The decision to buy an existing business is a significant step for anyone, whether you're an established business owner looking to expand your portfolio or a potential first-time owner.
The process can be challenging and lengthy, and it's critical that you perform due diligence at every step. From finding the perfect candidate and identifying red flags to negotiating a successful purchase price, success depends on knowing what you want, being thorough and having the right team assembled to support you along the way.
Here's what you need to know and do as you set out to buy a business.
Understand your motivation
Avoiding mistakes and achieving positive outcomes during the business buying process starts with being clear about your motivations. For example, are you interested in complementing or diversifying your existing portfolio of investments? Did you receive proceeds from a liquidity event that you want to reallocate into a new business opportunity? Or, are you interested in satisfying your entrepreneurial spirit?
Bill Ringham, director of Private Wealth Strategies at RBC Wealth Management–U.S., leads a team of wealth strategists and consultants throughout the country who work with financial advisors and clients on business succession strategies, and says having a passion about a particular industry or type of business is a driving factor for interested buyers.
“Whether they want to run the business and have their hands in the day-to-day operations or buy a business as a passive private equity investor, it's usually because it's something they are passionate about and enjoy," Ringham says.
Robert Stern, an ultra-high-net-worth strategist at RBC Wealth Management–U.S., says another motivation, particularly for purchasing an existing business, is that it may provide more security than a startup.
“There is a comfort level that comes from complementing your portfolio with an existing business that has a proven track record and projected future revenues," Stern says. “Having something in addition to stocks and bonds can be fairly attractive."
Explore all your options
In searching for existing businesses to buy, Stern recommends letting your goals guide you during the process.
“Industry is less important than alignment with the buyer's goals. Settle whether you want to expand into a new industry or add a complementary business," he says. "Then, examine the capital commitment required for entry. A large financial commitment may be more challenging but carry a bigger payoff in the long run."
He adds: "If you're looking for a complementary business, word of mouth, trade and industry associations, and business brokers can all help identify the perfect candidate."
Business brokers help buyers determine which businesses to target—and avoid—and can walk you through the purchasing process. Calling business owners directly and letting local networks know you're interested in buying a business could also yield new opportunities.
Carefully examine important documents
Once you've identified a business you're interested in, the important due diligence work begins, with an extensive list of documents and statements that should be analyzed. These could include, but are not limited to:
- Balance sheet and financial statements
- Operating agreements
- Official organizational documents
- Inventory catalog
- Business tax returns
- Corporate filings
- Income statements
- Letter of intent
- Contracts, leases, licenses and permits
Stern adds that a careful examination of overhead is critical. “Your review should have an eye for synergies and duplicative functions," he says. “If the company you currently own and the firm you're looking to acquire both have back-office and administrative functions, reducing the overlap could create a more profitable business going forward. A close look at accounts receivable and payable is one place to find that overlap."
Assemble a team to help with the process
You'll want to involve a banker, a certified public accountant (CPA) and an attorney you trust early in the process to help you vet candidates, uncover potential red flags and negotiate a purchase price. Along the way, this team can help you assess the underlying risk versus potential reward of your potential target.
“Your team members should specialize in the type of company you're considering, so that they can properly investigate the documents needed to uncover any potential red flags in a business," Ringham says. Those red flags may include spotty or inaccurate numbers; a short track record; falling profits (particularly ones that can't easily be explained by widespread economic factors); and a narrow or incomplete customer base.
“There are certain businesses that have an incredibly diverse customer base, and others where a significant portion of their revenue might come from one relationship," Ringham says. “That doesn't mean you have to steer clear, but you want to make sure that if you are buying a business and that large customer walks away, you know what that would do to the income and balance sheet."
Leverage relationships to finance the purchase
When it comes to financing your purchase, there are a number of options you might take. Perhaps you possess sufficient liquidity to purchase a business outright, or, if not, you may want to leverage banking relationships or business partners to help generate the liquidity needed for the purchase.
"Sometimes potential owners will work with other entities," says Stern. "For example, a family office could decide to acquire a portfolio company but may not want to finance the purchase themselves. In that case, they could collaborate with other family offices to acquire the business."
Sometimes a third party gets involved, explains Ringham.
"You could buy the business outright, or you can create an entity, whether it be a partnership, LLC, or a C or an S corp, where the entity itself purchases the business and you own the underlying entity," he adds. "You could be a 100-percent owner or a controlling owner with other minority owners."
Both Ringham and Stern say your bank can also potentially help you buy a business. Some banks will let you draw a line of credit based on your asset portfolio, known as a securities-based loan (SBL), so you don't have to sell assets to finance your business purchase, says Stern.
An SBL can provide quick access to capital, says Fred Rose, head of credit solutions at RBC Wealth Management–U.S. But because an SBL is based on market securities, which are likely to fluctuate, it's important to only borrow within your limits.
“Typically, you can borrow 60 to 70 percent of your equity investments and a little more of your bond investments," Rose says. “But it might be wise to borrow less than 50 percent of what you're allowed to borrow."
Another option is to consider government financing or tax incentives that may exist for certain business types or minority ownership.
Stern suggests checking with your financial advisor for an informal business valuation—"to give you a sense of what the business you're considering buying is currently worth"—as well as key performance indicators "that show where the business you're looking to acquire may be underperforming in the market, as well as inefficiencies that may make the business work even more profitably with some tidying up."
For a more formal business valuation prior to completing the acquisition, Stern suggests consulting with your CPA to see if their firm can provide that service.
Take your time and enjoy the ride
Buying a business is a big decision, but it can be both profitable and enjoyable when you pursue it smartly. Be thorough and surround yourself with a team of trusted advisors to achieve the outcomes you desire.