It can be a smart move to buy an existing business especially if you are not interested in starting one completely from scratch. This makes even more sense if you’re gearing up to purchase an existing franchise business. And the good news is that you are not alone. It’s estimated that half a million American businesses change ownership annually, and this figure is forecasted to go through the roof as more and more baby boomers retire.
Nonetheless, going to buy an existing business is not a bed of roses – it comes with its own fair share of challenges. That’s why it pays to know what you are getting yourself into right off the bat. In this article, we have rounded up 5 crucial things you need to know before taking over an existing business.
#1. Know Why the Business Has Been Put Up For Sale
There are myriads of reasons why a business owner might want to sell their business. It could be something as straightforward as moving to another state, country, etc. or something worrying like massive debt. Either way, it’s crucial to know why the business is not working out for the owner.
Most business sellers will go to a great length to conceal the real reason, so be sure to take your time, do some due diligence and ensure that no stone is left unturned. More importantly, watch out for these deal breakers:
- The business is lagging far behind the competitors
- There’s no longer a market for the services or products offered by the business
- There’s gravely inadequate foot traffic due to location issues
- Something went horribly wrong with their public image or brand
- There are erratic inventory problems – storage difficulty, low-quality products, extremely high costs of production, etc.
- The business is riding in lots of debt (this might not be a deal-breaker for some investors)
The list goes on and on.
#2. Taxes, Taxes, Taxes
Even if you are purchasing the assets of an existing business, the tax authorities can still come after you. This happens in many cases where the seller owed payroll, use, sales or other forms of business taxes. That’s why it is important to know if the seller is current in his payroll, sales and use tax payments. But don’t take their word for it. Go ahead and ask the state tax authority. In any case, make sure that you obtain a “clearance letter” from the state tax authority indicating that the seller is up-to-date in their taxes before closing the sale.
#3. Buy the Assets – Not the Business
It’s important to get one thing straight: it’s the assets of the business that you should buy. If the business on sale is an LLC or corporation, for instance, you shouldn’t purchase their stock no matter what. There’s a two-prong advantage to that: (1) you won’t assume any liability if the business is being sued or owes money to a third party, and (2) you’ll receive a more favorable tax treatment as you are only buying assets.
#4. Who will handle the Accounts Receivable – You or the Seller?
If the seller is owed money by existing customers on the closing date, then someone has to deal with the accounts receivable. And there are two ways you can approach this. For one, you can buy the accounts receivable as part of the deal (and, of course, at a discounted price). The other option is to allow the seller to collect the accrued debts whenever and however he or she sees fit. The bottom line is to agree on this before closing the deal.
#5. It’s Important to Do Your Due Diligence
There are lots of business agreements, files, documents, and statements that you will need to gather and take a closer look at preferably with the help of a business consultant, account or lawyer.
Here’s a due diligence checklist that might come in handy:
- Paper & Certification – these include organizational documents, Articles of Incorporation, Certificate of Good Standing, etc.
- Business Permits & Licenses
- Zoning Regulations – make sure that the business on sale has and isn’t been flouting any zoning laws.
- Environmental Laws
- Leases & Contracts
- Letter of Intent – you are better off analyzing this with the help of a lawyer
- Business Financials – Take a top-down look at all financials, from accounts payable to tax returns and everything in between.
These are just but a few things to consider before you buy existing business. When all’s said and done, if something smells fishy, it’s best to trust your instincts.