to buying an established business is to join a franchise. When you join a franchise, you’re not just buying a business; rather, you’re becoming part of a proven system that works. Along with this system, you’re also buying a recognised brand name and established reputation. This option is generally the most expensive up-front, but arguably carries the lowest risks.
In this chapter, I provide a summary of the pros and cons of buying a business versus starting from scratch versus joining a franchise. I also help you figure out how much to pay for a business, and provide checklists of the questions you should ask before buying a business or a franchise.
Weighing Up the Good and the Bad of Buying a Business
Just like marriage, having children and getting old, buying a business (as opposed to starting a business from scratch) has its advantages and disadvantages. However, by going into negotiations with your eyes open, you can often minimise the disadvantages and seal a winning deal.
Buying an existing business — the upside
So, what’s the lowdown on buying a business that’s already up and running? The best things are
You can look at the financial records for this business and know roughly what to expect: Although the financial records of the past are never a cast-iron prediction for the future, they’re usually a good indication.
Existing businesses come with established customer and supplier relationships: Customers are the gold nuggets of any business and so, by buying an existing business, you get your very own pot of gold. Existing supplier relationships are also a valuable resource that allow you to conduct your business in the most efficient and reliable way.
You’re (hopefully) buying something that works: If the business you’re thinking of buying is profitable, chances are the owners have arrived at a formula that works. This formula probably has several ingredients such as good staff, solid management, established premises and (if relevant to the business) stock lines that sell.
You can make money from day one: If you want instant sales and instant profit, buying a business — as opposed to starting a business from scratch — is the way to go.
You can sometimes score a bargain: It’s true! If a businessperson has had enough of running the business and wants to sell up, occasionally the asking price is very reasonable. You may find a business owner so desperate to get out that they ask for nothing for goodwill and, instead, ask only for the value of the business assets.
Buying an existing business — the downside
So, what are the possible pitfalls of buying an existing business? Consider the following:
You have to pay for goodwill: Not only does paying for goodwill chew up precious capital but many business owners also overestimate the worth of their business, meaning that you risk paying too much. (Don’t worry, I talk about business valuation methods in the section ‘Valuing an Existing Business’, later in this chapter.)
Goodwill may be linked more to the owner than you realise: A hairdressing salon is a good example. Sure, the salon may have solid sales and great goodwill, but are customers going to leave in droves because they’re attached to the previous owner’s way of styling their hair?
Unwanted baggage: Some businesses come complete with an inherited set of problems such as a particularly difficult staff member or a poor reputation for customer service. Turning around difficult behaviours or a poor culture of customer service can be very challenging.
Your ‘dream’ can be compromised: If you inherit someone else’s way of running a business, things are going to be a little different from if you start from scratch.
If this business is so good, why is it for sale? Maybe a legit reason exists such as owner illness, the owner retiring or a marriage break-up.
On the other hand, maybe the reason is more sinister such as a major shopping plaza about to open up next door, a highway about to carve through the town or a lease that isn’t likely to be renewed. Maybe the business has never been that successful in the first place.
Ask the owners why they’re selling and what they plan to do next. Don’t be shy to ask around — does anyone else know the owner? Check out whether any similar businesses in the area are for sale (maybe that proposed highway is going to flatten them all).
Sometimes it takes a wee bit of digging to get to the bottom of why someone is really selling, but until you’re truly sure of the reason, I recommend you hold back from making an offer to purchase.
Asking the Right Questions
When it comes to buying a business, the law isn’t forgiving of idiots. The law expects that if you buy a business, you’ve done your research and made an informed decision. You’re not entitled to a refund simply because you didn’t do your homework.
The scope of this book doesn’t allow me to tell you everything you need to know before signing a contract to buy a business — that job belongs to your accountant and solicitor. However, I can provide you with a few pointers about what to expect and what to look out for. Read on — with care …
Finding out who owns the intellectual property
When you buy a business you’re buying not only things such as stock, tools, and fixtures and fittings, but also the intellectual property, such as custom computer software, copyright registrations, distribution agreements, domain names, information databases (including customer lists), licences, patents, secret formulas and trademarks.
Analysing sales trends, profit and break-even
Spend some time considering how robust the business model is. For example, what’s the break-even point for sales? If sales drop by 10 per cent (which is quite possible during ownership change), is the business still sustainable?
The second thing to consider is how the gross profit of this business compares with industry trends. If the gross profit margin is higher than average for the industry, this business may be more vulnerable to competition.
