How to Buy a Business

Negotiating with the Owner

Find a business for sale. If you're thinking about buying an existing business, you must first locate one the owner is looking to give up. To find a business, you can talk to people you know in the industry or use a business broker. The broker can help you find a business for sale and will make a commission once the sale is completed. Keep in mind that brokers almost always represent and will be paid a commission by the seller. Make sure you double-check any information the broker provides you about businesses, and don't agree to buy a business if you have concerns about your ability to operate it profitably. Consider the location of the prospects you find. You want to look at how convenient each would be for you and how they could fit within your daily routine.

Choose the right business. Before you decide to buy a business, you should make sure it matches your interests, skills, and experience. You won't be able to reap many of the benefits of buying an existing business if you're in over your head or don't understand the market in which the business operates. In most cases, you want to avoid getting into a business sector in which you have no knowledge or experience. Keep in mind that each niche has its own demands. For example, just because you have experience running seafood restaurants doesn't necessarily mean you are ready to operate a bakery. Check market projections and profitability in that particular business sector, if you aren't already familiar with them. Check with trade organizations or the local Chamber of Commerce to find relevant information about how businesses are performing in your area. You want to focus on the region where the business is located, and look at similar businesses in the area who offer the same products or services. Consider talking to local business owners who run similar operations, both in terms of the products or services provided and the size and scope of the operation itself. For example, if you want to buy an independent coffee shop, owners of franchises or managers of national chain stores may not have useful information, but owners of other independent or family-owned stores in the area would.

Contact the business owner. Once you've decided which business you want to buy, you should send the owner a written letter of intent with a general offer along with your terms and conditions. This is the first formal communication you will have with the current business owner regarding your desire to purchase the business. You can check the website of your state's secretary of state to find the legal owner of the business you want to buy, as well as contact information. Secretary of State databases typically include information for corporations or LLCs registered to do business in the state. In some states you also can search d/b/a registries or listings, which are listings of the business names of sole proprietorships registered for use in that state. In other states, you may have to contact the county clerk in the county where the business is located. Begin your letter by stating who you are, that you intend to purchase the business, and how you intend to go about purchasing the business. Lay out your terms clearly. If there is any aspect that you consider non-negotiable – for example, you aren't interested in buying the business unless the company's client lists are included – state this in your letter. You also should include the basics of the deal, including how you plan to fund the purchase and a general schedule of payments you will make. Indicate whether you intend to purchase stock in the business, to purchase the business assets, or some combination thereof. Let the owner know that you are open to negotiations and would like to hire an appraiser to determine the actual value of the business. If the owner seems eager to sell, you should ask yourself why. Successful business owners seldom want to get rid of a profitable business unless there is a significant downside that could effect the potential value of the business to you. Keep in mind that your offer may change after you complete your research of the company, so the offer in your letter of intent should be at best a ballpark estimate. Emphasize that there's nothing binding about the offer and that it's subject to change.

Hire an experienced appraiser. An appraiser can analyze the business's records and provide a neutral estimate of what the business is actually worth. Since you want to pay as little as possible, and the current business owner may be inclined to overvalue the business to account for his or her time and investment as well as sentimental value, a third party expert is best positioned to objectively valuate the business. There are a number of different methods that can be used to value a business. For this reason, unless you're an expert in business valuation, hiring a professional will save you significant time and money as well as lessen your risk. You can expect an appraisal from a qualified professional to cost between $2,500 and $5,000. Look for an appraiser who has professional certification such as a CBA (Certified Business Appraiser), which indicates the appraiser has completed significant educational requirements and has experience in the field. To get a fair appraisal, insist on a professional appraiser who is completely independent from either you or the original business owner.

Narrow down what will be included in the sale. Before you start discussing a price, you need to determine which of the business's assets will be included in the sale and which you will be responsible for buying on your own. Keep in mind that buying an existing inventory can drastically decrease your startup costs, but only if the existing inventory or service contracts are included in the sale. While purchasing all of the business's assets may smooth the transition, avoid buying anything you don't need or that could become a liability. For example, the business may have unsold inventory that has been on the shelves for months and probably should be liquidated rather than transferred to you.

Consider consulting an attorney. Particularly if there are large sums of money involved, an experienced business attorney may be the best way to make sure you're getting a good deal and your interests are protected. An attorney should be included as part of a team of professionals who will assist you in buying the business. In addition to your attorney, your team may include your banker and an accountant. Look for a business attorney who has experience specifically in the buying and selling of existing businesses. You typically can find some candidates by checking with your local bar association or chamber of commerce. Your attorney also can determine what legal and organizational documents you will need to file and get them in order for you. Keep in mind that depending on the type of business you're purchasing, filing requirements from multiple state and federal agencies may be required. An experienced attorney can make sure you comply with these requirements.

Conducting Due Diligence

Request certified copies of the business's financial records. You should analyze the business's finances carefully before you make the final decision to purchase. You want to look at the business's actual financial statements for the past three to five years, not just a summary provided to you by the business. The statements should be accompanied by a certification statement from a CPA. Pay close attention to outstanding debts the business owes as well as any amounts owed to the business that you may have difficulty collecting. This also can affect your ultimate purchase price. You also want to review the business's tax returns for the past three to five years. Look at deductions and profitability, especially whether taxable income has increased or decreased in that time period. Hire a CPA to help you review and analyze the business's records. The CPA will verify the records rather than you having to take the company's statements at face value. Look at the company's advertising costs and compare the prices the business charges for its products or services with industry standards. You'll also want to find out how prices in the industry fluctuate and whether they are projected to increase or decrease in the future.

Analyze employee contracts and files. You want to make sure the company's personnel and payroll records are accurate and comply with the law. You also want to know who's getting paid what, and what skills they bring to the company. Reviewing personnel files and contracts can help you understand how the company works on a day-to-day basis, as well as where there are possibilities for you to reorganize staff for optimal efficiency. In addition to the files and contracts themselves, you may want to talk to employees directly to get their sense of the company's reputation and the strength of their dedication to and relationship with the company.

Evaluate trade secrets and intellectual property. The value of the business could be affected by the intellectual property included in the deal and the terms for its use. The business owner may want you to sign a confidentiality agreement. Under this agreement, you promise that any information you obtain will only be used for making your decision on whether to buy the business. Keep in mind that some intellectual property, such as patents, may have a value independent of the business itself. If you want ownership of that intellectual property as well, you may have to work out a separate deal. Talk to the original owner about whether complete ownership of the intellectual property will be included in the sale, or whether you simply will have a license to use that intellectual property in connection with this business for a specific period of time. Patents and trademarks also typically require the creation of additional documents that must be filed with the U.S. Patent and Trademark Office before the transfer of ownership is legally enforceable. If the business has considerable intellectual property, you might want to have it evaluated by an experienced intellectual property attorney.

Check for any past or pending litigation. If the company is embroiled in a lawsuit, you may be stepping into that legal trouble when you buy the business. In addition to records provided by the original seller, check court records to determine if any lawsuits have been filed against the company. Many courts have a searchable database of court docket information available online for free or for a nominal fee. Even if the company has no lawsuits against it, you also should check online customer reviews, industry associations, and organizations such as the Better Business Bureau to find out if the company has had any complaints – and if so, how those complaints were handled.

Pull any corporate documents or other registrations. Make sure the business currently has all required licenses and registrations and is in good standing with regulatory agencies. If your purchase of the business includes the purchase of any real property, make sure you check zoning restrictions and environmental regulations for the land and buildings. You want to make sure the property is in compliance with federal, state, and local laws and regulations. On the other hand, if the business is currently leasing the building in which it operates, you need to review copies of the lease and find out what you must do to transfer that lease into your name if you buy the business. If the lease doesn't permit transfer without permission of the landlord, you need to secure that permission before you agree to purchase the business. Make sure the business complies with federal and state safety regulations and that all applicable permits are up-to-date and in good standing.

Examine inventory and assets. Any existing products or materials that will be included in the sale should be assessed and valued. Keep in mind that you don't just have to take the original business owner's word for it. If the business has inventory that's been collecting dust for years, or if it isn't in line with your plans for the business, you may price it lower than the original business owner would. Get a list from the original owner of all the assets of the business, such as fixtures, office supplies, and electronics, along with names and model numbers of equipment. To value these assets, you must find out the original purchase price and how long ago each item was put in service.

Closing the Deal

Agree on a fair purchase price. Once your due diligence is complete you have a good idea of what you're willing to pay for the business. Negotiate with the original owner what assets will be included in the total purchase price for the business. You may choose to purchase some assets separately. Typically, businesses are purchased using installment agreements with a significant amount paid up front as a down payment. When negotiating a purchase price, keep your return on investment (ROI) in mind. If you're buying a small business, you typically want to ensure you'll achieve an ROI of between 15 and 30 percent. If you get much below that point, you'd do better from an investment standpoint to buy stocks or commodities than to buy a business. For example, if you're planning on buying a business for $500,000, you want to be able to realize a profit of at least $75,000. If you're buying a business that has never realized an annual profit of more than $50,000 in its 10 years of operation, you should attempt to negotiate a lower purchase price. The original owner may attempt to inflate intangible assets such as goodwill during price negotiations. However, keep in mind that goodwill and business reputation don't have any true monetary value as such. You shouldn't pay significantly more for a business with a good reputation than you would for one with a neutral reputation.

Determine a closing date. You should set your closing date far enough into the future that you both have time to complete whatever licenses and documents are necessary to fully transfer ownership of the business. For example, if your purchase includes company vehicles, you may have to transfer title and registration of those vehicles into your name or get new insurance policies. It can take time to get these types of things done.

Put your agreement in writing. You can find a template online or have an attorney draw up the agreement for you, but having a written contract for the purchase of the business is essential. If you don't have an attorney draw up the agreement for you, at least have one look over it before you sign it to make sure you've covered everything that's legally necessary and the agreement doesn't include any clauses that a court would refuse to enforce. In addition to the sales agreement itself, you probably will have other documents that must be prepared and filed, such as financing agreements, promissory notes, leases, and tax documents. If the transfer of any intellectual property including patents, trademarks, or copyrights is involved, you may have additional licenses or assignments that must be in writing to be valid under federal law.

Meet to go over the terms of the agreement. You and the owner of the business should go through your written agreement together and make sure it accurately represents your deal and that both of you accept those terms. The basic sales agreement covers the sale of the business and transfers any business assets that aren't specifically covered by another agreement. If you have multiple agreements, such as property leases or intellectual property licenses, these should be referenced in the sales agreement.

Sign the agreement. The agreement must be signed by you and the original owner before it will have any legal effect. You also should have the original business owner sign a covenant not to compete. This is essentially the flip side of the confidentiality agreement you signed earlier on in the process. Now that you're buying the business, this document requires a promise from the seller that he or she won't compete against the business for a specified period of time. Include an employment agreement if the original owner has agreed to stay with the business as a manager or consultant. For example, the original owner may agree to work with you over the first few weeks or months you own the business to train you on the business's operations.

Transfer ownership of the business. Once you've signed your agreement and made whatever upfront payment is required, begin transferring names and registrations with an eye toward your closing date. During the transition period, you'll be familiarizing yourself with the business as well as filing any documents required by state and federal agencies. Financing agreements governed by the Universal Commercial Code should be filed with your state's Secretary of State. Real property transfers typically must be recorded with the county recorder or county clerk, while vehicle ownership transfers must follow the requirements of your state's department of motor vehicles. You also must complete IRS Form 8594, which describes the assets you've acquired through the purchase of the business. There also may be an equivalent form for your state's tax department.

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