Home Business
(featured column)

Buying Your Freedom
by Elena Fawkner

If you're reading this article, it's probably because you're one of millions of people who dream of breaking free of indentured servitude to make it in a business of your own.

When it comes to making the break from the paid workforce to business ownership, you basically have two choices: to start a new business from scratch (often in your basement during the wee hours since you have to continue to work full-time in your Just Over Broke J.O.B. to pay the bills until your business gets off the ground) or to acquire an existing business.

In this article, we look at the advantages, disadvantages, traps (and how to avoid them) and issues to be borne in mind when buying an existing business.

ADVANTAGES

There are many advantages of acquiring an existing business rather than creating one from the ground up, including:

=> Less Risky

If the business has been around for a reasonable length of time, it's survived the dreaded first cut - that alarmingly high proportion of new business ventures that fail within their first couple of years.

=> Proven Concept

One of the most nail-biting parts of starting a new business is the worry that, while you THINK your idea will fly, you're really not sure until it's time to leave the nest. Acquiring an existing business should give you comfort that the idea behind the business works.

=> Existing Customer Base

Without a doubt one of the most difficult, expensive and time-consuming duties of a new business owner is cultivating a customer base. When you acquire an existing business your customer-base is ready-made and you can hit the ground running.

=> Predicting Future Growth

An existing business has a track record. You can review profit and loss reports, prior year tax returns and other financial information to see how the business has developed over time. This gives you an informed basis from which to predict the future growth of the business.

=> Reduced Need for Working Capital

With an established business you have immediate cash flow from the business's existing revenues. This means you only need enough working capital to meet day to day requirements, not a great wad of cash to see you through the first slow, painful months until you start generating cash which is invariably the case with a startup.

=> Existing Suppliers

Just as an existing business comes with a ready-made customer base, so too it comes with a ready-made supplier base and history of dealings. These suppliers will be keen to retain your business and so you will probably save a lot of time and expense that you would otherwise have had to expend to sort through competing supply terms. Existing suppliers are more likely to give you a good deal off the bat.

=> Capital Raising

Obtaining finance will also be less difficult (note I didn't say easier!) since you will be able to point to a track record.

DISADVANTAGES

The main disadvantage of an established business compared to a start up is cost. At first blush, acquiring an existing business is more costly than a startup. Over time, of course, it may turn out that a startup is a much more costly venture, especially if that startup venture fails.

ISSUES

Assuming that you decide an existing business may be for you, what do you need to think about?

=> Deciding on the Type of Business That's Right for You 

This is a very personal decision and will depend on your answers to the following questions, among others:
* Why do you want a business as opposed to a job?
* What special skills and background do you bring to the table?
* What is the nature of your work and/or business experience?
* What are your hobbies and special interests?
* How much can you afford to invest as a down payment?
* How much money do you need to generate to meet your living
expenses?

=> Finding the Business That's Right for You

Once you've decided on the type of business that you want to acquire, it's time to start the hunt. The most efficient way is to engage a business broker. Most vendors of businesses list their businesses with brokers rather than attempting to find buyers themselves. For this reason, you'll most likely find that the business that's right for you is listed with a broker.

You could, of course, also directly approach the owner of a business you're interested in buying to see whether there is any interest in selling. Depending on whether you're in a buyer's or a seller's market, you may put yourself at a negotiating disadvantage by doing this. Only make such an approach in a buyer's market.

=> Financing Your Business Acquisition

Probably the biggest hurdle you will face is getting finance for your small business acquisition.

Here are your basic options:

* Vendor Terms
Sometimes a vendor will be willing to sell you the business on terms. For example, a 10% downpayment followed by future payments from the cashflow of the business. The vendor will usually retain a lien over the assets of the business until the purchase price is paid in full.

* Loans
There are various sources of loans. For small businesses, your best bet is probably not the major financial institutions. Try instead loans guaranteed by the U.S. Small Business Administration (or the equivalent in your country if outside the U.S.) and community banks.

* Third Party Loan Guarantees
If you're short on security, consider the possibility of a creditworthy friend or relative acting as surety.

* Credit cards
Credit card financing should generally be treated as a last resort but utilized judiciously, credit cards can be useful for cash flow purposes so long as the outstanding balance is paid off each month. Don't use them for asset purchases though.

* Family and Friends
Not a good idea for everyone, but consider asking family and friends to invest in your business.

* Asset Sale/Leaseback
Another good way to raise cash is to sell an asset you have acquired as part of the business to a friend or relative and have them lease it back to you. You free up your capital and your friend or family member has an asset-backed security.

* Redeemable Preferred Stock
A good option if your business is held by a corporation and you are prepared to give up ownership equity in exchange for capital. There are securities issues to be aware of here so be sure to consult your lawyer.

=> Cashflow Considerations

Be sure the business generates enough cash flow to cover:
* operating expenses;
* your salary;
* financing costs; and
* a reasonable return on investment.

TRAPS FOR YOUNG PLAYERS

If your acquisition takes the form of acquiring the shares in a corporation rather that a simple asset purchase, beware. In these circumstances, the legal entity doesn't change, only the shareholders do. This means that if the corporation has any undisclosed debts, pending lawsuits and the like, these can still be sheeted home to the corporation despite the change in shareholding.

In addition to these traps for the unwary, beware also of overstated earnings, poor employee relations, overvalued inventory and uncollectible receivables.

AVOIDING THE TRAPS

Fortunately there is much you can do to flush out these hidden traps before you commit yourself.

=> Get Professional Advice and Assistance

First and foremost, do NOT attempt to acquire a business without the professional assistance of your lawyer and accountant.

=> Contractual Indemnities

Your lawyer will no doubt try to include provisions in the purchase and sale agreement whereby the vendor indemnifies you for any liabilities accruing prior to the dale of sale. The effectiveness of the indemnity as a protective mechanism depends on the solvency of the vendor.

=> Due Diligence

The best way to protect yourself is to educate yourself about exactly what it is you're getting yourself into. Your lawyer will guide you through the due diligence process which is nothing more mysterious than asking the right questions and making sure you get the right answers.

Here's a checklist of things that your lawyer will help you do during the due diligence period:

* Find out why the seller wants to get out of the business. 
* Review operating information.
* Review all contracts to ensure there are no hidden liabilities.
* Get a list of all the assets being sold including fixtures and equipment, patents, copyrights, trademarks etc. and make sure they are free of all encumbrances.
* Get a schedule of all the debts of the business that you will be assuming.
* Check the company's articles, bylaws and corporate minutes to ensure the company is what the vendor says it is.
* Check to ensure the company is in good standing.
* Get a list of shareholders as well as any special rights, stock transfer restrictions and pledges that may exist against the assets of the business or the stock.
* Check all financial documents including bank statements, audited financial reports, and bank and financing agreements to ensure there are no undisclosed security interests. 
* Physical inventory and inspection of all assets.

Acquiring an existing business is a major undertaking and one which must be accompanied by competent, professional advice. Assuming that you complete thorough due diligence so that you understand EXACTLY what you're acquiring (liabilities as well as assets), you may well find that despite the funds you invest, it's the most cost-effective way to go!

*  *  *

Want more money-saving tips?  Get a FREE subscription to our monthly Ezine!

Copyright © 2002 by Elena Fawkner