What You Should Know When Buying a Company
Table of contents
Safely Acquire an Existing Company Checklist
Here’s what you should know before purchasing an existing business.
For individuals interested in entrepreneurship, it may be a good idea to consider buying an existing business instead of launching one yourself. A business broker can help be remember they are commission driven.
Doing so would enable you to impact a company’s trajectory without having to take on the risks often associated with founding a business. Even buying a franchise has its risks because great franchises in wrong locations fail every day.
This is because, with an existing business, the target company already have an established customer base, senior management, cash flow, team dynamic, real estate (if interested), well ran business operations, and reputation to rely on. Additionally, you can avoid startup costs and growing pains often accompanying you when creating businesses from scratch. Funding start-up costs and a burn rate is no fun.
Acquiring an existing operation also presents the opportunity to implement changes that could promote the business’s growth in the future enjoying future market trends.
Please read our step-by-step guide to buying an existing business and how business valuations can protect you in your purchase decision, purchase price, and in deal structure.
Buying a Business Checklist
Here are a few things you should remember as you do your due diligence and analyze an existing business up for sale.
- Analyze the value of the business you are considering.
Before making any offers, you should have a good idea of the business’s true economic worth. You and the seller can seek independent valuations, like those done at BA FL|GA|HI, to help you determine which appraisal service best suits your situation. Our complete due diligence checklist can be found here.
Regardless of the valuation method the appraiser uses, your valuation will determine the fair market price of the business. As a result, it will consider aspects of the company, like its financial health and longevity, earnings history, business plan, and growth potential. Additionally, its fixed assets and liabilities will be analyzed. remember, tax returns trump internal financials unless a company has audited financials.
As a result of the due diligence process, you must request projected financial statements from the current business owner. These documents will help the analyst understand the business’s financial health and true economic value.
Read Buying a Small Business. What You Need to Know.
Methods to Value a Business
Appraisers often employ a few approaches to evaluate an existing small business and determine its fair market value. Those valuation methods include the following:
- Asset Approach: Although imperfect, this method determines a business’s value by taking the difference between its assets and liabilities. Assets analyzed include physical items like machinery, property, raw materials, and intangible items like intellectual property. Next, a monetary value is assigned to each asset. Then, each asset’s value is summed before any debts or liabilities are subtracted.
- Market Approach: This approach helps determine a business’s value by considering the market prices of similar assets or businesses that have recently sold or are in the process of selling.
- Price-to-Earnings Ratio (P/E): This method informs forecasted growth through prior profits. Although calculations used to reach the valuation are straightforward, the P/E ratio often varies from business to business. Expert valuators like those at BA FL|GA|HI can suggest the correct number to use for the business’ P/E ratio.
Expert valuators use this method to inform forecasted return growth through prior profits. A higher P/E ratio would be used for companies with high forecasted return growth or repeat earnings. For example, if the P/E ratio of three is used for a company that makes $500,000 in post-tax earnings, the enterprise would be valued at $1,500,000.
2. Determine whether the asking price is fair.
Keep in mind that selling a business for an individual often involves various emotions. As a result, the business owner as the seller might have an idea of what the business is worth that differs from what you, as the potential buyer, have in mind.
It is important to note that many business owners might be setting the sale price of their business randomly based on anticipated value and not facts. Additionally, the price might be influenced by external conditions like the state of the economy or personal financial issues.
Therefore, you, as the buyer, must closely assess the asking price. Being the most prepared party will give you leverage as you enter the negotiating stage.
4. Review all the business’ liabilities.
Although acquiring a business may help you avoid risks when starting a business, you should still consider the potential costs you would be acquiring with the purchase.
This is why it is important to consult legal and financial experts, such as attorneys and accountants, who can help you examine all liabilities associated with the enterprise.
It is vital that they consider whether the owner used any assets as collateral to secure loans, whether any liens had been imposed against any assets, and whether claims have been filed against the business.
This information does not necessarily mean you should not consider proceeding with the sale. Instead, use it to gain a clear understanding of what the purchase might actually entail.
Many people consider franchises because of the systems and procedures in place. Read our article about knowing the value when buying a franchise.
Buy a Business Conclusion:
Purchasing a business helps you avoid the costs associated with launching a business. But buying a business also imposes its own set of risks and challenges.
Understanding a company’s true value and worth can be extremely helpful as you strategize and consider making a potential purchase. Reach out to our appraisers at BA FL|GA|HI as you consider whether buying a business is the right decision for you.
Here is our checklist when valuing a company.