Guide To Buying a Business

Deciding to Buy a Business

There are four types of buyers individuals, small company owners, corporate buyers, and professional buyers. Below I discuss each type of business buyer and how to decide if buying a business is right for you.

Individuals Buying Businesses

Individuals can and do buy businesses. However, buying a business is a major commitment and as an individual you need to be confident going in that buying a business is the right course of action for you. Buying a business involves a substantial risk, in terms of both money and time. A great deal of this book will be spent trying to point out the pitfalls of an individual buying a business. I will also discuss the alternatives to purchasing a business, and the options that are available to a buyer if they do decide to buy a business. In short, buying a business is risky and so if I can't talk you out of it, at least I will show you how to mitigate those risks that can be decreased.

Before deciding to buy a business, you should weigh the alternative of creating one. Doing so gives you more control over the types of business, the customer list, and how the business affects your lifestyle.

As an individual, you need to think about how large a business you will buy. Here are some of the questions that you need to ask yourself.

How large a business can you afford to buy?

If you have a wife and kids and no trust fund or are nearing retirement and don't have enough money saved yet, buying a business is not a good idea. To get an idea of whether you can afford to buy a business go through the following calculations: First figure out how much income you need to generate to support yourself? For the purposes of this example, let's say that you need $80,000/year. Generally small businesses sell from 1 to 5 times annual earnings, so if you were doing an all cash deal you would need between 1 and 5 years income. (Multiples vary by industry, location, the business size, the businesses profitability, profit and sales growth, and the outlook for the company and the industry) You will get a better idea of what multiple to use when you read the section on valuing a company, but for now let's assume that you'd need to use a multiple of 3 times cash flow. So in an all cash deal,

$80,000 (income needed) X 3 = $240,000 purchase price of the business. Add to that $10,000 for a lawyer, a business broker, some travel expenses, and you need $250,000.

It is possible that you don't have $250,000 lying around in cash, so you decide that you will finance part of the business purchase. In almost all cases, you'll need 20% of the purchase price as a down payment plus the $10,000 in expenses. There is a catch, however, since you are financing part of the purchase price, the business will need to generate more than $80,000 annually to support you; it must generate $80,000 plus the amount of money that will go to servicing the debt. The exact amount will depend on the term (length) of the loan and the interest rate, pieces of information that you are unlikely to have at this early stage in the planning process. In our example we will use a seven year loan at 6.5%. Servicing a 6.5%, 7-year loan for the 80% of the business not covered by the down payment requires about $34,000 a year, leaving only $46,000 in cash flow to live on. You can download a spreadsheet that shows the example here and put your own assumptions in the highlighted cells to figure out how large a business you can afford to purchase.

To further complicate matters, you should assume that the business will go through some tough times as you learn how to run it. When you buy a business there will always be surprises and you need to build a safety factor in so that you can still survive if the business slows.

Next, Deciding to Buy a Business (Small Companies, Corporate Buyers, and Professional Buyers)