The 10 steps to buying a business (part one)

Don't rush through the all-important steps

The process of buying a business can be boiled down to one very simple question: is the business you’re buying the business you think you’re buying?

Some purchases are more straightforward than others. Often, this is reflected in the type of business you are purchasing.

For example, on BusinessesForSale.com, someone famously sold their newsagent to a milkman within 48 hours of him making the initial enquiry. The process was quick because the buyer was satisfied about what he was acquiring.

It was a typical newsagent, in a good location, with a trading history backed up by financial records, there were no outstanding legal issues and it was available at a price he believed was fair and affordable. Because the buyer was confident about his purchase (and it was an uncomplicated business) the process was quick and painless.

However, be warned, this is the exception, not the rule. But it does highlight a very important principle: if you have a thorough understanding of the business you are buying, then the process will be smoother.

Pick up a copy of the Financial Times and you will likely find a story or two about one company buying another. Businesses are continually bought and sold as a result of an opportunity being made available or because of a strategic plan.

Larger corporations buy businesses to take out a competitor, increase purchasing power or to acquire skilled employees.

The process of buying a business – whether it’s a pub, hotel or childcare nursery – is the same

However, as a first-time buyer you are likely to fall into different category – often driven by a desire to change your life, be your own boss or (in some cases) make an investment that offers better returns than other avenues (such as the stock market or a building society).

As a first-time buyer, you are unlikely to be buying a £50m software company or a 250-employee manufacturing business. But the process of buying a business – whether it’s a pub, hotel or childcare nursery – is the same.

The process might be shorter and simpler but it’s geared around the same principle: is the business you are buying the business you think you are buying?

You’re probably reading this because you’ve considered the advantages of buying a business over starting one from scratch. You know that your chances of success are greater because you’re already buying success.

You’re buying an established business that’s hopefully making money and has customers and employees already in place. You also know that if you buy a good business, you have the opportunity to make it a great one.

What you probably don’t know is how to buy one – so here’s how.

Step one: defining the business you want to buy

When larger corporations do this they call it ‘acquisition profiling’. For you, it will probably manifest itself in a series of questions such as: Which kind of business do I want to buy? How do I know which kind of business is right for me? Where do I start?

Even if you already know which business is right for you it’s still a good idea to do some research. Read up on any future legislation that may affect the business sector.

For example, deregulation plans for the gaming industry may be a wonderful opportunity. But new legislation on how care homes are run may prove restrictive. Know your facts and figures.
 
Each trade has its own trade magazines and associations and you should mine these resources for the expert, up-to-date information they provide. If, for example, you are thinking of buying a pub, then you should start subscribing to the Publican, a trade magazine for the industry, and contact the British Beer and Pub Association to find out why pubs often fail.

Get as much information about the sector as you can – and don’t be afraid to change your mind.
 
If you’re thinking of buying a hotel, ask yourself what makes one successful? Find an example of a successful hotel. Could you replicate that?

Go and stay in your favourite hotel and make notes as to why you like it so much. This might sound simplistic, but it will help you define the business you want to buy.

In many respects, if you have not decided on the type of business you want to buy this can be a very frustrating stage. Being sure of the business type is very important because it will have to be something you’ll enjoy and do well at.

However, never forget that sometimes the greatest benefit of business ownership is not what you do, but the fact that you are financially independent. Therefore if you’re unsure about the type of business you want to buy, but confident about being your own boss, you might want to consider buying a franchise.

Try looking on FranchiseSales.com, which features around 1,300 franchise opportunities.

At this stage you’ll also be considering how much to spend on buying a business. Careful financial planning is crucial, as you don’t want to overstretch yourself in the purchase only to find you have inadequate resources to make any changes or implement new plans.

Make sure you build some slack into your budgets. Start doing the maths now.

Step two: targeting the business

Once you’ve defined the parameters of the business you to want buy – the market sector, size, location (are you prepared to move?), the price range, et cetera – you’ll be in a position to start targeting the right business. There are two ways of targeting a business: find one already listed for sale, or approach a business not for sale and make an offer.

BusinessesForSale.com has thousands of businesses – most of which are represented by leading business agents, brokers and accountancy firms. It’ll make your task of targeting a business much easier than searching through a newspaper.

However, if the business you want to buy is not actively being marketed for sale there is nothing to stop you from approaching the owner directly and making an offer. Every business has its price.

If you go down this route then it is advisable to employ an intermediary to represent you. There are many business brokers (the estate agents of business buying) and accountancy firms who will target an opportunity on your behalf.

But be aware that this process can be expensive and that the costs should be proportionate to the size of the business you are targeting. There’s no point in spending £50k with a top-five accountancy firm if you’re targeting a post office.

But if you’re spending between £1m and £10m on buying a business then an experienced professional will be invaluable. BusinessesForSale.com has a directory of professionals who can be engaged for this type of activity.

Step three: quick and dirty DIY due diligence

Now things are getting interesting. You’ve narrowed down the opportunities and you’ve created a shortlist of businesses that interest you. Ideally, you will have about five or six targets on your list.

Before you engage lawyers and accountants and start the official due diligence process you should do your own – a DIY, quick and dirty version of due diligence.

What is due diligence? Well, it’s a technical term, used by accountants and lawyers to describe the process of making sure the business is what it says it is.

It’s no different to buying a car. The AA are the equivalent of an accountant as they will carry out a professional due diligence on your behalf for a fee.

But before you engage the AA you will do a bit of your own – kick the tyres, check the mileage and give it a test drive. It’s the same with a business.

Spending time on checking out the business could save you heartache down the line – whether you’re buying a fish and chip shop, a florist or an electrical engineering firm. Once you’ve got your shortlist you should get as much information as possible about each business on your list.

This is your chance to dig around and make sure the business is as good as it seems. If you’re buying a listed business for sale then it should come with a sales memorandum giving an overview of what is being sold.

This is a crucial stage. You must find out the truth about the business being sold.

Any flaws or irregularities could also help you to negotiate the price or make your decision to walk away much easier.

You will want to get access to financial records, including audited and management accounts. For this you will be asked to sign a confidentiality agreement.

Don’t be alarmed by this. This confidentiality agreement (which won’t be more than a couple of pages) is a promise by you not to reveal sensitive information to a third party and is designed to make the seller feel comfortable about sharing the knowledge of how his business is being run.

Remember, the business will still be operational and no owner likes it to be known – to his customers or competitors – that his business is up for sale.

You will also want access to information about existing contracts, either with suppliers or employees. You will want to research the local area and make sure there are no legal issues that might threaten your activity.

If you are buying a services business you may want to test the quality of those services by pretending to be a customer. If you’re buying a hotel, for example, you should stay there and review the standards.

This is your chance to get to the bottom of what is actually being sold before you employ expensive accountants and lawyers. It’s also a crucial stage if you are going to borrow money from a lender.

The surer you are about the business and the more evidence you can gather to back up your case, the easier it will be to start negotiations with a lender. From your shortlist of five or six you should be narrowing down to just one or two – the major target and a back-up.

Step four: negotiating the price

Once you are satisfied that you have done as much as possible to understand the business you’re targeting, you can start to talk about actually buying it. Inevitably this will mean a conversation with the business owner or intermediary (agent, broker or accountant) about the price of the business.

It’s important to note that at this early stage of discussions the price remains subject to contract. This means you can make an indicative offer that can change at some future point.

Between now and when the contract is drawn up you may discover some information about the business that will affect your perceived value of it, and you may wish to negotiate further on the price.

Similar situations arise in house buying. A surveyor’s report may reveal information that will change your opinion of the valuation.

So feel free to talk about what you are willing to pay at this stage, safe in the knowledge that it won’t be binding after further investigation. Of course, it might transpire that the business is actually undervalued, and that you have a real gem on your hands (but don’t ever count on it).

In this case, you may just want to pay the asking price.
 
Also, at this stage and throughout the process, don’t allow yourself to be rushed. Don’t be pushed into a quick sale; take your time.

Once you make an indicative offer a business owner or intermediary may want to rush things through. That’s only natural.

However, resist them. Remember, as a buyer, you hold most of the cards.

Take as much time as you need to get to the bottom of what it is you are buying. Don’t let them force a timetable on you that you feel uncomfortable with.

A timetable must be structured in your favour. You’re paying. You’re the buyer.

Step five: valuing the business

A price is the ultimate reflection of the value of the business. There are many valuation methods used to assess a business.

Most first-time buyers buy property-based businesses (such as pubs, child nurseries or coffee shops), meaning much of the valuation is based on the property itself. A surveyor’s report will give you comfort here.

However, when it comes to valuing a non-property-based business or valuing the rest of a business (the turnover of the pub, child nursery or coffee shop), you will want to look at methods such as multiple of earnings, discounted cash flow and asset valuation. You will also need to take into account intangibles such as intellectual property and goodwill.

Because you’re a first-time buyer using a multiple of earnings is a good starting point. As a general rule you can take a multiple of future profits to land on a price.

The majority of businesses sold are done so on a multiple of between three and eight times the profit. A business making profits of £100k, for example, would then be valued at between £300k and £800k.

If you were buying a hotel, restaurant or care home you would then have to factor into this calculation the value of the bricks and mortar.

There are companies that specialise in valuing certain types of businesses and you may wish to engage the services of an accountant with experience in buying and selling businesses when making an assessment.

However, in the final analysis, a business is ultimately worth what you’re willing to pay for it. 

Read part two of Buying a business: 10 steps