Summary
An exit strategy for a small business owner is for a third party to buy into their business. A third party business valuation is a good tool to facilitate someone buying a percentage of an existing small business.
Safely Buying into an Existing Business as part of Partnerships
Buying into an existing business involves key steps and essential research. This guide explains how to buy into an established company, covering management roles, financial evaluations, and securing financing. Follow these steps to protect your principal, make informed decisions, and transition smoothly into business ownership.
Like a marriage, a business partnership is tricky, and the proper due diligence needs to be done. Partnerships, especially if you are in the minority, require a deep dive into all facets of a company.
An exit strategy for a small business owner is for a third party to buy into their business. A third-party business valuation is a good tool for facilitating someone buying a percentage of an existing small business. Small businesses have trouble designing an exit strategy and letting a new person own a business partner, even with a business loan and good cash flow statements.
Please read our article on buying a small business.
Key Takeaways When Buying into an Existing Business
- Clearly define your investment and business partnership role and responsibilities to ensure smooth operations and prevent conflicts. Does your skill set match what the business needs?
- Before investing, conduct thorough research and due diligence to evaluate the business’s financial health and potential risks. Will the key employees stay? Is it a growing business model? Does the Better Business Bureau highly rate it? Does it have an established customer base?
- Secure appropriate financing options and finalize the purchase agreement with legal safeguards to ensure a successful acquisition.
- Make sure the buy-sell agreement covers all contingencies. Do your new business partners value your skillset and potential contributions, or just want your money?
Understanding Your Investment Role
Defining your investment role is the foundation of a successful business acquisition. Understanding your responsibilities and decision-making authority within the partnership prevents conflicts and ensures smooth operations. Before investing, outline the types of decisions you’ll make and who will handle other aspects of the business.
A partnership agreement outlines the specifics of profit-sharing and decision-making authority. This document should include components such as profit sharing, responsibilities, and any other agreed terms. Documenting all agreements helps maintain transparency and fosters a healthy partnership.
Your ownership percentage determines your share of the profits. Clearly defining roles and responsibilities within the partnership ensures that everyone knows their duties, reducing potential misunderstandings and conflicts.
Researching the Target Business
Thorough research is the backbone of any successful business acquisition. Begin by understanding the business from a financial standpoint and the overall landscape. Evaluate the business’s reputation by consulting current and former customers, employees, and local businesses to understand its performance and challenges.
Several key factors should be considered when deciding when to buy a business. These include a good labor pool, a solid customer base, established procedures, growing sales, and positive cash flow. Additionally, check for any problems that might indicate risks, such as poor customer service or legal troubles that could negatively affect the company’s reputation.
Examining financial statements assesses the business’s financial health and associated risks as part of the due diligence process. This includes evaluating revenue trends, expenses, labor costs, and profitability metrics. Understanding these aspects will help determine if the business is a viable investment that aligns with your goals.
Evaluating Financials of an Existing Business
Reviewing financials is a critical step in the business acquisition process. Analyzing financial statements provides a complete picture of a company’s assets, liabilities, revenues, and expenses. Confirm that a certified public accountant has audited tax returns and financial statements for accuracy.
Small companies won’t have audited financials, but make sure their QuickBooks ties into their tax returns. Their successful track record should be apparent in the strength of their balance sheet.
Profitability metrics, such as gross margin, offer insights into a company’s earnings effectiveness. Analyzing cash flow patterns assesses financial stability and cash generation ability. Trends in revenue and expense help determine whether the company is growing or facing financial difficulties.
Valuation methods combine income-based, asset-based, and market-based approaches. Engaging a professional valuator ensures a fair assessment and mitigates valuation conflicts. This comprehensive evaluation will help you make an informed decision and secure a sound investment.
Determining How Much to Invest
Determining how much to invest involves several considerations. First, assess the business’s worth using a blend of market and income-based approaches. The business assets approach, which considers tangible and intangible assets minus debts and liabilities, also provides insights into the business’s value.
Access business financials and organizational documents to evaluate the business’s value. Be aware of any debts and liabilities in the transaction, and be cautious about taking them on during the purchase. Additionally, costs such as subscriptions, travel, and advisory fees, which can add up during the acquisition process, should be considered.
Analyze the business’s income stream to ensure a clear path to profitability before investing. Assess your budget, goals, resources, size, location, sales strategy, and staffing needs to determine the right investment amount. You should consult your accountant for financial advice before using personal funds for a business purchase.
Securing Financing Options
Third-party financing options are a critical step in the business acquisition process. Explore various financing options such as private equity, business acquisition loan, and seller financing. Traditional bank loans and SBA 7(a) loans are standard methods for financing business purchases.
Acquisition loans require a down payment of 10% to 25%, and seller financing often entails staggered payments. Alternative financing options include using personal savings, obtaining family loans, or exploring different equity and debt financing types.
Secure financing that aligns with your investment goals and financial situation. Assess the terms and conditions of each financing option and ensure you have a solid plan for repaying any loans or financing agreements. This step will help you obtain the necessary funds for the business acquisition.
Conducting Due Diligence
Conducting due diligence ensures you make an informed decision when buying a business. Start by checking for business licenses and permits necessary for the business’s operation. Ensure compliance with local zoning restrictions to avoid legal complications.
Review any existing legal issues or ongoing litigation affecting the existing business you are targeting. Thoroughly examine financial documents, including income statements and balance sheets, to assess the business’s viability. Verify all employee information, including contracts and benefits, to evaluate potential risks.
Understand the business’s cash flow situation to evaluate its long-term sustainability. Analyze customer relationships and data to assess business stability and potential for growth. Conduct a complete inventory of the company’s physical assets, including inventory, equipment, and real estate. Identifying hidden issues, such as damaged equipment or potential reputational risks, is also essential.
Negotiating Terms
Negotiating terms is a crucial part of the business acquisition process. After deciding to proceed with the acquisition, begin by negotiating the price of the business. Make a non-binding offer regarding the purchase price, which can be written or verbal. We recommend using a written letter of intent (LOI) to get the broad strokes of the deal out of the way.
Include the price proposal and terms and conditions in the buyer’s letter of intent. The letter of intent is a non-binding agreement outlining the purchase structure and price. Seller debt refers to a situation where the seller assists in financing part of the purchase price. This arrangement can help facilitate the established business sale. Address potential discounts on the purchase price during negotiations, particularly in stock sales.
Negotiation aims to create a win-win deal for both the buyer and seller. Earnouts can be appealing as they tie part of the purchase price to future business performance, thereby reducing risk. However, conflicts may arise in earnout agreements if the buyer and seller disagree on performance metrics.
Please read our article on using earnouts to bridge value gaps to get a fair price.
Finalizing the Purchase Agreement
Finalizing the purchase agreement is the final step in the business acquisition process. A purchase agreement outlines the transaction’s terms and conditions, serving as a legal safeguard for both buyer and seller. State laws often require sellers to notify creditors before selling a business to protect creditor interests.
The buyer’s attorney and lender should conduct a UCC search to ensure that all purchased assets are free and clear of any liens.
The purchase agreement typically specifies when the ownership transfer and payment will occur. Buyers often perform a lien search to confirm no existing claims against the business’s assets before finalizing the purchase. Indemnity provisions in the purchase agreement define the seller’s responsibility to cover certain expenses the buyer may incur post-sale.
Hire a transaction lawyer to help prepare and ensure the final purchase agreement is legally sound and comprehensive. Following the decision to proceed with a deal, necessary documents should be drafted, including the purchase agreement, employment agreements, non-competes, earn-outs, business broker commissions, and leases.
Transitioning into Your New Role
Transitioning into your new role as a new business owner involves several steps to managing your business successfully. Establish a plan to cover previous responsibilities to prevent vital tasks from being neglected during the transition. Balancing respect for past practices and implementing your vision for the business is crucial. Make sure the organizational chart reflects your people’s actual job duties.
Open communication with employees and clients about the changes and future vision fosters security and trust. It’s common for some employees to resist changes after a business transition; focusing on those who align with your vision is more productive.
A mentor or support system can alleviate stress and help make better decisions during the role transition.
Post-Investment Strategies
Implementing effective post-investment strategies is crucial for business growth and stability. Buying an existing business allows you to start generating cash flow immediately. Streamlining business operations and reducing costs can improve cash flow over time.
Regularly reviewing financial projections allows for timely adjustments to business strategies and goals. Improving existing cash flow is crucial after investing to ensure sustainability and growth. Access to monthly financial and performance reports is essential. Don’t let the seller take your money and not keep you informed.
Summary
Buying into a business is a multifaceted process that requires careful planning and strategic thinking. From understanding your investment role to conducting thorough research and evaluating financials, each step is crucial for a successful acquisition. Determining the right amount to invest, securing financing, and negotiating terms are essential to ensure a fair deal.
Finalizing the purchase agreement and transitioning into your new role involves meticulous attention to detail and effective communication. Post-investment strategies are vital for sustaining and growing the business. By following these steps, you can navigate the complexities of business acquisition and set yourself up for long-term success.
Remember, each business acquisition is unique, and adapting these strategies to fit your specific situation is essential. With careful due diligence, planning, and execution, you can achieve your business goals and thrive as a new business owner.
Frequently Asked Questions
Why is it important to define my investment role before buying into a business?
Define your management and investment role to prevent conflicts and establish clear responsibilities. This will ensure smooth operations and effective decision-making within the business. You should have immediate access to business financials.
What factors should I consider when researching a business to buy?
When researching a business to buy, it is crucial to evaluate its reputation with existing customers, customer base, established brand, financial health, gross sales/gross margins trend, and potential risks like customer service issues or legal problems. These factors will ensure you make a well-informed decision.
How do I determine the right amount to invest in a business?
To determine the right amount to invest in a large or small business, assess its worth, consider additional costs, and analyze the income stream to ensure a clear path to profitability. This thorough evaluation will effectively guide your investment decision.
The return on your down payment should be in the 25-50% range when buying a business.
What are some common financing options for business acquisitions?
Standard financing options for business acquisitions include private equity, seller financing, business acquisition loans, traditional bank loans, and SBA 7(a) loans. Each option provides different benefits, so it’s essential to explore them to find the best fit for your acquisition needs.
Why is conducting due diligence important in the business acquisition process?
Due diligence is crucial as it allows for a comprehensive financial, legal, and operational evaluation. This evaluation enables an informed decision regarding the viability and risks of a particular business acquisition and helps mitigate potential issues post-acquisition.
If you can’t read a balance sheet and tie internal financials into the company’s tax returns, get professional help.