How to buy a business: Everything you need to know

Buying a business can give you a leg up as an owner because you don’t have to build the business from scratch. The business model, as well as products and services, are already built. Employees are trained and hired. Customers are already buying.

And with Baby Boomers expected to make an exit from the workforce within the next 10 to 15 years, there’s no shortage of existing businesses for you to consider. Baby Boomers alone own 12 million businesses and $10 trillion in assets, according to the California Association of Business Brokers. A whopping 70 percent of those are expected to change hands over the next few decades.

Yet buying a business can be complicated as you have to review business documents, licenses and finances as well as draw up a suitable sales agreement before you buy. You also need to do a great deal of research into the financial health and viability of the business you want to buy. By doing your due diligence during the process, you can ensure that you make a solid business purchase and avoid some challenges.

Know what type of business you want to buy

The first step in buying a business is to consider the type of business that you can lead best. Consider your goals, experience and whether your skillset fits a business you’re interested in buying.

For example, if you have experience in the tech industry, you’ll know the ins and outs of that industry better than someone without experience. Having experience and skills within that type of business will help you better understand and navigate the challenges that business faces. You can also position the business to meet a need that you know other competitors aren’t meeting, a feat only a seasoned professional can do.

Know your finances

Next, you’ll want to decide how much you’re willing to invest in the business, including the purchase price and any investment to grow or expand the business. You can find businesses that cost as cheap as $12,000 or higher than $400,000, depending on the industry and success of the business.

You’ll also likely need at least 10 percent to 20 percent of the purchase price on hand as the down payment, while a lender can finance the rest of the cost. Keep these numbers in mind when you’re deciding on a business so that you understand how much you need for that business to be profitable for you.

Search for available businesses

You can find available businesses for sale in a variety of ways, including:

• A commercial real estate broker. A commercial real estate broker may know about existing businesses for sale, particularly those with brick-and-mortar locations. You can then inquire more information about the business from the seller.
• Business broker. A business broker works for the seller and can answer many questions about the business as well as provide you with vital information such as financial and tax documents.
• Buying a franchise. You can work with the franchise’s corporation to buy the rights to use the franchise’s branding and advertising in your local area. You’ll want to review the franchise agreement to see what guidelines and limitations it places on you. Franchises can provide support such as location selection and marketing plans, but some also require stringent oversight of your business’s management.
• Online business marketplaces. You can find businesses to buy through an online directory by simply searching for businesses for sale in your browser.
• Business meetings and conferences. You can also find businesses by word of mouth if you attend business meetings and know of an owner who wants to sell the business.

Find out why an existing business is for sale

When deciding whether to buy a business, consider why the business is for sale. If the owner simply wants to retire or get out of the industry, the business should still be in a healthy place for you to take over. But some business owners sell because the business is failing. You’ll want to ask some probing questions to determine if the business is a good investment:

• Are sales increasing or decreasing?
• Does the business have too much debt? You can determine the business’s debt service coverage ratio, which should land ideally around 1.25 or higher.
• Does the business bring in plenty of revenue to cover expenses, including a decent owner salary?
• What market challenges has the business faced?
• Has the business attempted products or services that failed? Why did they fail?
• Does the business have tough competitors in its market?
• Does the business have a unique selling proposition?
• Does the business have a detailed and thorough business plan?

Focus on businesses that align with your financial situation and goals

At this point, you may have found several businesses that interest you, and you’ll want to choose the business that best aligns with your goals. First, you’ll need to choose a business that you can easily afford and that you expect to make a sizable return on your investment.

You may also have goals about how much time you want to spend on the business. Perhaps you want a business that can run mostly on its own, and you pop in throughout the week as your schedule allows. In other cases, you may need to manage the fine details of the business and be involved in day-to-day operations.

You should also consider a business with a vision that you can get behind. For example, you may opt for a business that helps underserved communities access education that they need to build a better life for themselves and their families. This business may be profitable, but may not be as profitable as other businesses for sale. In this situation, you may have to choose whether the vision of this business is important to you.

Paperwork due diligence

You’ve found a business that you think is a good fit. It’s time to dive into the nitty gritty of paperwork to see if the business is healthy or if there are any red flags. In this step, you want to cover all the bases from finances to legal documents to contracts and lease agreements. Doing your due diligence will help you see where the business is at and whether you can help it sustain and grow. Let’s look at some of the documents you’ll want to review:

Letter of intent

First, you’ll want to submit a letter of intent to the seller. This letter lets the seller know that you are serious about buying the business – without obligating you to buy just yet. The letter opens the door for the seller to share deep financial and tax information with you so that you can see the true state of the business. You may also have to sign a confidentiality agreement to keep these details about the business confidential and with the seller.

Business financial records

You’ll want to hire an accountant to help you pore over the financial records of the business from the past few years. The accountant will be able to help you see if the finances are healthy and may even supply revenue forecasts. The financial records you’ll want to go through include:

• Business bank statements
• Balance sheet
• Accounts receivable and accounts payable
• Profit and loss statements
• Debt schedule

Business licenses, permits and zoning laws

Depending on the industry, the business may need licenses and permits to operate in your state or local area. Check which business licenses the business needs and whether the business is up-to-date on these licensing regulations. For example, a restaurant may need a food handler’s license or food facility health permit. These licenses may need to be updated periodically.

You’ll also want to check the zoning laws in your area. Most areas are zoned for either commercial or residential use, and some are zoned for mixed-use. You’ll want to ensure that the business adheres to these laws, particularly if it has a physical location.

Business formation documents

You’ll want to ask for the business formation documents, such as the articles of incorporation or articles of organization. You’ll want to check that the business is legally formed and able to operate in your state. There may be no official documents if the business is a sole proprietorship. In this case, you may want to consider registering the business as an LLC or corporation to take advantage of tax benefits.

Leases and agreements

Next, you’ll want to review any contracts, leases or agreements the business has entered with other businesses. Make sure these contracts are in good standing, and if related to finances, use them to consider the financial health of the business. These agreements may help you get a full picture of the accounts payable that the business is responsible for. These leases or agreements include:

• Assets like equipment and inventory: Evaluate the current value and condition of the equipment
• Vendor contracts
• Loan agreements
• Client contracts for ongoing work

Other documents

You’ll want to ask the seller for any other documents about the business that you want to review, such as employee contracts or insurance policies. Reviewing these documents ensures that you have a well-rounded view of the business.

Calculate a price for the business

Every prospective business owner wants to make sure they’re getting a fair deal when buying an existing business. You’ll want the help of an accountant that specializes in business valuations here. The accountant may use several methods to evaluate the business and arrive at fair pricing, including:

• Earnings approach. This valuation method uses the business’s existing revenue and projections to determine how valuable the business is. The capitalized earnings approach would then set the valuation at an amount that would allow you to receive a return on investment.
• Assets approach. This method shows the value of a business based on its assets minus its liabilities, including tangible and intangible assets.
• Market approach. The market method relies on what similar businesses have been selling for in the local area.

Get capital for the purchase

Once you’ve found your ideal business and settled on the right price, you’ll need to get the capital to fund the purchase. Many business owners will use a business loan to cover the cost, but there are some alternative forms of financing.

• Business term loan. This loan offers a lump sum up front that you’ll repay over a set term, such as five years, with interest. The interest rate on this loan can be fixed or variable. You can lower the interest you’ll pay by securing the loan with business assets.
• Commercial real estate loan. A CRE loan offers long repayment terms as long as 25 years and with low interest rates, securing the loan with the real estate you’re purchasing.
• SBA loan. The SBA offers startup loans to businesses that can’t qualify for conventional financing. It grants low interest rates and long terms, but you will have to fill out a long list of paperwork. You’ll also have to wait 30 to 90 days for approval, unless you opt for an SBA Express loan.
• Seller financing. In some cases, the seller may be willing to draw up an agreement for you to pay for the business over time, somewhat like a loan. You can pay the seller as your business brings in revenue, while giving the seller an agreed-on amount, a win-win situation.
• Grants. Depending on your business model or industry, you may be able to secure a business grant. Grants are essentially free money that you don’t have to repay, and you can find grants from the government or through private entities. But grants are competitive, and you’re not guaranteed to win a grant if you apply.
• Crowdfunding. You could also choose to crowdfund the funds to buy the business, which raises money through personal contacts or investors. Some crowdfunding platforms like Kiva work like a loan, allowing you to pay back the amount over a period of time.
• Bootstrapping. According to the 2023 Small Business Credit Survey, about a third of businesses fund themselves without applying for credit. And 23 percent of those used personal funds to fund their businesses. This form of financing is called bootstrapping and involves using funds from the owner’s personal savings.

Close the deal

To finalize buying the business, you’ll need to hire a lawyer to help you draw up a satisfactory sales or purchase agreement. This agreement will outline the closing date of the sale, what is expected from each party, the property that is being transferred, the purchase price and any other conditions for the sale.

In addition to the sales agreement, you’ll also need:

• Transfer of leases or contracts: Any leases or contracts the business is currently under will need to get transferred under your name. These contracts include vehicle or equipment leases, commercial property leases or mortgages, utilities and patents or trademarks.
• Purchase price adjustment: This adjustment considers the value of the company from the date of its last valuation along with any potential decreases in its value, such as decreases in working capital.
• Asset acquisition statement: This statement identifies the assets you’ve gained from the sale and how much each one is worth. You’ll need to file this Form 8594 with your tax return.
• Non-compete agreement: This agreement prevents the former owner from opening a new business competitive with yours in your current industry and market.

Pros and cons of buying a business

Buying a business comes with advantages because you don’t have to build the business from the ground up. But you’ll have to quickly learn the challenges that business faces to determine if it’s a good investment.

Pros of buying a business

• Business is already performing and making sales. You won’t need to wait to make revenue from the business. You also get access to the business’s current customers, particularly useful with recurring customers.
• Eliminates time involved with starting a new business. Startup businesses take time to gather capital, inventory and infrastructure to run the business. With an existing business, the business is already set up and running.
• Access to financing that startups typically don’t qualify for. Most business lenders want to see anywhere from six months to two years in business before they will lend to you. You’ll have access to lenders if you buy a business that meets these requirements.
• Established businesses have a lower chance of failure. Many businesses fail within five years of opening, so businesses established beyond that time have a lower chance that they will have to close in the near future.

Cons of buying a business

• You inherit debt and other challenges from the existing business. The existing business owner may have made choices about financing and management that you wouldn’t have made. You’ll have to effectively manage any challenges that come from those choices.
• Some problems may be hidden. Sellers may not tell you every challenge about the business, leaving you to discover the problems – either before or after you purchase.
• Buying a business comes with a large, upfront cost. You will likely need tens or hundreds of thousands of dollars to acquire the business. However, you can get some of this funding from lenders.
• May need to update technology or equipment. The business may have equipment or technology that you will need to upgrade as soon as you buy the business. Upgrading may add to the total cost of purchase.

Bottom line

While buying a business can help you shave years off the runway to success as a business owner, every business comes with its fair share of challenges. When buying a business, you’ll need to do your due diligence to get an accurate picture of the market and business finances. You’ll also want to dig deep to find the problems within the business.

That way you know the exact steps you’ll need to take to help the business grow and ultimately determine if that business is a good investment. Ideally, you’ll find a business to buy that is thriving and provides high quality and value to its customers.