There are pros and cons to buying an existing business.
When you buy an existing business, you're buying the owner's assets, stock and customer loyalty. This trading record can help you get financing. But the departure of the previous owner can also have a negative effect, so previous takings aren't guaranteed.
The business might also:
- owe staff entitlements such as long service leave
- have a bad image that's difficult to change
- be overpriced or not easy to transfer
- have inadequate or old premises, plant or equipment
- be leased from a landlord who isn't willing to reassign the existing lease with its current entitlements.
The best way to avoid being caught out by these is to do proper research.
Research your industry
Research your industry to identify your customers and competitors. You want to know how the business is performing compared to others in the industry and its potential for growth in the future.
Before you invest, use the small business benchmarks tool on the Australian Taxation Office (ATO) website to work out how your potential business is performing compared to others in the industry.
Get an independent valuation
Next you need to verify the the business's finances and potential value by looking at the business's:
- work in progress (existing contracts).
This is called 'financial due diligence' and it's best to get an accountant to do it. A CPA survey found that 80% of buyers who did financial due diligence with an accountant avoided paying too much.
The owner might have based their sale price on projections of future earnings or by benchmarking against other similar businesses. By having the business independently valued, you can be sure that you're buying at the right price.
A business's assets can be tangible and intangible.
Tangible assets include:
They're usually valued with an estimation of how they've depreciated or their resale value.
Intangible assets includes things like intellectual property and goodwill.
What is goodwill?
Goodwill describes an existing business's reputation, viability and potential. For example, a strong client list or effective business processes can contribute to goodwill.
It's important to assess goodwill as part of the overall investment in a business. This will help to make sure the business will be profitable enough to:
- cover your capital repayments after tax
- provide you with a fair income.
Liabilities of the seller
A liability is money the business owes that decrease the value of the business.
Liabilties can include:
- debts owed to creditors, or
- employee entitlements such as annual leave and long service leave.
When you buy a business, you might have to take on responsibility for employee entitlements, so make sure all entitlements have been assessed and deducted from the purchase price. You wouldn't normally take over liability for debts, creditors or for future orders, so these shouldn't be calculated in the sale price at all.
For businesses that cost under $450,000, the seller must also provide the prospective buyer with a vendor's statement (or Section 52 statement).
You need to make sure the business you buy will continue to make a profit. Consider the business's commercial life and if there are other opportunities that might be a better investment.
Commercial life of the business
The value of a business fluctuates throughout its commercial life and it can't always be resold later for the same amount of money.
For example, a business's ability to remain profitable will be affected by:
- changes in the economy
- the arrival of competitor businesses
- the need to replace failing equipment
- cancelled contracts.
Opportunity costs describe the cost of passing up the next best choice when making a decision to invest. In other words, what are you missing out on?
Opportunity costs might be other sources of income or the chance to put the money into a term deposit.
Work in progress
Work in progress are the existing contracts a purchaser will receive from buying the business.
Work out your finances
So you've assessed the business and decided to buy. Now settle on how much it costs to take over and how much you'll need to source from elsewhere.