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May 30, 2022

How to Buy a Small Business: The Complete Guide

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How to Buy a Small Business: The Complete Guide

Unconventional Acquisitions

May 30, 2022

There are 3 major steps to buy a small business: finding a good business, valuing the business properly, funding the business & closing the deal.

How to Buy a Small Business

Sure, starting a new business sounds sexy, but so does success. According to the Bureau of Labor Statistics, 50% of new businesses fail before the end of their fifth year. It doesn’t sound so badass anymore, does it?

If you’ve never been a business owner (and even if you have), consider buying a small business that already exists. If you have no idea how to buy a small business, there’s a great club you can join. It’s called everyone who has ever purchased an existing business before.

We all had to start somewhere, right? So why not you, and why not now? So if you’re looking for a guide on how to buy a small business, keep reading.

How to Buy a Small Business: The Guide

1. What’s Your Type?

What do you love to do? What kind of skills and experience do you have? It’s a good idea to stick with what you know when it comes to a business acquisition.

If you’ve had a lifelong green thumb, consider buying a flower shop. Have you worked in retail since high school? Maybe you’re ready to own your own store? The skills and education you have can be excellent guides in the type of business you buy.

You don’t have to know everything about how to buy a business to be successful. However, knowing something about your product or service will help you.

Do What You Like…Unless It’s a Bad Business Idea

Have you heard the old adage, “Do what you love and never work a day in your life?” If you’re buying a small business, you’re going to do a lot of work. You’re not going to like every aspect of it, so this little quip is unhelpful.
That quote should say Do what you love unless it’s a bad business idea, then keep it as a hobby. Of course, nobody’s going to needlepoint that on a pillow, but it’s how you should approach business buying.

Buying a business that aligns with your interest gives you a few advantages.
First, you know more about the product or service than the average person. If you’re an avid rock climber, you know more about the rock climbing world’s equipment and levels of experience than a non-rock climber. You’ll have a better idea of target demographic needs and product costs right off the bat (or rock).

The second advantage of buying a business that aligns with your interests? You’re probably more passionate about rock climbing tools than antiques. It only makes sense that you’d put more time, energy, and effort into a store that sells outdoor equipment. You’re intrinsically more motivated and passionate about the product itself.

Passion for the business isn’t a must in buying a business. There are plenty of successful business owners who don’t know much about the product or service itself. If you aren’t passionate about the goods/services your business provides, hire someone passionate and knowledgeable as your operator.

Boring is Your Friend

Pushing your passion isn’t a good fit for you? Maybe there’s already an REI or two in your area. If that’s the case, it’s better to look at buying a business outside your interests or passion.

Think of something that’s necessary but super boring. Like, something you’d be almost embarrassed to say you own. Think vending machines, laundromats, and car washes. Purchasing a business that provides boring (yet necessary) goods and/or services might just be your golden ticket.

Purchasing a boring business like a laundromat has the potential for a low purchase price, upfront cash flow, and relatively low risk (if it’s healthy when you buy it). It’s not super sexy, but it could be super smart. At the end of the day, wouldn’t you rather be smart?

Answer: yes, you would.

The Steps of Buying a Small Business

‣‣ Step 1 to Buy a Small Business: Make Some Lists

If you’re still unsure what kind of business you should buy, start making lists.

First, list all the reasons you’d like to start a business. What do you hope to gain from buying a business? Next to that list, write down why you think you shouldn’t buy a business, including your fears.

The next day, write down all the ideas you have for businesses, including your passions/hobbies. Finally, list ten things you think you need to learn before buying a business.

Wait a day or two and write down what your gut says after having time to look at your lists and think about it. Maybe a few things will jump out at you that you haven’t seen before. This exercise could also help you see yourself as someone poised for a business opportunity rather than a newbie searching for your first business ownership experience.

1. Find What You’re Looking For

Ok, now you have an idea of what kinds of businesses you’re looking to buy. Now you have to find the business sellers. Before you start googling, find a legit business marketplace.

Sites like FlipWP, Swift Exits, Tiny Acquisitions, and AcquireBase are some newer business marketplaces. Check out our post for a detailed list of online communities and marketplaces that can help you score a great deal.

Also, get to know the business brokers in the area where you are looking to buy an existing business. As you build relationships with people connected to small business owners, you will increase your chances of finding a deal.

‣‣ Step 2 to Buy a Small Business: The Right Sellers

How will you know if that seller is the one? Of course, you should trust your gut. But your gut may be telling you not to eat that gas station chicken salad again, so you need some more resources.

Be on the lookout for motivated sellers. A motivated seller wants to find the right buyer for their company. These sellers are likely emotionally invested and want to see the business succeed.

Small business sellers nearing retirement are great candidates for a business sale. The ready-to-retire business owner will likely stick around to help you get that success, too.

If you can’t find any baby boomers selling their businesses, look for owners who are relocating. If they have a move-out date but no buyer, they’re motivated.

Restless owners may also be willing to work with you on terms of the sale. They may be more inclined to strike a creative deal than a traditional business owner.

Once you’ve found your match made in business seller heaven, you’re ready to move on to the next step. So get ready for some serious chatting.

Have a Chat

Take your time in getting to know the business seller. Of course, you want them to trust you, but you also want to make sure you can trust them. Here’s how.

Establish Trust

It might be a good idea to sign a non-disclosure agreement first. Having an NDA tells the business seller you’re serious about the potential sale. In addition, it serves as an opportunity for you to show that you’re trustworthy and won’t blab sensitive details.

You can give the business owners your business and/or personal history, depending on the situation. Suppose this is your first business venture, highlight why you’re a great candidate for this sale. Then, position yourself as the wise investor looking for your next opportunity.

Talk about your plans for business growth and how your ownership will affect employees. For example, if you’re trying to take over Pete’s Pizza, and he’s had the same three employees for the last 20 years, tell Pete what will happen to those employees when you’re the big cheese.

Ask All the Questions

Ask to see some documentation on this business. Ask for financial statements. What are their profit margins, cash flow, and assets? What are their most significant liabilities or outstanding debts?

You can discover some of these answers by looking at past tax returns. You can also lookup your business on its county website to determine if any delinquent taxes or tax liens are against it. Finally, ask why the owner is selling their business.

Ask employees or operators about their experiences with the owner. Ask them if they’d like to see changes made to the business. Ask them what they like about their jobs and their boss.

‣ How Much is That Business in the Window?

Discussing valuation is where things could get awkward. But they won’t, because you’ll prepare in advance. How much you can pay for a business should be based on its valuation, profit, and earning potential.

How much cash can you make by taking over this business tomorrow? If it’s not yet profitable, why? Can you make money right away? The business valuation for most small businesses should be somewhere in the neighborhood of 2X-4X profit (also called SDE in these smaller deals).

If you can’t make money right away, rethink the sale. If you have the potential to make more money, get yourself a business plan with a timeline. Your best deals will be the ones you can scale after your purchase.

‣‣ Step 3 of Buying a Small Business The Valuation Station

Before making any offers, you need to know how much money the business is worth (valuation). There are several different ways to calculate the valuation of a business.

The easiest way is to subtract current assets from the company’s liabilities. While this method is a decent place to start, it’s oversimplified and doesn’t always give an accurate picture of a company’s financial state.

The discounted cash flow method projects future earnings to find the company’s valuation. For most of the businesses we buy, this multiple of earnings is our method. The problem with this method? You can’t predict the future (right, pandemic/2020?).

Here’s our Free deal calculator to help you determine the value quickly.

Enterprise value is calculated by adding debt and equity and subtracting cash that’s not going back into the business. This method is helpful to find out who is financing their operation with equity and who fuels their growth through debt.

There are several other ways to calculate valuation. The method you use will depend on the size and type of the company you intend to buy. If you’re not confident finding the valuation of a company on your own, hire an accountant or CPA.

Don’t just sit back and let the pro crunch the numbers. Instead, ask them to involve you in the process, so you learn, too. Understanding business valuations should be on your list of ten things to learn if you don’t already know how to do it.

‣‣ Step 4 of Buying a Small Business: Get Your Ducks in a Row (Funding)

There are several different ways you can go about purchasing a small business. Your method will depend on your research and relationship with the business seller.

A small business seller waiting to retire won’t take the same pitch as the entrepreneur hoping to offload her 15th business so she can fund her 20th. Instead, explore your options and read the room before coming to the table with a solid offer.

‣ Traditional Business Loans or SBA Loans to buy a small business

These are pretty straightforward. You go to the bank/credit union, and they’ll tell you how much you can borrow. They’ll probably give you a letter of preapproval to prove that you can have the business loan, HELOC, or type of loan for which you’ve applied.

Knowing you have the capital gives the business seller confidence in your ability to follow through and fund the business. It also tells her she will get paid. Win-win.

Be aware that this process takes a long time. You may have to wait a month or longer for all the wheels to start turning. There will also be fees associated with the borrowing process, so be prepared for that as well.

‣ Private Investors

Angel investors, business partners, and sometimes even relatives, who believe in you, are all ways you can acquire the funds you need without incurring financial institution fees and delays. Many private investors are willing to make unconventional deals as well.

Private funds could be an opportunity for you to get a little creative with your business funding. Think about offering percentages of equity in the business as payment. Of course, the exact model you take depends on the investors, business needs, and your creativity.

‣ Own Cash to buy a Small Business

There’s a reason people say cash is king. You don’t have to rely on anyone else for funding. It’s your cash, spend it how you want to.

Business sellers know they’re going to get paid faster with cash and might be willing to negotiate on price. The business owner knows they’ll get their full payment right away with cash.

If you’re buying an already profitable business (it should be) with cash, you’ve just scored instant cash flow. That’s a pretty good way to start off your first business venture.

‣ How to Buy a Small Business with no money of your own: Seller Financing

Some people don’t have cash or loans to fund a small business acquisition. If this is the case with you, it’s ok. Many successful business owners bought their businesses with little to no money down. No, they weren’t MLMs or peer-to-peer models.

These were car washes, laundromats, and highly profitable businesses purchased by negotiating smart deals with existing business owners. Read more about how you can be successful with this method here. With proper motivation, you can make seller financing opportunities happen.

‣‣ Step 5 (final stage) of Buying a Small Business: Make The Offer

Once you’ve talked with your finance people and know what you can afford, make the offer. You may get rejected, and that’s ok. Either go back to the drawing board and come back with a different offer or move on.

If you’re still feeling shaky about your dealmaking skills, we can help you out. It’s important to be organized before and after you bring your offer to the seller.

‣ Letter of Intent (LOI)

Your offer should include a letter of intent. This is a non-binding document outlining sale terms.

Your letter of intent outlines the type of financing, type of business, timeline, confidentiality, and other terms. Read this for more details and ideas to help you draft your ROI.

1. Do the Due (Diligence That Is)

As much as we’d like to believe all business sellers are honest, not all of them are. Even honest sellers might not be 100% knowledgeable about their own business. It’s your job to do due diligence before a business purchase.

‣ Not Too Taxing

You can ask to see the last five years’ tax returns. It could be a red flag if the owner is weird about getting them to you. If numbers aren’t your forte, hire a CPA to review the tax documents with you.

Notice, I said with you and not for you. If this will be your business, you should be open to learning what you don’t know. You’re paying that tax person regardless, so why not learn something, too?

Don’t forget about property taxes. These should be easy enough to find on the county website. If Pete’s Pizza Palace had late payments or penalties, you might want to pass on that purchase or at least find out why it happened.

‣ Digging It

If you buy this business, their problems become your problems. Those problems may include debt, outstanding agreements, contracts, or liens. But, unfortunately, most places won’t include their black eyes and skeletons in their elevator pitch.

It’s up to you to determine what kinds of liabilities you’re taking on with this business buy. Keep in mind that some risks are worth taking. Not all debt is a deal-breaker.

Use the brain your mama gave you to weigh the risks. If they outweigh the rewards, you might want to tell Pete, “thanks, but no thanks.” But, on the other hand, you might think Pete’s secret sauce is worth the risks and purchase his Pizza Palace.

Make New Friends

Part of due diligence is getting a sense of the business culture. For example, what do employees think about how the business is run? What would they like to stay the same? What changes would they make?

Do employees have concerns about ownership changing hands? If so, why?

You can learn a lot about company culture by spending a few days with those working there. Of course, building relationships with your potential employees can’t hurt, either.

Close the Front Door

Here it is. Closing the deal. The business seller accepted your offer, and you’re buying a small business.

If you’ve done steps 1-5 correctly, you should be confident you’re making the right decision. Make sure your closing day is well documented, and the terms of your sale are straightforward.

Again, don’t be afraid to pay the pros here. Make sure a lawyer and accountant/CPA have helped you through this process. Few surprises at or after this point are good.

Now give yourself a high five (maybe when nobody is looking). You just bought a business.

Make It Work and Make It Grow

Depending on the business sellers’ situation, you may or may not be on your own with this step. If you’ve asked for a smooth hand-off, the business sellers will be around to help you. On the other hand, if this was a cut-and-run situation, you’re diving in on your own.

Now is a great time to follow a business plan you should have written before the purchase.

If you haven’t made a business plan already, make one now. How are you going to foster growth? Where will your funding come from?

What will you do with/for current employees? If you’re not an expert in the services or products, hire a business operator. Then, once your operation is a well-oiled machine, you can focus on your next.

Business success can be addicting…you’ve been warned.

Is Buying a Small Business Right For You?

Whether you’re buying a franchise or a small mom-and-pop shop, you can succeed in buying a business. You can make it work with a good legal team, plenty of research, and creative financing.
Of course, there’s much more to know about this process than one post can teach. Each situation has its own nuances and scenarios. And, if you don’t know why you’re buying a business, there’s not much point in learning how to buy a small business.

How to Buy a Small Business

If you’re serious about being a successful small business owner, you need our Business Buying Course! Learn with Industry Experts How to Build Freedom and Passive Income Through Acquisitions.

Learn How to Buy a Small Business with Industry Experts

Let us show you the proven methods to find, analyze, buy and build small businesses. It’s not rocket science, it’s the class no one teaches.

Time to build a path to freedom through small business acquisition whether you are a W2 employee, an entrepreneur, a small business owner, or searching for passive income investments. Whether this is your first of one or first of many, you’ll gain the confidence to buy the right business. Maybe you’ve already bought your first business, and you’re ready for more.

Commit yourself 30 minutes a day, one month straight- I promise you will know what 99% don’t. It’s time to take the first step.

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