Thinking About Buying a Business?

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In my experience, there are four important steps to take before making the purchase commitment. (1) Understand why you want to buy it, (2) understand exactly why the seller is selling, (3) verify the financial statements, and (4) value the business based on cash flows above all other methods. Then get a good, experienced attorney to draft your purchase agreement.

First, why do you want this business? Are you buying yourself a job? Once you buy the business, you are married to it and will probably work harder than you ever thought possible. You can’t quit, it’s hard to take vacations, and if you have to move away for some reason, you could lose your investment. As a business owner, you might not be entitled to unemployment or disability benefits if you are unable to work due to illness or injury. If you just got another job and invested the purchase price in real estate or the stock market, would you be better off? You would have less control day-to-day, but more flexibility in your life overall. These are important considerations.

Second, why is the seller selling? Be a detective. The business might have been thriving recently, but maybe there is a new competitive threat on the horizon. Or a product becoming obsolete and inadedquate R&D spending, or high management turnover, or limited availabiltiy of affordable staff housing, or a new freeway that will cut off half your customer base, or a hospital that is closing nearby, and so on. Ask a LOT of questions and get the answers in writing, as part of the representations and warranties of the seller in your purchase agreement.

Third, please find a way to verify the numbers. I once saw a business purchased based on the faked report of an outside accountant. The business financials should be audited by a reputable acconting firm, and you should verify the audited financials with that firm, don’t just accept the audited financials the business owner gives you.

Fourth, base your valuation on cash flow. Start with the existing cash flow produced by the business. Reduce it because when the seller leaves, you could lose good will, key staff, or key customers. Reduce it further to factor in unknown risks. Reduce it further by the amount you could earn if you took another job elsewhere, or the amount you would have to pay someone else to run the business. What is left over is your actual profit. Now, how much would you invest to achieve the same profit? If you put the money in a bank, how much would it take for the interest rate to equal that profit? How much would you pay for an apartment building to achieve the same return as the estimated cash flow from this business? What about stocks or bonds? You get the idea…

Feel free to contact us with any questions. Good luck!

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