The world is filled with people grousing about their corporate jobs and dreaming of going out on their own as small business owners, but relatively few take the plunge. The problem… many just have no idea where to start. That is the first and largest reason fledgling entrepreneurs take over an existing small or medium-sized business, rather than starting a new business from scratch.
1. The Test Phase Is Over
An untested concept can be a dangerous thing. It takes a long time to build up a business from scratch. And the hard fact is, 80% of them fail within 18 months. When you buy an existing business, the grunt work is done. The business is up and running. It has real customers, and there’s money coming in. Step right in and take on the challenge. You see the pitfall, though. You still have plenty of prep work before you plunge in.
2. It’s Still Your Big Idea
A business success story always begins with a big idea. In buying an existing business, you might think you’re just buying someone else’s idea. That’s not the case, if you do it right.
The process begins with a consideration of your own interests, skills and experience. Maybe you fantasize about running a nice little Italian restaurant. But if you are not a cook, think again. Or sign up for cooking classes and see if you love the reality. Yes, you can always keep on the chef, or hire a new one. But if you’re going to run a restaurant, you’d better know how to cook.
There are drawbacks to buying an established business: The initial costs are likely to be higher. You’re paying for a successful concept, a built-in customer base, a good location and the years of legwork that built it up. You’re getting tangible assets, like equipment, stock and a trained staff.
However, just as important, you’re getting a track record of proven success to take to a bank when you apply for a small business loan.
3. The Numbers Are Real
Starting a business from scratch requires a business plan. So does taking one over, but in this case the numbers are not guesses, they’re real.
Not that you can accept them at face value. You need to make sure there aren’t hidden pitfalls attached to the transaction, like unpaid debts or expensive structural problems. In short, is the current owner getting out for a reason? Your own legwork can give you the answers. Search local media archives and talk to local business people to find out about any past problems. Study the account books to see if business is growing or falling off. Make sure an attorney reviews the contract for dangerous loopholes.
You also have to consider the big picture. Past performance does not guarantee future results. The books show a business’s past not its future. If the business is selling a product that young people don’t want; if Amazon sells it cheaper; if the town’s big employer is moving to China, this may not be the business for you.
4. You’re Investing in a Commodity
When you take over an existing business, you’re buying a valuable commodity. But just how valuable is it? There are accepted methods for determining how much an ongoing business is worth:
- Cash flow method: The business you’re considering brings in a certain amount of money each month. That cash flow must cover all the costs, including any new loans you take on to finance it. You may have big plans to expand or draw in customers, but if that cash flow isn’t positive to start with, you’ll sink before you can make that happen.
- Tangible assets method: A going business will have in place some equipment, some stock, maybe even some real estate. If this is your dream Italian restaurant, it may have a secret recipe or two. How much is it all worth? That’s the tangible assets method.
Most small businesses sell in the range of 1.5 to 2.5 times annual discretionary earnings. That’s a real number to work toward. If you’re not comfortable doing this on your own, you can call in a professional business appraiser. You also need to know how to obtain financing.
5. You’re Getting “Goodwill”
Exactly what is goodwill (the value of a company’s reputation) worth, when considering the overall value of a business? Goodwill and such are ways people have to try to embellish the value of their company. They may help the sale but you cannot eat them or sell them so they are of little value when it comes to computing the value of the business. Fair enough. But a lack of goodwill is deadly. If you’re buying the right business, you’re building on a good reputation built up over years. It’s part of the deal, and it’s yours to keep or lose.
The Bottom Line
If you’re in a corporate job but are entrepreneurially minded, taking over a small business, rather than launching a new one, may reduce some of the risks. Most important, it reduces the long lead time before your entrepreneurial dream becomes a solid earner. Or it can, if you put in the legwork that’s needed to confirm that this is the business for you.
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