How to buy a business or franchise

For entrepreneurs who are planning to make business acquisitions part of their growth program, we recommend reviewing the Buying Businesses session in our Growing a Business course.

This should be a step-by-step sequential process. Here are the steps:

FIRST: Decide whether you will be buying a business to provide you with a full-time job or will be making the purchase as a part-time investment.

SECOND: Thoroughly investigate the industry you are considering to conclude if this is really a business to which you can make a commitment.

THIRD: Attend industry meetings, talk to existing business owners, spend time at typical businesses and visit competitive locations to determine if those who are already in the industry share your conclusions.

FOURTH: Decide whether you want to start a new business or buy an existing business.

FIFTH: Investigate the advantages of buying companies in your own field. These benefits are spelled out in the Buying Businesses session of Growing a Business.

AND FINALLY: Appraise your own experience, skills, and background and decide if this business is a good fit for you.

• Are the economics of the business sound?
• Is there a reasonable predictability of future growth in earnings?
• Is there a sound financial foundation?
• Does bad management in the business create an especially good opportunity?
• Have the evaluations in the Choosing the Right Business session been confirmed?

Business Opportunities for Sale

There are many sources for learning about business opportunities. Here are some of the most popular:

• Business opportunity brokers
• Classified newspaper ads
• Companies that supply or set up new locations
• Business opportunity trade shows
• A franchiser for any particular type of business

An internet search can also provide resources for learning about business purchase opportunities.

Financial Ability

Most people will not pay cash for a business, so some sort of financing will be involved. The equity position that will be required (the amount of cash necessary to put down) will determine the type and size of business you will be able to buy.

Depending on the business you select, you will need sufficient operating capital in addition to the down payment.

The source of the equity funds should be cash or liquid assets and not borrowed money.

Evaluating a Business

Remember that this is your decision and only you can decide whether a business is for you. Don't let any expert decide whether or not you should buy a business. Instead, ask them for specific advice on the various components of the business. Here are two examples of how your attorney will be an important expert:

• Have your attorney review the lease.
• Your attorney should advise you as to whether you should purchase the stock or the assets of the business. If there are unpaid (and possibly unknown) liabilities including amounts owed to government agencies, you may be advised to purchase the assets rather than the stock.
• For insights into how Warren Buffett evaluated companies to buy, visit our the Buying Businesses session in the Growing a Business course.

The following experts can be helpful:

• Attorney
• Accountant
• Banker
• Business opportunity broker
• Equipment suppliers or vendors
• Other business owners

How to Determine a Business's Worth

• This is the "due diligence" process. A buyer must obtain and examine the seller's financial statement and records. If the business is listed with a broker, the broker should have this information. The information you need should include the following:
• Profit and Loss records for the past 24-36 months
• Current Balance Sheet
• Cash deposit records
• Utility bills
• Supplier bills
• In making your offer, use all the information you have collected to determine your net income. This will give you a basis for making an offer based on a capitalization rate (the desired return) you will want. For example, if a business will show an annual net of $50,000 and you have determined you want a 25% return of your investment (without considering financing) you would offer $200,000 for the business.

 Sources of Business Financing

• The seller of an existing business will often provide some of the financing and will be your best source of financing. Businesses are sold by motivated sellers. In many cases, the seller will take some cash down and let you pay the rest out of earnings over a period of time.
• The SBA (Small Business Administration) offers loan guarantee programs through commercial lenders. These will usually need to be secured by additional assets.
• Equipment suppliers often have financing programs available for the development of a new business.
• Venture capital firms, commercial banks, and relatives offer an additional source.
• Review the sources in the Financing the Business session.

Other Factors to Consider in Determining Value

• Unless you are also buying the property, the lease is probably the most important document you will evaluate. Review the Choosing a Business Location session. The following are the most relevant lease items:
• The term or length of the base lease.
• Options to the base lease term.
• A rent that is affordable and competitive.
• How often and how much are the adjustments to the base rent?
• NNN (triple net lease) charges.
• Assignment provisions.
• The landlord's contributions to the improvements, if a new business.
• What is the quality of the improvements and fixtures: will they need replacement?
• What is the quality and size of the inventory: is it overstocked with obsolete items?
• What is the condition and amount of the receivables: are they collectible?
• If I am to buy the payables, how current are they and what is the accurate total?
• Is there an order backlog?
• How strong are customer relationships: the goodwill you will pay for?
• Is the primary marketplace stable or changing?
• Does the business have, or can it obtain, all necessary government approvals and licenses? Are there any exorbitant fees?
• Is the seller motivated or anxious?

How to Verify Revenue and Receivables Information

• Ask for the seller's personal and business tax returns. In some businesses, you can determine the income by analyzing utility bills or supplier's records.
• If you are skeptical about the information's accuracy, make your offer to purchase based on a trial period where both you and the owner collect the receipts. 
• The receivables of a business (amounts still owed by customers) can be best verified by requiring written verification from people who owe the business money.
• Interview the owners of similar businesses for financial comparisons.

Buying an Existing Business vs. Starting a New Business

• Is it affordable? A new business will often cost more than an existing business of the same type. An existing business may be the only way to enter the industry.
• Location is an important factor. In some communities, certain types of business can no longer be built and an existing business will be the only way to enter the industry. Proximity to your home will also be a factor.
• Some benefits of starting a new business:
• Everything is new and works
• Customers like to go to a new business
• The area may be under-served
• The value of the new business after you open may be greater than the cost of equipment
• New and inventive ideas may be better executed
• Benefits of purchasing an existing business:
• The business has a track record of income and expenses
• Operating costs are often lower than in a new business
• The business will already have trained employees
• There may be true goodwill already built in
• The business may already dominate the market in the trade area

Key Advantages and Disadvantages

• Advantages:
  • Franchiser has proven business formula and can offer ongoing support in all facets of the operation
• Disadvantages:
  • Risk of poor and/or unprofitable location
  • Loss of absolute control
  • Big up-front fees and ongoing fees to franchiser

What Should I Know about a Prospective Franchiser?

• Obtain the financial statement(s) of the franchiser.
• Obtain copies of profit and loss statements on franchise locations that you select.
• Determine whether there are any franchisee lawsuits pending against franchiser.
• Conduct due diligence interviews with other franchisees that you select. (Probably the least important step in your "due diligence" investigation is talking to the franchisees that the franchiser provided as references.)
• Existing franchises will normally be happy to share information on the success or shortcomings of their operations.
• Don't rely too much on "pro forma" financial statements. These statements are estimates provided in advance regarding future prospects.
• If you plan to become a franchiser (not a franchisee) the Franchising Your Business session in the Growing a Business course will be of special interest.

Becoming a Franchiser

• Advantages:
• Eliminates workman's compensation insurance, health insurance costs, and employee-related problems
• Rapid expansion possible over broad geographical area
• Franchisees provide expansion capital
• Franchisees are motivated operators

• Disadvantages:
• Loss of absolute control
• Problems with unprofitable and/or difficult franchisees
• Controlled by state and federal franchising statutes

• Visit different operations, both independently owned and franchised, and interview the owners for advice.
• Attend trade shows.
• Get to understand your intended business really well before you decide to buy or start one.
• Analyze any appropriate existing business that is for sale:
• Get the necessary information from a business opportunity broker.
• Describe your method for evaluating the business.
• Describe your financing plan on purchasing that business.
• Conduct the same analysis for a franchised operation. Study the term and conditions of a real franchise agreement, item by item.

THE TOP 10 DO'S

1. Decide first whether to be in business full-time, part-time or with your family.
2. Thoroughly investigate the industry first. If possible, work for someone else in the business first.
3. Appraise your experience, skills and likes to determine if the business is a good fit.
4. Look to the economics of the business more than how well or poorly it has been run.
5. Look to the seller as the best source of financing when purchasing a business.
6. Pursue a structured "due diligence" process. Ask for help from your lawyer and accountant.
7. Verify receivables by written verification from people owing the business money.
8. Perform your own evaluation of the business's real estate location.
9. Deal only with established, well-financed and widely successful franchisers.
10. Determine the names of all franchisees in your area and go talk to them.

THE TOP 10 DON'TS

1. Permit any expert to decide for you whether or not you should buy a business.
2. Buy a business or franchise without your lawyer approving all documents.
3. Buy a business or franchise without your accountant reviewing their records.
4. Rely on information or advice from franchise or other selling agents.
5. Rely on pro forma financial statements (future predictions.)
6. Be in a rush. (Wait patiently for the fat opportunity by looking at lots of them.)
7. Rely on the seller's evaluation of inventory and other assets.
8. Deal with start-up or poorly experienced and financed franchisers.
9. Hesitate to walk away from a deal that is not a potential home run.
10. Overlook comparing what you can do as an individual vs. as a franchisee.

If you are currently writing or have developed a business plan, consider taking a moment now to include any information about your business related to this session. As a reminder, MOBI’s free Business Plan Template and any worksheets, checklists, and templates from this course are available for you to download. Just visit the list of MOBI Resource Documents on the Resources & Tools page of our website.

Here are some key terms and definitions used in this session or related to this session: