Buying an existing business may initially seem like a wise and easy choice for people who want to get into the business world or extend their business holdings. After all, doing so allows you to skip over the complex and oftentimes difficult aspects of building a company from scratch and ideally, jump right into making profits. However, just because the business is established doesn’t mean it is worth your time, effort, and money. There are numerous factors every entrepreneur should consider before purchasing an existing business to help ensure that the transaction will in fact fulfill your goals. In today’s blog, we have detailed six of the most important things you should consider before moving forward with the purchase.
Discover the key considerations before buying an established business. While the allure of skipping the challenges of starting from scratch may be tempting, it’s crucial to evaluate whether the venture aligns with your objectives. At The Matus Law Group, our experienced New Jersey real estate lawyers are here to provide guidance and support throughout the process. Call (732) 281-0060 to schedule a consultation and make an informed choice that sets you on the path to success.
1) Is the timing right?
First and foremost, you have to think of timing. Is it a good time for you to spend the money on a new business? Is the economy open to it? It is easy to get excited about the potential of purchasing a new company, but if the timing does not match up with your finances and other important factors, the transaction could prove ruinous.
2) Are there issues with the company’s books?
You should always conduct thorough due diligence of the company’s books. Unfortunately, you cannot simply take the current owner’s word for anything. The company’s books will give you an idea of how viable and financially sound the business is, and also alert you to potential issues that the owner did not mention. Issues and discrepancies in the books could indicate serious problems that you will want to avoid.
3) Company’s reputation in the community
You want to make sure that if you buy an established business, it has a good reputation within the community in which it operates. Community reputation can tell you a lot about a company’s history, and a poor reputation in the community could be more of a mountain to overcome than you will want to deal with when you gain control of the business.
4) Potential for growth
Consider why you want to purchase the business. Are you happy keeping things exactly as they were? Is the company as profitable as you want it to be? Most people buy businesses in hopes of growing them into something more. If that is the case for you, you will want to take a close look at the company’s potential for growth. If the potential is limited, it may not be worth your time and money.
5) Why is the seller leaving?
Are they leaving due to their health? Retirement? Or are they leaving because business is slow and they are trying to cut their losses? Get a clear picture of why the current owner wants to sell, and ensure it is not a reason that will affect the company’s ability to succeed once you take control.
6) Is it worth the price?
Conduct a thorough cost/benefit analysis of the sale. Is there a high enough potential for the business to have future success for you to spend the money that is being asked? Simply put, what are the chances that this purchase will pay off for you down the road?
Considering these six factors will help you to make a smarter and more informed decision when you make the choice to purchase an established business. If you are considering purchasing an existing business, the Matus Law Group can help. Give us a call today!
7. Reputation and Market Presence
Examining an existing business’ reputation is a pivotal step when considering a purchase. A strong reputation acts as a springboard for new ownership, offering a head start in customer trust and market positioning. In contrast, reversing a negative reputation requires a considerable investment of resources and time—often with uncertain outcomes. Engaging with stakeholders such as owners, employees, and vendors can uncover insights into the business’s standing and inform the viability of your investment.
The market presence of a business, often reflected in its market value, reveals much about its stability and growth potential. Market value considerations encompass tangible assets, income, and financial health indicators, painting a comprehensive picture of where the business stands in the competitive landscape. A robust market presence can suggest a thriving enterprise, while a weak presence might indicate underlying challenges.
Lastly, understanding liabilities is crucial to assessing a business’s financial health. A high ratio of liabilities to assets can be a red flag, signaling potential financial distress. Conversely, a manageable level of liabilities compared to income and assets can indicate a business with a strong foundation, poised for growth and success in the hands of a new owner.
| 6 Factors to Consider Before Buying an Established Business | Details |
|---|---|
| Timing | Consider if it is a good time financially and if the economy is favorable for purchasing a new business. |
| Issues with the company’s books | Conduct thorough due diligence of the company’s books to ensure financial viability and identify potential issues. |
| Company’s reputation in the community | Assess the business’s reputation within the community as it can impact its history and future prospects. |
| Potential for growth | Evaluate the business’s potential for growth and whether it aligns with your goals and expectations. |
| Reasons for the seller’s departure | Understand why the current owner wants to sell and ensure their reasons won’t negatively affect the business. |
| Cost-benefit analysis of the purchase | Perform a comprehensive evaluation of the sale to determine if the potential benefits outweigh the costs. |
What is the Rule of Thumb for Valuing a Business?
Two commonly used types of rules of thumb can typically be identified. The first one involves a percentage of annual sales, or preferably, the sales/revenues of the past 12 months. For instance, suppose the previous year’s total sales amounted to $100,000. According to the rule of thumb indicating a 40 percent multiple of annual sales, the corresponding price would be $40,000.
Many experts have stated that revenue multiples tend to be more reliable than earnings multiples. This is because earnings multiples often involve adjustments to the earnings, which can be subjective, as well as the multiple itself. On the other hand, sales or revenues, which are essentially fixed figures, provide a more straightforward basis. In the event that sales taxes have not been deducted, it might be necessary to subtract them, although the sales figure remains unchanged. The only subjective aspect of this method lies in determining the appropriate percentage. The advantage is that when provided by an expert, the percentage multiplier becomes less subjective.
The second rule of thumb involves a multiple of earnings. In the case of small businesses, the multiple is typically applied to what is known as Seller’s Discretionary Earnings (SDE). The earnings of the business are then multiplied by a multiplier, typically ranging from 0 to 4. Several sources also highlight the use of a multiple based on EBIT and/or EBITDA.
The following terms are used to express earnings:
- EBDIT (EBITDA): Earnings before depreciation (and other non-cash charges), interest, and taxes.
- EBDT: Earnings before depreciation (and other non-cash charges) and taxes.
- EBIT: Earnings before interest and taxes.
It is crucial to acknowledge that these general guidelines are simplified approaches and might not capture the complete complexity and distinct aspects of a business. To obtain a more precise valuation, it is recommended to consult a New Jersey real estate attorney who can utilize more comprehensive methods customized to the particular business and industry. Arrange a consultation with The Matus Law Group to discuss your specific needs. Contact us at (732) 281-0060 to schedule a consultation.
