Here’s How to Find a Small Business for Sale
Building a small business from the ground up can be a daunting prospect — and one that comes with a seemingly never-ending list of things to consider. What products or services should you sell? Where will you house the business? How will you find customers?
If you’ve been bitten by the entrepreneurial bug but don’t quite know where to start, buying a preexisting business with a built-in customer base can be a good option, according to Steve Hamilton, a senior adviser at the University of Houston Small Business Development Center, which offers consulting assistance to business owners.
“You don’t have to start from scratch, and sometimes it can be less capital and less hassle,” Hamilton said. “Every entrepreneur should definitely consider it.”
Finding a small business for sale
The business-for-sale marketplace is booming right now: According to BizBuySell.com’s year-end Insight Report, sales were up 27 percent year-over-year in 2017, which means there are plenty of options out there for an eager entrepreneur in search of a small business. You just need to know where to look.
Much like you would work with a real estate agent when buying or selling a house, a business broker can help you buy or sell a business. A broker will not only help you figure out what type of business best meets your areas of interest and expertise, but will oversee negotiations and help close the deal. (Just keep in mind that a broker actually works on behalf of the seller.) Finding a reputable broker is key, so you’ll need to do your research. If you’re part of an entrepreneur’s network, ask for a referral from a trusted peer. Other business associates — like a lawyer or accountant — might also be able to recommend brokers. The International Business Brokers Association, a nonprofit organization, has a search tool that can help you locate a broker with expertise in your industry.
Once you’ve narrowed down your list to a handful of candidates, check the Better Business Bureau to see if the brokerage has any marks against it. Ask the broker to give you some names and phone numbers of a few recent clients and call to see what their experience was like. Even a cursory Google search should give you a better understanding of the broker’s reputation. (And if the brokerage doesn’t have a legitimate website, consider that a big red flag.)
Before you sign on the dotted line with a broker, make sure the their commissions and fees have been clearly explained to you — brokers typically charge a 5 percent to 10 percent commission on sales, which is often paid by the seller, but that may not always be the case and there could be other charges involved, so make sure you know what your financial responsibility will be.
There are a number of websites, including BizBuySell.com, BizQuest.com and BusinessesForSale.com, where you can find listings for small businesses. Most allow you to search by region, price and industry to narrow your focus to the kinds of enterprises in which you’re interested. You’ll likely still want to enlist the help of a broker or lawyer to help you evaluate the business and complete the reams of paperwork necessary to close the deal.
Newspapers continue to be a great place to find listings, Hamilton said. Craigslist.com is another place you’ll want to check, but make sure you’re very cautious about answering ads online. Conversely, you might want to run a newspaper or online ad of your own seeking a business to buy.
Once again, your associates and acquaintances might be able to help in your business search. Let them know you’re interested in buying a business and ask if they have any leads or can recommend other entrepreneurs. Alternately, visiting local small businesses and striking up conversations with the owners could net leads — whether it’s that business for sale or a neighboring one. Entrepreneurs don’t always publicly list their companies — they don’t want to scare off employees or customers — so you might need to ask around to find out which businesses in your area are on the market. And don’t just target the types of businesses you’re interested in — think broadly, because you never know where you can find a new lead.
Things to consider when buying an existing business
Once you’ve homed in on a small business you’re interested in buying, you must thoroughly vet it. You might want to consider using an accountant and/or lawyer to help.
Get your hands on as many financial documents as possible — income statements, balance sheets, cash flows, sales receipts — from at least the last three years, Hamilton said. He also recommends looking at tax returns if they’re available. If they’re not available, that could be a red flag. All of these documents should help paint a picture of the company’s financial fitness.
In addition, you’ll want to see a valuation of the company, so you have an idea of what a fair purchase price should be. Typically, the responsibility falls on the seller to have the valuation done — in fact, some brokers won’t even work with a seller if he or she refuses to have a valuation — but that’s not always the case, Hamilton said.
“If you’re desperate, you can pay for the valuation,” Hamilton said. “But that doesn’t guarantee the seller is going to sell it for that.” Many sellers let emotions and sentimental attachment dictate the price, Hamilton said, which is why a valuation is so important.
Property and inventory.
If you’re buying a brick-and-mortar business, you’ll most likely be leasing or purchasing the accompanying lot or building. Be sure to give it a proper inspection. Is the roof leaking? Is the sidewalk cracked? Is the wiring shot? These are the types of things you’ll want to know long before moving in. Another tangible you’ll want to check out is the inventory. Does the quantity match up to the records? Is it in good condition, or has it been damaged or kept past its expiration date? You’ll lose money if you can’t make a sale.
Buying a going concern often means inheriting certain obligations and contracts. With whom is the previous owner doing business? And when do those agreements expire? This is also where the lease would come into play — make sure it will transfer over and that the lessor is aware of transition.
Investigating a company’s liabilities is just as important as investigating its assets. Some liabilities are to be expected, but Hamilton warns against taking on too many of a previous owner’s debts.
“You want to make sure you’re buying the assets of the company not the liabilities,” he said. For instance, if a company is worth $400,000 but the owner has $300,000 in liabilities, he might try to charge you a purchase price of $700,000 to pay off his creditors. Tactics like these are why it’s always a good idea to have a valuation done.
For continuity’s sake, you will probably keep some, if not all, of the previous owner’s employees on the payroll as you make the transition and learn the ropes of your new business. Find out as much as you can about the employees and the company’s organizational chart.
When you purchase a company you’re not just buying a physical entity — you’re buying good will — or the lack thereof — too. If the business has a poor reputation in the community, it will be difficult — or even impossible — to change dissatisfied customers’ opinions, and your sales will ultimately suffer.
Check out the company’s standing with the Better Business Bureau. Have there been complaints? If so, what are they and how recently were they made? If you’re buying a food-service establishment, check with the Department of Health for the business’ scores for the last few years. Have there been any major infractions? And don’t forget to click on over to Yelp and other review sites to read customers’ unfiltered opinions about the business’ level of customer service and quality.
If you’re buying a business-to-business company rather than a business-to-consumer company, get a list of companies with which it does business so you can call for referrals.
You’ll also want to take a close look at the industry as a whole. If your business is part of an industry in decline or one that has recently fallen out of favor for some reason, you might want to reconsider where you’re investing your money.
If any of your due diligence raises issues — whether it’s damaged inventory or numbers that just don’t add up — bring it to the seller’s attention right away and ask for an explanation. You can mitigate issues like damaged inventory by negotiating a reduced sale price, but bad financials might be indicative of bigger problems you don’t want to take on.
Another thing to keep in mind, according to Hamilton, is to be cautious regarding businesses in which the owner is actually the business. For instance, accounting firms are popular businesses to buy and sell, but clients might be leery about trusting their financials with a stranger, meaning you could lose a significant number of clients from the start. For a scenario like this, Hamilton said you might want to consider adding an earn-out to the sales agreement, which means that part of the seller’s compensation for the business will depend on how well the business does in its first few years after the sale. This strategy is designed to decrease the buyer’s risk.
How to make an offer
If the business has passed all of your due diligence, you’re ready to seal the deal. Here’s what you’ll need to do:
1. Assemble your squad.
If you haven’t yet, now is the time to enlist the services of an accountant, banker, and lawyer to execute the proper paperwork and obtain funding. If you haven’t had a valuation done, the bank will guide you through it during the financing process. “I can assure you the financial institution is not going to over-lend,” Hamilton Hamilton.
2. Negotiate a price.
Whether you’re relying on a valuation or your banker’s guidance, you should already have a pretty good idea of what the business is worth. Now’s the time to sit down with the seller and iron out all the specifics about the price. If you discovered any red flags during due diligence that could affect the dollar amount — for example, damaged inventory — make sure you address those at this time, as well as any potential earn-outs.
3. Get funding.
There is a number of ways to pay for your small business. If a lump sum of cash is an option for you, make sure you leave enough in your budget to actually run the business. Another option is borrowing money from a family member. Like any business transaction, you’ll want to create a paper trail documenting how much you borrowed and how you plan to repay it. There are also tax implications for you and your lender, so make sure to have a good understanding of those.
For many people, a small business loan will be the best option — as someone acquiring a preexisting business, you’ll have a leg up on entrepreneurs starting from scratch. You will have piles of paperwork — including cash flow analyses, balance sheets, accounts receivables and equipment valuations to show your bank, making you a much less risky loan candidate than someone just starting a business. And, as a potential small business owner, you might be able to take advantage of an SBA loan which is partially guaranteed by the U.S. Small Business Administration. An SBA loan comes with a lot of pros, including low interest rates and long financing terms.
There are also a few other options to consider, including having the seller finance the sale (in lieu of a lender), enlisting a business partner to help fund some — if not all — of the costs or selling stock to employees. In some cases, leasing the business from the seller might also be a possibility.
Just remember that no matter which financing option you choose, you’ll likely need to have a certain percentage of cash on hand for a down payment. And you’ll also need to provide supporting documentation that shows the value of the business you’re buying and your plans for turning a profit.
4. Gather all the necessary documentation.
You will have gathered much of the paperwork needed to form the foundation of your business agreement during due diligence, including:
- Contracts and leases: agreements with vendors and the leasing company
- Financial statements: balance sheets, income statements, cash-flow statements accounts payable and receivable
- Tax returns: ideally from the last five years
- Status of inventory, machinery and buildings
There is also a number of other documents you’ll need to draft with your lawyer for the sale. These include the letter of intent, confidentiality agreement, and sales agreement.
5. Letter of intent:
Also known as a term sheet, a letter of intent lays out the terms and conditions of the sale, including purchase price, payment method and schedule, the assets you’ll be buying and any noncompete agreements. The letter of intent is not binding, but it’s an important first draft of the final contract you both will sign, so it’s a good idea — and a time-saving measure — to have one done.
6. Confidentiality agreement.
Also known as a nondisclosure agreement, a confidentiality agreement protects the seller throughout the purchasing process, guaranteeing that the buyer does not reveal sensitive information. In many cases, a seller signs an NDA before the business name will even be made known to the potential buyer. There are often two levels of protection inherent in an NDA: One making the process itself confidential — meaning employees, customers and vendors will not be made aware of the sale — and another ensuring the seller does not disseminate confidential information about the business, like assets, liabilities and sales.
7. Sales agreement.
This document is binding, unlike the letter of intent. It plainly spells out everything you’re purchasing, which typically includes tangible assets, intangible assets (such as goodwill), intellectual property (such as patents) and customer lists. This is something you’ll definitely want to have your lawyer put together to make sure everything is covered before you sign on the dotted line.
Once you have all of the paperwork completed, you’ll need to create a few more supporting documents to make the transaction complete:
- Bill of sale. This is what actually transfers the seller’s assets to you, and serves as legal proof that you are now the business’s rightful owner.
- Purchase price adjustment. This document is the one that stipulates things like an earn-out.
- Asset acquisition statement. This document goes into greater detail about exactly what you’re buying and for how much. You’ll use IRS Form 8594, which is very important for your taxes.
- Additional paperwork. Depending on the type of company you’re purchasing, you might also need paperwork for vehicles, franchises and bulk sales.
Once all of that is complete, you’ll be finished. You will be an official small business owner.
The bottom line
Doing your due diligence during every step of the purchasing process — from finding a broker to signing on the dotted line — will go a long way toward making the sales transaction as transparent and painless as possible. Enlisting the help of a qualified, dedicated team — including a broker, accountant, lawyer and banker — will ensure you avoid common pitfalls associated with buying a small business, as well as guarantee all of your paperwork is legal and binding.
Although no sale is perfect, following a thorough action plan should deliver a good outcome for buyer and seller alike. And that good outcome will propel you into the future to grow and expand a new enterprise you can proudly call your very own.