Entrepreneurs

7 questions to ask before buying a business

Pablo Sierra, who has no background in books but is getting into it because there is strong demand is photographed at the Walls of Books bookstore in Washington, D.C. on December 07, 2015.
Marvin Joseph | The Washington Post | Getty Images
Pablo Sierra, who has no background in books but is getting into it because there is strong demand is photographed at the Walls of Books bookstore in Washington, D.C. on December 07, 2015.

Now may be a great time for would-be entrepreneurs to buy an existing business. You can capitalize on its loyal customer base, trained staff and the opportunity for increasing cash flow in this postrecession environment.

Purchases of small businesses are among their highest levels since BizBuySell.com and BizQuest.com, which together feature 76,000 listings for sale, began tracking them in 2007.

"There are less deals to be had than a few years back when financing was tight," says Bob House, general manager for the sites. "We still hear that it's a buyer's market, but it's starting to shift and even out."

Median revenue of sold businesses on BizBuySell in 2015 also grew to $449,462, up from $417,562 in 2014, while the median sales price also increased 7.6 percent to $199,000.

Whether becoming a first-time business owner or acquiring a business to expand your current company, ask the following questions before signing on the dotted line:


Source: RazzleDazzle Barbershop.

1. Will demand exist for the business' products and services for years to come?

Many buyers purchase companies based on their interests rather than whether they are viable moneymakers, such as when a foodie buys a restaurant, says Ronald Recardo, managing partner of the business consultancy Catalyst Consulting Group.

"If you chase the wrong rabbit and buy the wrong business, it doesn't matter how smart you are. You might not be able to bring it back," he says.

The business should also have a competitive advantage and not be a fad, said entrepreneur David Lopez, who has started, bought and sold several different kinds of businesses, including Froots, Franchise Value Solutions, Bingo Dental and Cross Country Auto Transport and Dental Fix Rx.

2. Are there holes in the financials?

Buyers should request bank statements, profit and loss statements, contracts with suppliers and employees, lease agreements and tax returns from the seller as part of their due diligence, said Alan Pinck, an enrolled tax agent and owner of A. Pinck & Associates, and volunteer for the federal business assistance program Service Corps of Retired Executives.

House said to request revenues broken out by key product areas and customer groups. Examine trends over time and scrutinize any prepaid services such as Groupon deals and memberships, which the new owner would have to honor without being paid for, Pinck said.

"The smaller the business, the less sophisticated. You can ask all the right questions but they might not have the data available, or the data is in their head," Recardo said.

If a seller cannot produce data or it's in a shoe-box, that may be indicative of the state of the business too, according to Lopez. Every piece of equipment and inventory must be valued and itemized for the IRS by both buyer and seller. Both accounts should match, Pinck said.

3. Am I just in this for the money?

Buying a business is like buying an income, said House, and it has the potential to grow over time. But don't go in with an exit strategy already in mind, explains Lopez: "You have to think long term. If you're thinking short term, you won't make it." Though BizBuySell reports businesses are on average purchased at a 10 percent discount off their asking prices, that may not be enough to make up for the downsides.

4. Do I really want to do this all day?

"Very few businesses are good for investment purposes [only]," Pinck said, and that's because they can't run themselves the way a passive investment like real estate can. Even if you hire a general manager, you will still need to be present to ensure its success, said Lopez.

Recardo suggests observing an acquisition firsthand to see if you can commit day in, day out.

5. What is the best way to finance this?

Business acquisitions generally are financed through Small Business Administration–backed lenders, home equity loans, private partnerships or by the sellers. Sellers often offer better terms, such as less money down, Recardo said, and then have an incentive for setting you up for success.

It could be a loan or "an agreement to take deferred payments of profits plus an upfront payment," said Barbara Findley Schenck, small business strategist and author of "Selling Your Business for Dummies." Schenck recommended asking the seller how they would ideally structure the deal. Then evaluate all options for risk and feasibility.

6. Why is the seller selling?

Schenck said buyers should ask sellers what they would do differently if they stayed to understand their view of the business' future and how they've built their brand.

"You may be able to add value and boost the business, but maybe not," said Recardo.

7. Is the company's success tied to the owner?

If the current owner is material to the business' success — especially with medical and legal-related businesses — ask if the owner plans to stay and/or work in the area after the sale, Schenck said. If he or she is, it could make transitioning clients difficult.