7 Reasons to Buy a Going Business
7 Reasons to Buy a Going Business
There are seven reasons to buy a going business:
You get an established customer base, experienced employees, a recognized market position and business operating systems which are in place. You often get the best combination of seller, bank or vendor financing possible.
If all these elements are in place, you, as a buyer of a going business, will also get immediate cash flow and a reduced risk of business failure.
Customers, Employees, Market Position & Established Systems . . .
Customers and/or clients have loyalties to locations and businesses that remain even when the owner sells. The customer/client base can always be preserved. Most sellers will agree to a transition period to assist in this preservation.
Recruiting customers and clients is expensive when starting a business from scratch. An old customer/client list is valuable because customers buy on a cyclical basis. Even a ten-year-old customer list might be valuable if customers purchase from the business every ten years. I once worked with an appliance dealer who maintained a past customer list to use for re-sale opportunities.
Experienced, skilled and predictable employees are a valued asset of a going concern. They're not on the balance sheet, and a buyer really doesn't pay for them directly. They often know the business operations quite well, however, and they can be re-energized by new ownership.
The timing of employee interviews before a business purchase varies widely. Usually, the buyer is allowed to talk with key employees only after a purchase and sale agreement has been signed, and it is certain that the buyer will buy the business. This demonstrates how important key employees really are! Sellers don't want to risk losing them.
A going business has a market position measured by its sales level and profitability. Start-up operations face many stumbling blocks. They can mis-design their products and mis-position their services. They can get the prices wrong. They can stock the wrong inventory. If you purchase an established business, the chance that you will make these errors is minimized.
Also minimizing the chances for failure are the business’ established systems. Sales and marketing, accounting, inventory tracking, employee payroll and production systems are all in place. Employees know what to do. Customers even have established patterns of buying from the business. There may be changes needed, but the buyer of a going business has a head start over a start-up competitor.
In a start-up, all systems have to be created from scratch. Anyone who has started a business from scratch can tell you how difficult this is. Just think, for example, how long it took you to learn and fully utilize your last new software program. Now, multiply that by 100! There are at least 100 different 'systems' in any small business.
Financing, Cash Flow & Reduced Risk
Because of the first four advantages - customers, employees, market position and established systems - more favorable financing terms are available to the buyer of an established business. Seller, bank and even vendor financing is often readily available.
Along with the buyer, the seller, banker and vendor become partners in the business, sharing some of the risk. Every creditor feels more secure with an established entity, and most banks don't finance new start-ups at all. For going businesses, seller financing at below-market rates is common.
A buyer of a going concern often has immediate cash flow. In fact, that’s what the financing partners (the seller, the banker and the vendors) want to see. These lenders will only agree to participate in transactions that make sense to them. They know they won't get paid unless the cash flow works for the new business owner.
In a new start-up, vendors may still help, but the buyer must fund the start-up for months and sometimes even years until the business gets going. Most start-ups fail, in fact, because they run out of money before they succeed.
Existing businesses, on the other hand, are much less likely to fail than start-ups. The risk is lower because the customers, employees and market position are known, the financing is more favorable, and the cash flow is immediate.
Why, then, do some of us start new businesses? One reason is that we want a 'clean business' without the inherent liabilities of a going concern. But, asset sales are the norm - instead of stock sales - so that no legal liabilities are assumed anyway in most business transfers.
A second reason – that there are operational systems that can't easily be changed – is usually just wrong. Small businesses are quite flexible and changeable. Employees nearly always welcome enlightened change.
The most common reason for starting from scratch is to avoid paying for 'goodwill' or 'blue sky'. My experience is that we pay for it anyway.
In 1981, I had a chance to buy the only established business brokerage firm in Maine for $125,000, with plenty of seller financing, an experienced and friendly seller, a great name and location and an established track record of financial success. Instead, I started my own business, Maine Business Brokers. In the 1980's, my new firm struggled and barely survived, while the firm I didn't buy made profits many times in excess of its 1981 asking price.
At the time, I wanted a 'clean business.' My style was different from the seller, and I feared that I could not change the business into what I wanted. I also didn’t want to pay for 'blue sky.'
What I didn't realize is that paying for established cash flow would have made more sense. It took me years and a great deal of working capital to make my phone ring as much as theirs. I figure that not paying $125,000 in 1981 cost me well in excess of $1,000,000 in lost income. Ouch!
Franchises & Network MLMs
Two other common mistakes I see made by naive buyers are the purchase of a worthless franchise or the latest network multi-level marketing (MLM) 'opportunity.' Legitimate franchises and network marketing companies do exist. There are, however, many more bad ones than good ones!
A good franchise should give you an instant market position and/or a protected territory, proven operational systems with excellent long-term support and perhaps even some financing. But, a franchise that only sells you a plan, a pile of equipment, a one-week seminar and a life-long obligation to pay royalties and buy supplies from them is a rip-off!
The rule of thumb I would advise following on the purchase of franchises is simple. Consider only those you have heard about before. If you have never before heard of the franchise you are thinking about buying, forget it. If you don't know about it, who does? There is no value to a franchise that isn't readily recognized by its potential customers. Name recognition in the market is supposed to be the biggest benefit franchises offer. The value of the manual and training will quickly fade.
The long-term value of a good franchise is the market position and information you get from a strong franchisor. There should be other franchisees you can talk to, and meet with, on a regular basis. A good way to evaluate a franchise and check its legitimacy is to call other franchisees and look at buying an existing franchise. You can then look at real income and expense numbers, not just someone's projection.
Business 'network marketing' or 'multi-level marketing' opportunities that require you to resell the opportunity to your friends and neighbors to build a 'multi-level marketing' organization are even more ill advised than a bad franchise. The failure rate on these businesses approaches 100%.
Most network marketers sell 'unique' products. Some are okay; most aren't legitimate enough to make it in the normal retail distribution channels. As for the extra sales you could get from getting your friends to sign up too, forget it. Your friends will likely fail. The multi-level marketers may also tell you it's a part-time effort. Don't you believe it! No start-up is ever part-time.
My advice here is the same as that given for franchises: consider only those you recognize. Wide market acceptance of the product or service is essential for success. Otherwise, the only way an MLM works is if you get in early, recruit others and sell hard during the early growth curve, then bail out before the inevitable crash. This is not a very good way to build a business career.
If you want to sell products, buy a retail store. The margins are better and you won't alienate your friends and relatives. To get other people to sell for you so that you can make money from their efforts, hire salespeople for your store. That's the way it's done in the legitimate business world.
Due Diligence: Do Your Homework
When you buy a business, there is no substitute for doing your homework. You need to exercise ‘due diligence’ in examining what you're buying.
Areas requiring due diligence are the same as the categories of business buying advantages: customers, employees, market position, systems, financing, cash flow and risk.
With an existing owner by your side, your job is made much easier. There are more known factors to build upon as you plan your future. You can grow the business you acquire to an exciting new level and by-pass many of the start-up frustrations.
Consistent profitability. Well trained staff and a variety of e-commerce clients.
The cyclical nature of the economy can add uncertainty to the timing of an acquisition, or an exit from a business. However, unlike the clarity of an improving economy or the risks inherent in a downturn, buying or selling at a market high creates a unique set of challenges.