If you have an entrepreneurial heart but do not want to go through the extremely hard yards of setting everything up from scratch, buying an existing business may be the right move for you.
A common misunderstanding is that there is a huge upfront cost when buying an existing business but the truth is that there are huge upfront costs associated with starting them too!
1. Identifying the right industry for you
The first step in buying a business is working out which industry is perfect for your skill sets and know-how. There are a few important questions to answer properly when determining which industry is right for you:
- Do you have a working knowledge of this particular industry?
- Do your skill-sets and know-how to give you a competitive advantage in this industry?
- Is this industry growing or shrinking?
- Do you have the capital to acquire a business in this industry?
Once you’ve answered these questions truthfully, you should have an idea of whether the industry you looking at is right for you.
2. Know your budget
This is extremely important. Contrary to stories of entrepreneurs using their credit cards to pay for their business ventures, it is generally a bad idea to mix too much debt into a business venture. It is certain that if you have a loan, you will need to make regular repayments but business performance is never guaranteed so you want to err on the side of caution. If you are going for a business loan, speak to a business banker to work out what you can borrow to determine your budget.
Please note: Do an analysis of your own personal balance sheet and speak to your accountant to get an honest opinion on your budget for acquiring a business. Make sure you take into consideration working capital (payroll, rent, utilities, other variable costs). A good start requires a good foundation, so you want to make sure you do this step right.
3. Shortlist businesses available
Once you know what industry you would like to purchase into and roughly how much you can afford to spend, you will need to shortlist potential businesses to acquire.
To do this, browse through our business listings and shortlist ones which fit your criteria in terms of :
- Asking price
You will need to work out what is important to you at this stage. There is no point in looking at businesses 50km away if you do not want to travel to and from work. If you do not want to spend over $XXX, then don’t look at businesses that are much higher than your budget. You get the idea!
Shortlist however many businesses you like, at the end of the day, it is a big commitment so you want to make sure that it is the right business for you.
4. Research shortlisted businesses
This is the part where you go undercover and scout the potential business to see how they truly operate. It could be getting a family member to pretend to be a client, watching a cafe from across the street to see how many patrons they have. Do this whilst looking at their financials.
You will need to liaise with the business owners’ business broker and sign a confidentiality agreement to have access to sensitive financials. This is the step to do a bit of research and due diligence before bringing in the professionals to examine the financials/contracts.
5. Find industry benchmarks
Go on the ATO website to find the industry benchmark for your industry. This will give you a good idea of whether their profit and business valuation are close or way off industry norms. As a rule of thumb, most businesses are either valued based on their balance sheet (if there is no goodwill) or 3X annual net profits. Work out a baseline of what your target business might be worth so that when you begin negotiations, you have an idea of what your target price is. You can use the ATO’s list of industry benchmarks as it is publicly available.
6. Begin negotiations
At this point in the acquisition process, you will have a clearer picture of both the business and the industry within which it operates. With your understanding of the business’ activities, you can begin to talk directly to the current owners and work towards a mutually beneficial deal.
The most important point of negotiation is obviously price. Do not be scared to negotiate and ask them to drop the price. Although there is no contract to contractually bind you to a sale, use phrases such as “If I were to offer $XXX, would the business owner sell?” to protect yourself. This is lightyears better than saying “I will buy the business for $XXX.”.
7. Valuation of the business
So you think the business is right for you, you’re certain about the industry and think that the owner will sell for a certain price range. It’s vital to bring in the experts to provide a proper valuation on the business. Assets such as real estate, equipment, plant, and machinery will often make up the bulk of any valuation. These are easier to appraise but turnover, profitability and ongoing contracts are much more difficult. A specialist accountant is probably the right person to speak to in terms of valuation.
8. Offer and contract
It is time to put in a formal offer to the business broker or business owner. This is where you will need to hire a business lawyer to prepare your formal business offer. If they accept, then you will need to get your lawyer to write up the relevant contracts which are usually your state’s Business Broker’s form of Sale of Business Agreement.
This formal agreement should specify the following:
This agreement should detail any special conditions precedent to the settlement such as “subject to”: “finance”, “due diligence”. Speak to your lawyer to find out what is possible to protect yourself so that you don’t come out second best.
As a general rule of thumb, the buyer should pay a deposit. This should be no more than 10% of the purchase price and should be stipulated in the contract.
You will need to determine what third party approvals are required and these should also be conditions
of the sale agreement. All third party approval conditions need to be in writing; such as lessor’s consent, grant of statutory license/permit, issue of the new franchise agreement, staff agreeing to transfer employment to the buyer, etc.
It is best practice to organise settlement dates based on “trigger dates”. Rather than have an arbitrary day to settle, it makes more sense to have the settlement date maybe 5 days after all due diligence, third party conditions performed/satisfied and finance is formally approved. Refer to your lawyer on how to optimise this for your benefit.
Please note: Ensure that your due diligence and all other requirements and information are accepted prior to approaching a bank to finalize finance. Banks need all this information prior to unconditionally approving a loan for businesses. It is recommended that you have obviously spoken to your bank or financier at a much earlier stage to get your financial capacity so that you are not caught off guard after spending money on legal and accounting professionals.
9. Execute contract
Execute the contract as specified, as this will ensure that if there are any issues, you have at least fulfilled your side of the bargain. If there are any issues, you should bring this up with your lawyer to ensure that your rights are upheld.
10. Complete handover
Once the business has changed hands, work extra diligently in ensuring that the changeover is smooth so that you don’t lose its existing clientele. In many cases, the previous business owner would look help with the transition especially if it is part of the contract. Don’t change too many things until the business has begun running smoothly.
Although the process of buying a business is quite daunting, countless Australians buy businesses every year. It is quite similar to buying real estate and you just need to be conscious of all the potential issues to protect yourself and your investment.