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How to Buy a Small Business: An Aspiring New Owner’s Guide

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How to Buy a Small Business: An Aspiring New Owner’s Guide

Updated: November 20th, 2023

Shelves filled with candy -How to Buy a Small Business

While big corporations may have the lion’s share of the headlines, small businesses are the true engine of the American economy. And there is nothing little about the level of competition among small businesses! Forbes magazine has estimated that the total number of U.S. small businesses is around 27 million, and the Small Business Administration has put that number even higher at over 28 million.

If you’re looking at these numbers, and you’re considering buying a small business instead of starting your own, it’s an exciting venture that can also be overwhelming if you’re unsure of where to start. Before you dive into this new chapter of your life, it’s important to have a solid understanding of the process and avoid common pitfalls that can lead to regrets. 

From conducting due diligence to understanding the financial aspects, our guide will provide you with the essential information you need to make a well-informed decision and set yourself up for success as a small business owner.

Why consider an existing business acquisition?

Starting a business from scratch can be tough because of existing competitors and new ones arriving every quarter. 

Instead of starting from scratch, acquiring an existing business allows you to immediately gain access to an existing customer base, distribution channels, and brand reputation. If you’re looking to acquire a business that complements your own, you can leverage synergies and cross-selling opportunities to drive growth. 

Plus, acquiring a small business can be a strategic move to eliminate competition and increase market share. By acquiring a competitor, you can consolidate resources and gain a larger market presence, which can lead to increased market power and profitability.

How to Complete a Successful Small Business Acquisition

If you’re wondering how to buy a small business, this guide will walk you through the important tasks to consider when buying an existing business, as well as financing options to consider before submitting your purchase bid for a small business acquisition. 

First, Define Your Goals and Research the Market

Before diving into the process of buying an existing business, take the time to define your goals and research the market. 

Ask yourself what type of business you’re interested in, what industry you want to be a part of, and what your long-term objectives are. Conduct market research to understand the current trends, competition, and potential growth opportunities in your chosen industry, and measure what you learn against the business’s established brand. 

Go beyond the quantitative data and check the pulse of the situation of the existing business within its community. Here are some places to check the reputation of a small business and its owner(s):

  • Local office of the Better Business Bureau
  • Local police station
  • Local SBA office
  • Customer reviews on Yelp page(s) of the small business
  • GlassDoor page of current and past employees
  • Mentions in social media, such as Twitter and Facebook
  • Mentions in local newspapers, websites, and blogs

Supplement the sentiment of the community about the existing business with research on plans of large competitors, such as large franchises and big box stores, to move into the area. What would happen if you buy a hardware store and a Home Depot would move into the area next year? During your research, inquire directly with franchises and big box companies about their plans to move into the area.

Seek Professional Help

A small business acquisition involves complex legal, financial, and operational considerations. It’s crucial to seek professional help to guide you through the process. 

For example, seek the help of a certified accountant if you lack the accounting chops to properly interpret these documents. A reputable certified public accountant (CPA) can guide you to the rest of the necessary financial statements, such as the schedule of inventory, description of depreciation and amortization methods, and the company’s general ledger, and provide a proper interpretation of those documents. 

Using a CPA will also help you to have more accurate figures when filing your own tax return and its necessary forms, such as Form 8594, Asset Acquisition Statement Under Section 1060. Make sure that all financial statements include an audit letter from a CPA individual or firm. As nice and friendly as the owner may be, don’t just take his word for it.

In addition, no matter the size of the small business, hire the services of a qualified attorney to review the legal and organizational documents that you’re planning to acquire. 

An attorney can also help you interpret any documented issues with small business owners, such as a claim of wrongful termination by an employee, a grievance procedure to settle a dispute with a supplier, a dispute of intellectual property, or an environmental investigation. 

Plus, working together with your CPA, the attorney can provide a thorough evaluation of the overall condition of the small business, help you draft a sales agreement, and go over important steps before closing the sale.

Dig Deep into Finances

Cash is king and the cash flow statement is its messenger. Any reputable business owner putting up his company for sale would offer you an insight into incoming and outgoing cash flows. 

Keep in mind that you may be required to sign a confidentiality agreement to have access to a small business’ financial statements, including its cash flow statement. 

TIP: Use our guide on how to perform a cash flow analysis the right way and determine whether or not the existing business is sustainable and the potential future earnings.

Going back three to five years, here is a sample of some key questions for financial projections:

  • How many times out of the year does the existing small business have to tap into financing to cover cash crunches? Are those gaps predictable?
  • Is there any existing cash flow from investing activities (e.g. sale of equipment that wore out or acquisitions of real estate to expand retail space)? If not, then are there any that need to take place?
  • Are there any outstanding loan balances? What is the pattern of repayment of loans based on incoming cash flows?
  • Does the current level of financing allow the business to bulk up inventory or hire extra help during periods of high customer demand?
  • What is the historical level of cash surplus throughout the last five years?
  • What is the level of accounts receivable? What percentage of those accounts are collected within 30 days? 60 days? 90 days? Are there any losses due to uncollectible accounts?

Depending on the nature of the existing business, you will have additional questions. Do your due diligence by checking the amounts from the cash flow statement against those from the balance sheet and income statement.

Examine Owner’s Discretionary Income (ODI)

Owner’s discretionary income (ODI) refers to the amount of money that an individual or business owner has available for personal use or discretionary spending after all necessary expenses and taxes have been deducted. It represents the income that can be used at the owner’s discretion for personal expenses, savings, investments, or other non-essential purposes.

In a business acquisition, ODI would be your take-home check after paying your suppliers, employees, business expenses, and taxes. A large mismatch between the ODI and your total budget for living expenses can create a real financial burden. 

Depending on your level of management experience, you may think that you have what it takes to increase that ODI to a number that you’re comfortable with. Still, keep in mind that founding a startup or managing a small business is not the same as turning around a declining small business.

Identify any patterns in the ODI and ask the current owner questions about those patterns, particularly when you see a large, one-time drop or a downhill trend. Inquire with the seller if she’s willing to put in writing to back up those numbers. That’s a good sign that you can trust those numbers.

Gather All Legal Documents

In addition to the financial statements, it’s vital to gather all applicable documents to complete a successful transfer of property from the previous owner to you. This includes physical assets (fixed assets, vehicles, and leases of equipment), real estate (including deeds, mortgages, title policies, surveys, zoning approvals, variances or use permits), and intellectual properties.

Make sure that the company is up to date in all of its necessary licenses, permits, taxes, filings with applicable regulatory agencies, and fees for those items. 

Whenever possible, ask your attorney to get certificates that you’re cleared of any responsibility for amounts that the seller owes, particularly any kind of federal and state taxes.

Here’s another tip: request your attorney to draft a covenant not to compete in which the seller agrees not to compete against the business.

Make a Budget for the Acquisition Process

When buying a business, there are often numerous costs involved such as acquisition costs, legal fees, due diligence expenses, and potential restructuring costs. By creating a budget, the acquiring company can assess the financial feasibility of the takeover and determine if it aligns with its strategic goals.

Budgeting also helps in estimating the potential return on investment and identifying any potential risks or challenges that may arise during the takeover process. Additionally, having a budget in place ensures that the acquiring company has a clear understanding of the financial commitments and obligations associated with the takeover, enabling them to make informed decisions and mitigate any potential financial risks.

Overall, budgeting for a business sale is essential for ensuring financial stability, minimizing uncertainties, and maximizing the chances of a successful transition.

TIP: Use our free budgeting template to evaluate potential changes that you would implement, such as increases in advertising to announce that the business is under new management, cuts in labor expenses as you bring in your own team, or inventory purchase savings from switching suppliers. By using numbers to calculate the effects of your decisions, you’ll have a more accurate picture of the potential range of your new business.

Financing the Purchase of a Business

When you’re seeking financing to complete a small business purchase, don’t forget to check all of your available options when it comes to a business acquisition loan. 

SBA 7(a) Loan Program

If your target small business meets the requirements of the SBA’s 7(a) loan program, you can use the proceeds from the loan for the business acquisition or expansion. Through an SBA-approved lender, you can qualify for up to $5 million in financing. The Small Business Administration sets no minimum loan amount. 

The key benefit of using a 7(a) business loan is that the SBA incentivizes the lender to approve the loan by guaranteeing 75% of the loan that the lender makes to the borrower. You must come up with the remaining 25% of the loan but that money can come from a wide variety of SBA-approved sources, including seller credit, gift from your relatives, or venture capital. (Note: SBA can guarantee as much as 85% on loans of up to $150,000 and 75% on loans of more than $150,000.)

To learn more about the 7(a) loan program, including fees, interesting rates, and terms, visit the SBA’s website

Other Online Lenders

When speed is of the essence, you could also opt for an unsecured personal loan from an online lender for your business acquisition. However, there are three disadvantages to these types of loans.

The first one is that unsecured personal loans are often capped under $50,000, which would only cover a small portion of your small business acquisition. 

The second one is that unsecured personal loans often charge much higher interest rates (as much as 80%!)  than other types of loans. 

The third one is that unsecured personal loans have several fees, such as an origination fee of up to 5%, a service charge, a late payment fee, and, sometimes even, a prepayment fee.

Additionally, some online lending sites are just aggregators of several lenders and don’t generate the loans themselves. 

So, you’ll have a hard time finding out in advance which fees will be attached to your loan or which APR rates will be offered and making a timely comparison of your financing options.

When done right, buying an existing business allows you to become your own boss faster and gives you a leg up on the competition with a proven business model. Spend some time evaluating your options and doing the necessary legwork to back up any claims. Be patient throughout the entire process and be willing to try alternatives particularly when it comes to finding financing.

Funding Circle’s Term Loans

Another option to consider is a term loan from Funding Circle with competitive interest rates. A key advantage of a Funding Circle business term loan is the speed to process your application, providing you with a decision within 48 hours, an offer within three days, and a deposit of funds in your account within one week. 

Unlike Funding Circle, getting a loan through a traditional lender may require you to wait up to 14 weeks to receive your  loan proceeds. Speed matters in the acquisition of a small business and Funding Circle’s streamlined loan decision process could give you the edge over competing bidders to close on a deal.

Count on Funding Circle

Buying an existing business can be a great way to enter the entrepreneurial world and skip some of the challenges of starting from scratch. However, it’s important to approach the process with caution and careful consideration, and it requires thorough research, evaluation, and a clear understanding of the industry and market. 

If you’re considering buying a small business, take the time to arm yourself with the right knowledge and resources so you can make a wise investment and achieve your entrepreneurial dreams!

With Funding Circle, borrow up to $500K with term lengths up to 84 months. Our simple online application takes just minutes to complete —some applicants may even get a decision as soon as 1 hour after submitting documents. 
If you’re considering buying a small business, take the time to arm yourself with the right knowledge and resources so you can make a wise investment and achieve your entrepreneurial dreams!


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