Starting a new business is challenging. Buying an existing business has its advantages, including knowing what is already there and improving on it: trained employees, existing customers, and operating expenses.
Brad Nakase, Attorney
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Example – As an entrepreneur, Ronald loves reading business news to learn about successful ventures. One day, he sees that a restaurant chain called “Burrito Land” is about to be put on sale. Ronald is shocked that the company is being sold, because according to his understanding, it is very popular among young people and seems to be doing well financially. In the past, Ronald himself ran a bistro, and for a while now he has been interested in taking on a new project. That said, he is not interested in starting a business from the ground up again. That involved a lot of time, energy, and money. Ronald would like to invest his time in an already established business and take it to the next level of success. He knows that there are advantages to buying an existing business and would like to reap the rewards.
Starting a small business can be an exciting and rewarding time for any entrepreneur. The owner can focus on pursuing their own dreams, creating a successful company from modest beginnings. However, not everyone is suited for this entrepreneurial route, nor do they necessarily aspire to it. Instead of starting their own business from the ground up, some entrepreneurs prefer to purchase an existing business. By purchasing an already established company, an entrepreneur can avoid the difficult startup period while still enjoying the advantages and excitement of running a business.
At the same time, while there are certainly benefits to buying an existing business, there are also risks worth considering, according to the SBA when buying an existing business. This article will review the pros and cons of purchasing an established small business so that an entrepreneur interesting pursuing this route can make an informed decision.
When buying an existing business, it is a good idea for an entrepreneur to hire an attorney to assist with due diligence. Due diligence means the process of verifying the information, financial condition, and accuracy of a business.
When an entrepreneur purchases an already established business, he or she will have a good conception of how the market has responded to the services or products offered.
For instance, if an entrepreneur purchases an existing restaurant that is already a popular fixture in the community, then he or she can be sure that local customers enjoy the food and frequent the spot. Because of this, the new business owner can be confident that existing patrons will continue to visit the establishment even under new ownership.
Therefore, it is important that an entrepreneur do his or her due diligence when considering purchasing a business. He or she should be sure that the product or service is already popular or well-received. This forms an important factor in the decision-making process. Once an entrepreneur identifies a business for sale that he or she is interested in, they should consider whether there is already a successful business plan in place.
Example: From his research, Ronald knows that the market loves Burrito Land’s food and service. Each of its locations in his city is extremely popular, with customers lining up around the block every day of the week. When Ronald asks around, people tell him that they love the quality of the ingredients, the taste, and the dining experience. Based on this survey, Ronald determines that new ownership would not change the customers’ devotion to the restaurant. As the new owner, he would enjoy the same market popularity.
When an entrepreneur purchases an existing business, in addition to having products and services already market tested, he or she will also be positioned to start selling immediately.
For instance, if a business owner is creating a retail store from the ground up, he or she will need to do the following vital tasks:
When an entrepreneur purchases an already existing business, he or she has less work to do, because the business has already gone through its startup phase. Therefore, the following will already have been completed:
When an entrepreneur buys a business, the previous owner will have already completed much of the difficult startup work. That said, a new owner may wish to hire more staff members, remodel the physical location (or shop for a new one), and upgrade existing equipment, among other changes or adjustments.
However, because most of the more difficult aspects of creating a business have been completed, a new owner can focus on tailoring the business to his or her specific preference, as well as improving it.
Example: Ronald has already had experience getting a business started from the ground up, and he understand how much work it takes. He is looking forward to walking into an established setup. Burrito Land already has trained staff who know how to prepare the food. The relationships with vendors are already taken care of, so food arrives on time and in good quality. Also, the locations are already established, so Ronald will not have to worry about choosing the right places for restaurants. He only has to worry about expansion and determining the proper growth rate.
A business’ brand plays an important role in establishing and growing a customer base and presence in the market. It is difficult to begin a new brand in a crowded marketplace. This is because existing business owners will have an advantage, making breaking in a hard task. It is common for entrepreneurs to struggle growing their brands and focusing attention on their products and services, during the startup phase especially.
That said, over time a business’ brand should find momentum and become more familiar to the public. If an entrepreneur buys an established business, however, it is common that he or she will inherit the brand and market share, which are functionally built in. This can save a business owner time and money, because he or she will not have to invest either in marketing or advertising to build a brand.
Example: Ronald knows how difficult it is to create a brand that stands out. He is therefore pleased that Burrito Land’s previous owners already spent the time and money building a brand image: fast, fresh, build-your-own burritos. With three locations in the city already, people are beginning to recognize the company’s logo, sometimes without the name. Burrito Land also has an established social media presence with fifty thousand followers on Instagram, so Ronald has a head start in growing the company’s following and online presence.
When an entrepreneur purchases an existing business, he or she will find it easier to get additional working capital through traditional financing options. This means that the business’ new owner will find it easier to secure a loan than it might be to get approved for a startup business loan amount.
Also, the business acquisition loan application process is not very difficult or stressful because the lender can study the established business’ finances.
For instance, lender will be able to examine the revenues, profits, and other financial statements to establish the viability of the business. If the business appears financially healthy, then a lender feels that he or she is taking on less risk by approving a loan. This will increase the probability that an entrepreneur will receive a small business loan.
Occasionally, an entrepreneur may be able to get an SBA loan for purchasing a business. Some funding programs, however, cannot be used to purchase a business. This is because they are meant to cover existing business expenses.
Example: With an understanding of Burrito Land’s finances, Ronald is more likely to receive a loan to help him purchase the company. He knows that the restaurant chain is financially sound because he has looked at their revenues and profits. When Ronald approaches a lender with his plans to keep the company on the same financial track, the lender feels assured that Burrito Land will continue to prosper.
A business that has already been established should enjoy a customer base that will stay make purchases under new ownership. It can be difficult for a startup owner to spread the word about a new business and gain customers. This process takes a lot of creativity and marketing, which involves both time and money. Therefore, it can be beneficial to purchase a business that people already know about.
Example: Burrito Land’s previous owners spent a lot of money on marketing and advertising. They keep in touch with the local community on Facebook, where they offer discounts and prizes to loyal customers. On Instagram, they post tasty-looking photos of their food. A social media employee posts funny comments on Twitter, and even took the company viral when he challenged Chipotle to a burrito-off. Thanks to this customer engagement, Burrito Land has a devoted following of customers that will keep coming even with new ownership.
The reality is that not many business owners will sell a successful business for a cheap price. If the business is flourishing, then the previous owners will probably ask for a steep price so that they can get a good return on their investment. Because of this, an entrepreneur should be sure to compare startup costs against the cost of buying an existing business. If, in the long-term, it is cheaper to establish one’s own business and brand, then this may be a better option than purchasing a very expensive established company. This will ultimately depend on the existing business’ quality, and whether its high price is worth paying.
However, if an entrepreneur decides to purchase a cheap business, there is a risk that the brand has been tainted in some way, or that the markets do not like a product or service offered. Bringing a bad brand back to life or resuscitating a struggling business is very difficult, taking both time and money. In this situation, an entrepreneur should consider whether a particular business is worth all the effort, even if it is inexpensive.
Example: Because of Burrito Land’s success, its purchase comes with a hefty price tag. If Ronald wants to buy the company, he will have to pay a premium. However, Ronald feels oddly reassured. He knows that a more expensive company is valuable because it is better-run and does not have many problems. He will pay more upfront buying the company, but he will overall spend less, because he will not have to spend money to adjust operations.
An entrepreneur may buy an established company in the hopes that it requires little improvement or few changes. Essentially, he or she hopes to simply walk in the door and take over. However, an entrepreneur may end up dealing with a wide range of issues as the new owner. It will be hard to assess how well the business is operating internally until the new owner gets in the driver’s seat.
There are a few red flags to watch out for, which include the following:
It is possible that in trying to implement changes, an entrepreneur may unwittingly create new problems within a business. For instance, current employees may reject policy changes and quit. It is advisable to learn as much about a business as possible prior to buying it, to reduce the risk of regretting the purchase.
Example: When Ronald buys Burrito Land, he will thankfully not have to make any operational changes. The employees are happy because they are paid well and given benefits. The company also enjoys a solid relationship with vendors, and thanks to loyal customers, there is no issue with cash flow.
It is very possible that an entrepreneur may fall victim to a scam artist or unscrupulous seller. A previous business owner may misrepresent financial date or necessary repairs, meaning that a new owner could inherit a dud business, or one in serious need of help.
If an entrepreneur finds themselves in this unsavory situation, he or she may have legal options. However, legal fees can accumulate quickly. To avoid falling victim to a scam, an entrepreneur should review all legal documents with a lawyer and conduct extensive research before buying an established business.
It might also be a good idea to hire a business broker to assist in buying an existing business. As broker can help research businesses, review letters of intent, and facilitate negotiations between parties.
Example: When Ronald considers buying Burrito Land, the first thing he does is contact his corporate lawyer, Phil. Phil helps Ronald review all the legal and financial documents involved in the sale to ensure they are legit. Both men want to make sure that Burrito Land is being honest about its financials so that Ronald is not trapped on a sinking ship.
When an entrepreneur buys an existing business, he or she is inheriting someone else’s vision. The business’ new owner will have to shape the business model to their personal liking and make changes to reflect their own vision. For instance, an entrepreneur may wish to enact the following changes:
These types of changes require time and money. Sometimes, a business owner may never feel like the company belongs to them because they did not start it from the ground up. If an entrepreneur is worried that this fate may befall them, then it would be wise to wait to start their own company.
Example: Ronald firmly believes in Burrito Land’s operational style. Having run his own bistro in the past, he can appreciate the to-go method of sale, and he believes that he will fit in with the company culture nicely. Because he has already had a company designed with his own vision in mind, he does not feel the need to create his own vision. He is perfectly happy to adopt the former owners’ vision and goals.
If an existing business has experienced public relations issues, then this could harm sales going forward. Whether the issues stem from bad customer service or legal troubles, these problems can damage the new owner’s entrepreneurial career. This is true even if the owner did not run the business when particular issues occurred.
Unfortunately, when customers or clients associate a business with scandal or negativity, they may not change their mind simply because the business has a new owner. In fact, they may not even learn that the business has new ownership. There may be benefits to buying a business, but none of these would outweigh buying a business with a reputation that cannot be redeemed.
Example: Luckily, Burrito Land has not endured any public relations’ crises. Ronald knows that a similar startup chain suffered a cockroach infestation that permanently damaged the brand’s reputation. People began Photoshopping a cockroach into the company’s logo. Ronald hopes to make Burrito Land’s ownership transition seamless, so customers are not even aware of a change.
There are advantages and disadvantages associated with buying an established business. An entrepreneur should consider their particular situation, their financing options, and the type of business they are interested in. It is wise to take the time to assess these factors before making a major decision.
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