licences are up to date and that the business isn’t involved in any lawsuits.
The key is to research the sector you’re interested in, including the best time to buy, and shortlist two or three businesses that look attractive.
- View the business and carry out a valuation
The existing owner may not have told his staff and business contacts that he or she is looking to sell their business. Consequently, it is important to be discreet when you arrange to view the business.
Get detailed income records, tax returns, balance sheets, and financial forecasts.
There are a number of methods that can be used to value a business and these are set out below:
Multiple of Earnings: In this instance, a variable figure known as a price to earnings (PE) ratio is used. This PE ratio often varies from industry to industry. Using this technique, a valuation is derived by establishing what the income of the business is and then multiplying it by the PE figure. For example, if your business generates £100,000 post tax profit and is in an industry where a PE ratio of 5 is considered reasonable, the business would be valued at 5 x £100,000 = £500,000.
The key to this technique is how to find the PE figure. Business consultants often use figures between 4 and 10 dependent upon the industry and the specific circumstances of the particular business. In a small business, for example, the generating of profit can be quite precarious. Key staff could leave the business or a major customer may cancel a contract often leaving the business in a dire situation. As such, PE ratios are normally smaller for small businesses compared to larger concerns where they are often better placed to survive the often tumultuous nature of commerce.
It should also be remembered that businesses where profits are growing rapidly will also command a higher earnings multiple than firms where profit growth is low or there is no growth at all. Most incoming purchasers will want to see that there is potential for growth, not stagnation.
Valuing Assets: This technique involves valuing all the tangible assets of the company (stock, machinery, property etc). This method is often employed when valuing a company whose business model is based around holding these kind of assets such as property companies.
Cost To Duplicate: Often heard in the BBC TV program “Dragon’s Den”, the judges analyse a business looking for investment and dismiss the valuation based upon the cost to actually replicate a similar business from scratch. This would often include the cost of developing a customer base and reputation, recruiting and training staff, purchasing assets and developing products and services.
Discounted Cashflow: This technique involves forecasting how much cash flow the business will produce in the future and then, using an expected rate of investment return, calculating how much that cash flow is worth. A higher discount rate is typically applied to new business ventures, as there is a high risk that the company will inevitably fail to generate sustainable cash flows. The trouble with this method is that the quality of the DCF depends on the valuer’s ability to forecast future market conditions and make good assumptions about long-term growth rates. In many cases, projecting sales and earnings beyond a few years becomes something of a guessing game.
Industry Valuations: In certain industries, when businesses are bought and sold on a regular basis, industry accepted standards are sometimes used to value a company. Examples of such industries include recruitment agencies and accountancy practices.
Going Concern Valuation
This kind of valuation assumes that your business is going to keep on going under its new owners. When calculating the value of a going concern’s assets, you need to take into account the business’s intangible assets, because those assets are going to transfer to the new owner. You also need to take into account the goodwill that your company has. It can be viewed as an asset with a quantifiable value, and it can be bought and sold like any other asset.
- Research the Industry the business operates in
It is important to research the broader industry that the business is a part of. You don’t want to buy a business, only to find out that the industry is in decline
Get a comprehensive understanding of the industry, determine whether the industry is on the rise, or whether it is going to experience a massive downturn in the near future.
Find out about emerging trends within the industry and determine whether they will have a significant impact on the way the business operates.
- Analyse the market
Find out as much as you can about the customers of the business. You will need to establish who will be competing with you for customers and also establish the mechanism involved in targeting new customers. Will you be looking to expand beyond the existing customer base or stick with the businesses core customer group?
- How are you going to pay for the business?
You may be in the fortunate position that you are a cash buyer in which case the purchase of the business will be relatively straightforward. However, for the majority of purchasers, finance will need to be arranged. You may already have a good relationship with your bank in which case they should be your first port of call. Alternatively, there are other specialised institutional investors in the market that lend to people buying businesses or alternatively you could raise finance from external investors.
A commercial lender will require detailed accounts of the business along with a business plan with growth projections and details of your own assets.
- The Offer
If you are happy with your due diligence and everything checks out, now is the time to consider making an offer. The “consideration” is what the seller gets when he is selling. In order for there to be a binding agreement there needs to be an offer, acceptance, consideration and intention to enter into a legal contract. You can take professional advice as to the valuation of the business but in any transaction, the seller has to be satisfied they are getting a good deal and the buyer has to believe they are getting value for their money.
It is important to consider the structure of any offer received. Is it a payment due on the day you buy the business; is it related to the performance of the business after the seller leaves; or is there a split payment of cash upfront in addition to delayed consideration?
- The sale process
Once you have made your offer and if the seller has decided to accept, you should instruct your lawyers and accountants, who will work closely during the sale process. Being in touch with your lawyers and accountants early on in the transaction helps to avoid unnecessary pressure later on.
- Conclusion
If you are looking to buy an existing business, you need to be realistic about the process and the amount of work involved. As outlined above, there are both advantages and disadvantages of buying an existing business and it is important that you have carefully considered all options before proceeding with a purchase.
How we can help
We have a proven track-record of dealing with company sales and purchases. We will guide you through the process and ensure all checks are carried out swiftly and efficiently and we firmly believe that with the right solicitors by your side, the entire process will seem more manageable and far less daunting.
How to Contact Our Corporate Solicitors
It is important for you to be well informed about the issues and possible implications of a business sale. However, expert legal support is crucial in terms of ensuring a positive outcome to your case…
To speak to our Corporate solicitors today, simply call us on 0345 901 0445, or click here to make a free enquiry. We are well known across the country and can assist wherever you are based. We also have offices based in Cheshire and London.
Comments are closed.
