Buying a business is an exciting prospect that can turn into a valuable long-term investment – if you do it correctly. Taking the time to ask the right questions and research an existing business can help you avoid making a costly mistake.
Sequoia Legal is a commercial law firm based in Denver, CO. We support the planning, negotiation, and purchase of existing businesses so you can move ahead with your new business venture, confident that buying a company in Denver is a financially and legally sound investment.
What to Consider Before Buying an Established Business
Before you buy a business in Denver, you need to weigh the costs and benefits, identify potential issues with an existing business, and consider unanticipated costs. Sometimes the opportunity to buy a business appears promising – until you dig into the financials and realize you may lose more money than you make.
Knowing the right questions to ask when buying a business can ensure your purchase doesn’t leave you with unanticipated expenses, losses, or legal issues.
1. Why Is the Owner Selling Their Business?
If you’re considering buying a small business in Denver, one of your first questions should be to ask why the business is for sale. Generally, the answer will lend insight into whether the purchase of a particular business has the potential to be a financial asset or a loss.
Business owners sell for a variety of reasons, such as retirement. If a business owner is selling for reasons related to loss of revenue or economic instability, a company might not be a profitable venture.
2. What Is the Future of this Business?
A central element of due diligence is conducting thorough industry and market research. A successful business relies on market demand. Consider whether the business will still have a role in the market in the years ahead.
Look into competitors and compare details like revenue, size, and growth with the business you’re considering purchasing. Looking at data from the past can give you a bird’s eye view of where a business sits in the local landscape and what its chances for continued success will be in the years to come.
3. Are There Any Outstanding Debts?
Debt incurred in the name of a business remains with that business regardless of who the owner is. When a business carries outstanding debt, that debt becomes a problem for the new owner. You’ll need to consider why this debt exists and how you'll pay it off.
High levels of debt show that a business may not be as lucrative as revenue streams might indicate.
4. What Are the Operational Expenses?
If you’re new to the process of buying existing businesses, revenue alone can make a purchase seem worthwhile. Don’t overlook operating expenses. Much of a small business’s revenue stream can flow back into operational costs – often resulting in little profit.
Take a close look at the difference in gross profit and operating profit, and consider if reducing operating expenses is an option given the industry and business model.
5. Does Intellectual Property Need to Be Transferred?
The term “intellectual property” can sound daunting or even irrelevant, but it’s commonplace in many companies. Items that can fall under the domain of intellectual property include:
- Business name;
- Business logo;
- Trademarks and copyrights;
- Internal methodologies;
- Automated processes;
- Trade secrets.
When you’re just learning how to buy a small business, you might not consider how much of the purchase is tied to intellectual property – and often, you must purchase this separately.
6. Are There Any Outstanding Lawsuits Against the Business or Its Owners?
Before moving forward with the purchase of a company, a potential buyer should check whether the owners or the business itself are dealing with lawsuits or any other legal concerns. Expensive issues like a product liability lawsuit can become your responsibility upon purchase.
What Are the Benefits of Buying an Existing Business?
There are many practical and financial benefits to purchasing a company rather than starting your own business:
- Financing options: it can be much easier to secure financing for a company with an established reputation and customer base, as these elements reduce the risk assumed by a lender.
- Established brand name: buying an existing business sidesteps one of the most challenging parts of creating a new business – the struggle and expense of establishing a brand name.
- Established customer base: competition exists in every sector of business, and convincing customers to choose you over a competitor is central to success. An existing business already has a customer base established.
- Pre-existing Supply Chain: significant time and resources are saved when a business already has a supply chain. These relationships can also be an asset in providing feedback on where optimization is needed.
- Prepared staff and internal processes: established internal processes and knowledgeable staff are two of the greatest assets of an existing business. Streamlined operations can be the key to a company’s success.
- Growth brings greater revenue: an existing business should already have established revenue. Growing an established business can more easily bring higher financial returns, as a baseline profit already exists.
- Track record of success: the purchase of an existing business brings lower risk. A track record of success exists already, allowing the focus to be placed on continued maintenance and growth.
Purchasing an existing business saves you the extensive work that goes into creating a business from the ground up.
Potential Cons of Buying an Existing Business
While purchasing an existing business has benefits, there are also possible downsides to consider:
- Initial investment can be costly: the initial investment in an established business can be much higher than in a startup, where you can begin with small expenses and increase over time.
- Technology and procedures may be outdated: consider whether technology and internal procedures need additional financial investments. These investments can significantly impact your after-purchase costs – although you can use these items to negotiate the purchase price.
- Company reputation and culture may need improvement: an existing brand name can be an asset – or a curse. It can take significant work to undo the harm of a bad reputation or an unhealthy company culture.
Can you buy a business impacted by these downsides? Absolutely. However, success is contingent upon having a workable plan for addressing them.
7 Steps to Buying an Existing Business
Although the particulars differ widely, purchasing nearly any existing business will follow seven key steps. Knowing what to expect from the process can help you set expectations accordingly.
Step 1: Find a Business to Purchase
Often, a potential buyer is interested in becoming a business owner but isn’t sure of what type of business or even what industry to begin looking in.
If you find yourself without clear goals, begin by considering what you know. For example, if you’ve ever worked in a restaurant, you have a much clearer understanding of the challenges that come with maintaining a business in that industry.
Jumping into the purchase of a company with no knowledge of the field and no experience in owning a business can be far more challenging and, at times, disastrous. After narrowing down the industry, you can begin searching for a specific business to purchase.
Step 2: Get Questions Answered
Once you’ve identified a business you’re interested in purchasing, it’s time to get a general sense of how the business functions. It's not yet necessary to request financial records – that comes later. At this stage, focus on learning more about the day-to-day reality of running the business.
This is a good time to ask general questions about topics like sales and growth. It's also a chance to learn about the daily responsibilities and challenges you’ll face when you step into the role of business owner.
Step 3: Evaluate the Price
Identifying a fair price for a business is one of the most contentious points of a business sale – and often a key reason why a prospective sale falls apart.
A business owner is likely hoping for a return on years of work and financial investment, while a buyer must consider additional expenses, such as the need to replace outdated technology after purchase.
- Earnings approach: the earnings approach is best for businesses that are already profitable and have growth estimates that indicate continued revenue increase. This approach establishes price by examining past, present, and estimated future earnings. The capitalized earnings method and the discounted cash flow method both take an earnings approach to identify price.
- Assets approach: the assets approach is often used for companies that aren't yet profitable or for those in high-capital industries like production or shipping. This approach totals up the value of all physical and non-physical assets and subtracts debts, liabilities, and other losses to arrive at a fair business value.
- Market approach: the market approach assesses value by examining the market price of recent sales in the same industry and geographic location. This approach helps identify a fair price range and accounts for local factors. It’s often used in conjunction with an earnings or assets approach to confirm a fair price.
Step 4: Issue a Letter of Intent
A letter of intent (LOI) is a formal agreement sent to the seller notifying them of your intention to purchase their business. An LOI isn’t a contract and doesn’t legally bind you to go through with the purchase. However, it does bring legal ramifications that benefit the buyer.
An LOI gives you the first opportunity to make an offer, even if another potential buyer comes forward.
Step 5: Do Your Due Diligence
One of the most crucial tips for buying a business is to do your due diligence – and do it thoroughly. This is a key area in which a business attorney can make a significant difference, guiding you to ask questions you might not think of.
Due diligence is the process of researching every aspect you need to know about to make an informed decision about moving forward with the purchase.
At this stage, you’ll be granted access to a company’s records. You’ll need to examine financial statements, tax records, and legal records and look into the overall operations of the company.
Items that need to be investigated and assessed during due diligence include:
- All organizational documents;
- Bank records;
- Three years’ worth of tax return statements;
- Income, cash flow, and balance statements for the current year;
- Revenue statements broken down by customer;
- Existing business contracts;
- Documents related to business debt;
- Documents related to any legal issues;
- Complete list of owned and leased inventory, equipment, and assets;
- Leasing and property documents;
- Information related to marketing and advertising;
- Managerial information;
- License and permit requirements and documents;
- Documents related to zoning laws and environmental regulations.
It can’t be overstated that a failure to conduct thorough due diligence can be a catastrophic mistake. If you fail to uncover crucial information about a company’s finances, operations, or legal status, the results can be costly.
The best route for ensuring due diligence is done well is to allow a business lawyer to oversee the process.
Step 6: Secure Financing
Securing financing takes time, so it typically happens in tandem with due diligence. The standard arrangement for the purchase of an existing business involves both debt and equity – you’ll need to come up with some part of the cost while you will secure the remainder through a loan.
Popular financing options for purchasing a small business include:
- SBA loan;
- Rollover for Business Startups (ROBS);
- Bank loan;
- Seller financing.
Seller financing isn’t always available, but this method also has benefits worth considering. The approach involves taking a loan directly from the business seller, eliminating the third party.
Step 7: Close the Transaction
Provided that due diligence doesn’t reveal any concerns that stop the purchase, closing on a sale occurs once the investigation is complete and financing has been approved.
At this time, you’ll need to draft a final closing agreement. Then, you and the seller go through the agreement item by item, agreeing or challenging each point.
As with due diligence, drafting a closing agreement and negotiating the terms should be overseen by a legal professional with experience in both contract and business law. When you lack expertise in these fields, it’s impossible to know whether you’re getting a fair deal and what the potential legal and financial implications of your terms might be.
You and the seller will meet on your closing date to review and sign the contract. Once documentation is complete, funds are released to the seller, and you become the new business owner.
Do I Need an Attorney to Buy a Business?
Learning the basics on how to buy a business from the internet is a good way to dip your toes in the water – but it’s a mistake to purchase a business without an experienced business attorney on your side.
Purchasing a business involves an immense amount of research into a wide range of documents, and it’s impossible to know how or where your own lack of knowledge is harming you during the process of research and negotiation.
Working with a lawyer ensures that your long-term finances are protected, the risk is mitigated, and you walk away with a better deal than you’d achieve without the representation of a legal professional.
How Much Does It Cost to Hire a Lawyer to Buy a Business?
The cost of hiring a business lawyer to assist with purchasing a business is impacted by many factors. Different law firms set different fees, and elements like company size, the complexity of due diligence, and geographic location all play a role in the overall cost.
Ultimately, a lawyer’s cost is nearly always preferable to the cost you risk by not having research and negotiation handled by a legal professional.
Get Legal Help
Purchasing a business is an exciting opportunity. It requires effort and expertise, but the process goes smoothly when you work with one of Sequoia Legal’s experienced business lawyers.
In preparation for a consult, you should collect as much information as you can about the business you’re interested in buying, as well as information about your own finances.
If you’re ready to move forward with purchasing a business in Denver, Sequoia Legal can help. Contact us today to schedule a consultation.