Should You Buy or Start a Small Business?
When many of us think about the start of a small business owner’s journey, we see someone starting with a spark of an idea. From there, the entrepreneur works to make their idea a reality. They work out financing, real estate, equipment, and staffing. They find their core customer base. Over time they grow, evolve, and survive. Or they don’t. But the main point is that the small business owner is there from the start to the finish.
The problem with this vision is that it doesn’t include a huge part of the small business segment that buys into a business rather than starts it from scratch. Not every entrepreneur is cut out to run a startup. Sometimes, you’d have better odds of success if you found an existing business. And small businesses go up for sale every single day. It could be as simple as the current owner is retiring after decades of work or you could find a franchise opportunity with an ongoing brand. Whether you should buy or grow a business depends on your needs and expectations.
The biggest difference in buying a small business rather than starting one yourself is that you have the opportunity to buy a well-oiled machine that is already working. The previous owner has already come up with the concept, tested the market, and proven that it can work. You’ll walk into a situation where there is already product on the shelves, employees on the clock, and customers waiting to buy. You’ve also got access to all of their records and customer data, which can be incredibly valuable in this day and age.
A startup business goes through several stages: Development, Startup, Growth and Establishment, and finally Expansion. In fact, it’s not uncommon for it to take you years to get through each one. But if you buy an already established business, many of these stages have already been completed. In many cases, you can skip right to expanding the business.
Financially, buying a small business can be a better bet, too. A startup business might not make its first sale for a long time after the initial seed has been planted. And then it might not turn a profit for years. There are some businesses that never make a profit. Sometimes you don’t realize that until it’s too late. On the other hand, if you buy an established small business, sales are already happening and you could start making a profit from day one.
Inheriting Someone Else’s Problems
One of the biggest pros of buying versus starting a small business is that it has already got a proven track record. But that is also one of the biggest cons. Whatever problems the business already has will also come along with it. Whether it’s a history of bad online reviews, debt to vendors, or problems with the state sales tax commission, when the sale goes final, you’ll be the one on the hook for it. You could find yourself spending years rebuilding the business’ reputation or turning the company culture around.
Or you could find yourself pouring a lot of money into tax issues or necessary equipment repairs.
While it’s impossible to know exactly what the future will be, it’s best to do your research. You need to go through the books with a fine tooth comb. You should also be investigating the brand’s reputation. Talk to customers, vendors, and employees. Don’t be afraid to bring in a business consultant who can show you the right questions to ask and the right information to go over. It may not be cheap to hire a consultant to review everything but it will be worth every penny to avoid making a bad investment.
It’s easier to get financing for an existing business than it is for a startup business, whether you are looking for private investors or bank loans. The reason is that it’s easier to get someone to invest money into the known rather than the unknown. With an established business, you can show what the current finances look like so they can educated guess of what might happen in the future. Established businesses also have assets that can be leveraged for loans, which can make it look better to banks who are considering issuing a loan.
This is especially true when it comes to real estate, which tends to hold its value better than other assets.
If you’re considering financing for your new business, make sure that you have been very thorough with the current finances. You will need to know the operational history, profitability, and the stability of the revenues. You will also need to demonstrate the ability to repay the loan based on the current business income. You need to calculate all of the assets of the business, including real estate, equipment, vehicles, and accounts receivable. You’ll also probably need between 10 percent to 25 percent down payment for most loans.
Higher Initial Costs
In some ways, buying a small business mitigates some of the risks of starting a business. But that comes with a hefty price tag. You are buying an established business, which comes along with ready-to-run employees, assets, and customers. You are paying for the time, money, and work the current owners put into it to get it where it is today. They have made their mistakes and now they are offering you something that has already been proven to work.
That said, you still need to figure out the best price to pay. Pay too much and it might be too difficult to recoup your costs. If the owner is charging too little, it might be a sign that all is not what it seems. Avoid issues later down the road by doing your research.
Valuation before buying a small business can be done a number of ways–-discounted cash flow analysis, asset valuation, sales multiplying, etc. The method you use will depend on your own personal preference. Just don’t make the rookie mistake of thinking revenue equals value. Revenue means nothing if the business isn’t making a profit. If you’re unsure of how to value the business, leave it to a professional. You’re better off getting some outside help than making a costly mistake.