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Is Buying an Existing Business Right for You?

Startup
Article
08/29/2019

Running a small business is not a job for the faint of heart. Entrepreneurs work long hours and take on many different challenges requiring a broad range of business skills. Potential business owners looking for a new venture may choose to build a company from the ground up, or buy an existing company or franchise. Companies with a loyal customer base and steady revenue stream can be enticing, though the initial investment might be higher than starting small and building slowly. Let's look at some of the pros and cons of buying an existing business.

Why you may want to buy an existing business instead of starting one from scratch

There are several advantages of buying a successful existing business, from convenience to a quicker (and safer) return on investment. Knowing the benefits of this business strategy may well tempt the aspiring entrepreneur.

1. Better financing options

Existing businesses already generate a revenue stream to help cover costs, whereas startups often seek financing to pay expenses before they even open their doors to customers. Often, established businesses have a reputation in the community and a customer base. This gives lenders assurance and can persuade them to offer financing options with more favorable terms. Established businesses may also use assets and inventory as collateral, which can secure favorable financing in comparison to startups.

2. Already established brand

An established business often enjoys brand loyalty with customers and is known in the market. As a new owner, you may have ideas about tweaking the existing brand, but you won't need to make a large investment in marketing to develop something completely new. Adjusting a brand when you already have a loyal customer base is much easier than building a market presence from nothing.

3. Existing customers

Being able to count on a reliable number of customers from the outset is one of the advantages of buying an existing business. The benefit is twofold: a solid customer base and a steady cash flow.

Customer base

A built-in customer base is a huge advantage to an entrepreneur. Customer loyalty can translate into lower marketing expenses and the ability to bring in sales from the get go. Although current customers may expect certain products and features associated with the company's current product line, they will also be interested in learning how the business may change and what new products will be offered. By invigorating the business and adding a fresh perspective, new owners can hope to increase sales and profit.

Cash flow

Bringing in sales from day one also helps generate cash flow, which is vital to new owners trying to develop their businesses. Owners of startups must devote a significant amount of time to finding investors or attracting financing, while buyers of established businesses can focus on running their new company earlier in the process. A steady revenue stream also allows owners to make improvements and upgrades, while startups may need to run on a much leaner budget until they're able to generate more cash from operations.

4. Well-established supply chain

Existing relationships with vendors and other business partners are essential to a smooth business transition. Your supply chain not only provides an important network of business contacts but also can offer help and advice on how to sustain or improve the business. They've been working with the established company for years, and they may know what systems or operations are working well and what needs improvement. Comparatively, owners of startups must spend more time and energy seeking out and creating valuable business relationships and growing them incrementally.

5. Access to trained staff and proven internal processes

Among the many pros of buying an existing business, perhaps none is more critical than starting out with the workforce and established operational systems that presumably made the company attractive enough for you to buy it in the first place.

Business operations

An existing business should have systems in place to track financial information, inventory, and sales, as well as to perform other essential tasks. Starting from scratch means spending time and money to develop these processes. In cases where outside assistance would be required to set up a new venture, some gains in cost-efficiency may be recognized by buying an established business instead.

Staff and transition assistance

In some situations, the previous owner or other employees will agree to stay and help manage the company through a transition period. Files and documentation should also be passed along to assist new owners in learning the details about the company. Even if the previous owner is only reachable by phone or email, having someone available who knows the business can bring the new owners up to speed in a shorter amount of time. Additionally, longtime employees who remain after the sale can provide valuable information and an outlook on what's kept the business alive through market cycles. This institutional memory, combined with some staff continuity, can be important. Customers will feel more comfortable sticking with a new business if they see a familiar face behind the front desk during a transition period.

6. More financial reward in growth

Growing an already established revenue stream can provide a larger payoff compared with initial business generated by a startup. Practically speaking, the energy and effort required to grow either a new or established business by 25 percent may be about the same. The key difference is there can be more financial reward with an existing business purchase because the added revenue stream comes from a larger base of customers. The original owner has lent expertise and knowledge developed over the years to build more efficient processes, which in turn can bring in more profit. Initial investments in marketing, which generally take years to pay off, may also benefit second owners.

7. Greater likelihood of success

Based on 12 years of tracking by the Small Business Administration, 80 percent of small businesses survive their first year — meaning around 20 percent do not succeed. This can be compared with the report that one in 12 of all small businesses close each year, which is around 8 percent. If a business has weathered the first five years or more, chances are that the original owners did something right or hit upon a product or service with a verified market in the community. When you buy a business that's already successful, you're likely increasing your chances of success compared to an untested startup.

Potential cons of buying an existing business

As with any investment, there are both pros and cons. Research the company as much as possible prior to making an offer. Don't limit your information to what is presented by the current owner; get out into the community and talk to vendors, customers, and anyone else who has dealt with the business for sale. Engage a financial adviser to study the information provided by the current owner and offer advice on pricing. You can also work through the buying-an-existing-business checklist provided by SCORE. There are several factors to consider, but generally aspiring entrepreneurs must be mindful of the initial outlay of money and wary of the situation they're walking into.

High cost for the initial investment

Purchasing an existing business can require a sizable investment. Even “inexpensive” industries and online-only businesses have costs.

Buying an established business will often cost more than starting from the ground up. Further, established businesses that are highly profitable will likely cost more than those involving more risk or a "fixer-upper" in need of an investment in technology or modernized equipment (see below). In comparison, when starting your own business, you have the option to start with a smaller investment and grow slowly over time.

Dated processes and technology

The existing structure can also be one of the cons of buying an existing business. Overstaffing and inefficient processes are examples of hurdles that must be overcome before the company can achieve its full potential. Ask the current owners about inspecting company systems before the purchase, to get an idea of what needs to be upgraded. If technology appears outdated and needs to be replaced or redeveloped, work this into the overall cost of the business. Sometimes, outdated systems are so entrenched throughout the company that it might be easier to create a new business from scratch.

Existing company reputation and culture

If the existing business has a poor reputation in the community or many negative customer reviews online, this may pose a challenge for new owners. Inheriting a poor reputation for customer service means new management will need to go the extra mile to make sure they're exceeding expectations. As such, you may not be able to raise prices to keep up with competition. Prior to buying an established business, consider how much effort will be required to reshape negative aspects of a company's reputation or culture, and factor this into your decision.

What to consider before buying an established business

When considering a business purchase, it's important not to cut corners in your evaluation. What you see on the outside may not be a true picture of how the company is run behind the scenes. Keeping the pros and cons in mind can help you spot potential issues, and provide a basis of comparison when evaluating more than one business opportunity. If you're serious about buying an existing business, use a checklist of best practices to give you the best chance at success.

Determine the type of business you want to own and run every day

Would you prefer a solo work-from-home endeavor as opposed to managing a retail shop with set hours? Before buying a business, consider the personal commitment and how it will differ from your current job situation. If you've never run a business before, consider buying a franchise that offers more operational guidance and set policies and procedures. Location and industry are big factors in deciding what type of business to purchase. Also, getting up to speed on a job in a new field may require a further investment in training and education.

Find out why the owner is selling the business

Early in the evaluation process, ask why the business is up for sale. Are the owners retiring? Do they want to switch careers? Do they want to back away from day-to-day management to pursue other endeavors? Discussions with the current owners should also include questions about how much time they're putting into the business — so you can better decide whether you can do the same.

View the opportunity from the inside

One way to find out how the business is currently run is to become part of it on a temporary basis. Shadowing the owner for several days or weeks allows you to evaluate the processes and the training level of current employees. You'll also develop a feel for the overall company culture and decide whether the company is a good fit for your managerial skills.

Investigate the business's financial condition

Before committing to an acquisition, it's vital to acquire a full understanding of the company's finances and market value. At the point where you're seriously considering a purchase, ask for the advice of independent financial advisers. Call on accountants, tax professionals, and legal experts to evaluate the pros and cons. Small business advisory organizations like SCORE can also offer a mentor to help those looking to head into new business ownership.

Understanding debt, assets, and cash flow when buying an established business

Even if you consider yourself to be financially savvy, professionals with expertise in small business can provide valuable insight and may even catch nuances in the financials that you've missed. Financial professionals examine everything, from the company history to its current financial position, by measuring asset values, revenue streams, and cash flow projections. Tax professionals who keep up with the latest legislation can offer recommendations about the purchase and reorganization of a business into a more favorable structure.

Valuing an existing business for sale

An owner selling a business will ask for a price they believe makes a deal financially worthwhile for them. They will also offer information to support their asking price, such as the company balance sheet, cash flow statement, and sales data. Many factors come into play when valuing a business for sale, and different methodologies may be employed. In addition to physical assets and sales numbers, a company's brand and reputation may often contribute to the worth of the business. The balance sheet values are a good starting point, but true insight is only obtained with a deeper analytical dive into the company.

Explore financing options for buying an existing business

If you don’t purchase a business all in cash, one financing option is a business acquisition loan, which is structured for the purpose of buying an established business or franchise. Other options include secured or unsecured bank loans, or SBA loans, which can be obtained through a traditional lender but are backed by the U.S. Small Business Administration. You may also consider applying for a business line of credit to manage cash flow fluctuations as you acquire and make changes to an existing business. You may also want to fund part of the purchase with crowdfunding or seller financing. And finally, if you don't want to take out a loan, you can seek the financial support of an outside investor or try to partner with another business in exchange for a partial ownership stake.

Buying an established business can be one of the best ways to get a jump start on entrepreneurial success. If you've dreamed about owning your own business and need financing, consider finding capital through business loans.

This website contains articles posted for informational and educational value. Paychex is not responsible for information contained within any of these materials. Any opinions expressed within materials are not necessarily the opinion of, or supported by, Paychex. The information in these materials should not be considered legal or accounting advice, and it should not substitute for legal, accounting, and other professional advice where the facts and circumstances warrant.