Buying a Business 101: 5 Basic Steps to Consider When Buying a Business
Author: Elliott Holland
When buying a business, take time to review the company details to be sure it’s in good standing. Here’s what the process entails.
Key Takeaways
Buying a business comes with various risks
Conduct due diligence in five crucial steps before buying a business
Decide whether to buy shares or assets
If you wish to own a business but don’t want to start from scratch, you may consider buying an existing one. This method of acquiring a business is an excellent way to capitalize on an established brand and operational infrastructure to potentially realize immediate profits. Buying a company might also be less risky than starting from zero, as you can skip some pain points.
Before you finalize the purchase, there are several steps for buying a company to consider. The first and most important is to determine the type of business you want to buy. It should be something you’re passionate about expanding and taking to the next level.
However, passion alone won’t help you in the buying process. Your next step is to create a checklist for buying a business and to make a list of questions to ask in the buying process. Here are a few steps to set you on track.
1. Choose the right industry
Your best bet is often to choose a line of work you’ll be comfortable doing yourself. Better yet, it can help to go for an industry you have substantial experience with to avoid struggling with overseeing the business. However, that’s not to say you have to be involved in the day-to-day running of the business.
To manage your team, you must know the ins and outs of the business and industry. If you don’t have experience in the industry and still want to buy the business, get involved in the daily operations to learn as much as possible.
2. Conduct independent business valuation
It’s common for sellers to overvalue their business, so you’ll need to figure out the actual value of the business you want to buy. Determining how much a company is worth is complex, especially if you decide to do it yourself. It’s advisable to hire a licensed business valuator for an unbiased and accurate understanding of the value of the business you intend to buy.
A valuator may use one of the following valuation methods depending on the type of business and available information:
Multiples approach
This method entails applying a valuation multiple, which may be based on earnings before interest, taxes, depreciation, and amortization (EBITDA) or revenue. The specific figure the valuator uses and the type of ratio depends on factors like industry, size of the company, and multiples used by comparable businesses.
Earnings-based method
This technique is primarily applicable for businesses with reasonable returns and value that is more than that of their assets alone. The valuator reviews past results and projected earnings or cash flow to determine the company’s value.
Asset-based method
This option is best for businesses that derive more value from assets than operations. A good example is a business in the real estate industry.
3. Review the assets
The seller should provide a detailed spec sheet of all assets included in the deal process and their value. As far as intellectual property is concerned, confirm that brand ownership is correct and that trademarks and patents are included in the deal if they exist.
Let a business lawyer help you evaluate how intellectual property is captured and protected. Proper due diligence on these assets will help protect the business’s most important assets, especially if the company is in technology, research, science, or development.
4. Analyze the business status
When buying a business, you’ll want to do background checks, and some of these require working with a good accountant to help you review the business’s financials. It’s also advisable to have an experienced business attorney provide legal representation in the negotiations and explain the transaction’s structure.
The seller might ask for a signed confidentiality agreement, and you may want to have a lawyer review it before you sign. The document, also called a nondisclosure agreement, protects the business owner if you decide against buying the company after reviewing the business’s confidential information.
In addition, here are some of the business documents you must review carefully with the help of a lawyer and accountant as you conduct your due diligence:
Business financials: Review balance sheets, tax returns, advertising costs, accounts payable, and other documents
Contracts and leases: Ensure the landlord is willing to transfer the lease to you
Environmental regulations: Certify the business doesn’t violate environmental laws
Zoning laws: Check if the company complies with the area’s zoning requirements
Legal liabilities: Determine how much debt burden you’ll inherit
5. Decide whether to go all in or buy shares
At this point in the due diligence process, you should have enough information to decide whether to buy shares of the company or the underlying assets. If you buy shares, you’ll also acquire assets and liabilities. That means you’ll inherit the employees and any potential severance costs.
Buying the company’s assets means you can depreciate the assets and deduct this expense when filing corporate taxes. On the other hand, a share purchase doesn’t offer these tax savings until you sell the shares.
As a tip, it’s often a good idea to form a separate company when buying the company’s assets. The new entity will act as the purchaser, which will be advantageous because you may get better tax treatment. Your tax basis in the assets will be the amount you pay for them, not the amount the seller paid a long time ago.
Get the steps of buying a business right with Guardian Due Diligence
The process of buying a business is long and complex, and it requires you to be actively involved in the process. You need to evaluate the company and review its legal and business documents carefully. Working with a business professional can help identify any loopholes that may mar the deal.
At Guardian Due Diligence, we can help you complete the due diligence process before buying a business. Our team has evaluated more than 1,500 deals and can help you, too. Contact us to schedule a call with our team to get started.