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5 Things to Consider Before Buying a Business

 

No matter how experienced, successful, or wealthy you are, research plays an integral role in the purchase of a business. Buying a company isn’t something to take lightly or do rashly. Having said that, are you prepared?

5 Tips and Best Practices

Buying a business is a lot like buying an investment property. Any way you slice it, due diligence is a must.

“Whether the home is old or brand-new, neglecting to order a home inspection before purchasing it is a big mistake,” Houston-based property management firm Green Residential explains. “Most homes and apartments have a problem or three, whether external or internal, that you can use as leverage to drive down the asking price.”

In other words, doing due diligence – whether on a piece of real estate or a business – provides both peace of mind and leverage. It’s a two-for-one deal.

If this is the first time you’ve purchased a small business and you’re unsure of how to proceed, have no fear. Here are some of the top things you need to do during the research phase.

  1.     Figure Out Your Financing

Start with your financing, since this will almost certainly dictate whether or not the purchase of a business is financially feasible. It’s best to meet with as many prospective lenders as possible to get an idea of what sort of loan packages, financing terms, and interest rates exist. Once you zero in on a specific business, you can circle back with them to figure out the exact terms (since financing packages are dependent on the specific business being purchased).

  1.     Buy the Assets, Not the Business

If the seller is a corporation or LLC, you need to make sure that you’re buying the assets of the business – not stock in the business. You should purchase the assets of the business and then form a separate company to act as the purchaser. There are a couple of reasons for this:

“First, you get a better tax treatment, since your ‘tax basis’ in the assets will be the amount you paid for them, rather than the amount your seller paid for them long, long ago,” entrepreneur Cliff Ennico writes. “Second, if he owes money to people or is being sued by someone, you won’t assume any of those liabilities if you buy the assets.”

  1.     Figure Out Accounts Receivable

In many cases, a business being sold will have some outstanding accounts receivable. It’s a smart idea to determine who will be responsible for collecting these before finalizing the purchase.

There are generally a couple of options. Either you’ll purchase the accounts receivable at closing (for a discounted rate), or you’ll have it written into the contract that the seller is required to collect them. In most cases, the former option is preferred. It gives you more control and prevents having a former owner involved in your new business.

  1.     Determine the ODI

Are you familiar with the ODI acronym? It stands for “owner’s discretionary income,” which is what the seller is taking out of the business after paying for supplies, employees, rent, overhead expenses, and taxes.

“If you can't live on the current ODI, or if ODI has been declining for several years, watch out! The business is going downhill,” Ennico advises. “If the ODI seems healthy, get the seller to put it in writing, and hold back on naming your purchase price for a few months so you can confirm the seller's ODI numbers are accurate.”

  1.     Phase Out the Previous Owner

If possible, try to avoid an immediate transfer of ownership. It’s best if you can phase out the previous owner over a period of time. Not only does this help in terms of managing employees and existing clients, but it also gives you time to learn the business.

Make a Smart Decision

There’s nothing casual about buying a small business. Whether it’s a couple thousand dollars or a few million, the ramifications of purchasing a business are deep and wide. Do your due diligence ahead of time and make a smart, intelligent choice that’s rooted in facts and not emotions. Your future self will thank you for all of the hard work you put in.

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