Finances and Taxes

How to Buy a Business: Your Comprehensive Guide

Jenna Lee Business finance writer 

Not everyone wants to start a business from scratch. Sure, doing so gives you full control, but there’s no sugarcoating that it’s a long and difficult process—and there’s no guarantee all that work will be worth it in the end. In fact, the Bureau of Labor Statistics reports that 20% of small businesses in the United States fold within the first year.

If you’ve dreamt of owning your own business, buying one could be a safer and more efficient way to get your foot in the door and hit the ground running. Instead of having to experiment with different vendors, processes, and even products until you succeed, buying a business gives you a proven concept, established brand, trained team, existing customers, and set systems—allowing you to spend your time, energy, and focus on scaling the business.

And if you already own a business, acquiring another business can help you gain market share, scale operations, and easily enter new markets.

Of course, buying a business isn’t all sunshine and rainbows. For one, while it’s convenient not having to build everything from scratch, it can be hard to change processes and people once they’re set in their ways. Plus, it can take a while to get to know the ins and outs of the company and earn the existing team’s trust and respect. Additionally, while it may save you money in the long run, it can be pretty expensive upfront since you’re typically purchasing everything—from the equipment and inventory to the intellectual property.

The biggest deterrent, though, might be the fact that buying a business can take a long time. Sure, it may be easier than starting a business, but it’s still extremely complicated and time-consuming —as two professors from the Vlerick Business School’s Center for Mergers, Acquisitions, and Buyouts told Forbes, “Finding a company for sale can take 12 to 24 months. Statistics show that before finally signing the share purchase agreement, you will have looked into over 100 teasers, done preliminary due diligence on 15 targets, and signed 2 to 4 letters of intent.”

The bottom line: if you’re serious about buying a business, start looking ASAP and brace yourself for a long journey. While it’s best to work with experts who can guide you through the process (we’ll help you build your dream team in step four), it’s also helpful to know what buying a business generally looks like so you can mentally prepare.

Keep reading to learn how it works.

Step 1: Figure out what type of business you want to purchase

There are tens of thousands of businesses for sale today, so your first step is to think about what type of business you want to purchase so you can narrow down your options.

If you can already picture your dream company, great! You can move on to step two. If not, try thinking about the following factors:

  • Type of business. What kind of business would suit your interests and experience? Are you more familiar and comfortable with a certain business model (e.g. B2B vs. B2C), industry, or company size?
  • Location. Where do you want to live? What’s the labor pool like, and what are the costs of doing business in the area? Do you even want a brick-and-mortar business, or would you prefer a fully remote company?
  • Culture fit. If you already have a team, what kind of culture would mesh well with your values and current employees? Perhaps more importantly, what kind of culture do you want to avoid?
  • Potential ROI. Which industries are growing? Which are packed with competition? Which tend to have higher margins?
  • How much work you’re willing to put in. Do you want to buy a company that’s already thriving, or do you want to fix one up and help it reach its full potential?
  • Budget. What’s the maximum amount you’re willing and able to spend? (Setting a hard budget is a great way to narrow your search.)
  • On- or off-market. Do you want to buy a business that’s for sale, or are you up for casting a wider net and trying to buy a business that’s not currently on the market? You may be able to convince the owner to sell if you offer enough cash, but it’s usually easier if the business is already for sale.

Note: For the rest of this piece, we’ll assume you want to buy an existing business, not a franchise.

With franchises, a company licenses its brand, procedures, model, and other aspects to you, and you manage the business for that location with support from the parent company in the form of built-in brand recognition, processes, marketing, and more. Buying a franchise could be a good option if you want to own a business (and the cash flow that comes with it) but don’t want to spend a lot of time running the day-to-day operations. However, because franchises are part of a larger company, you don’t get as much control as if you were to purchase a standalone, existing business.

Step 2: Find a specific business you want to purchase

Once you’ve narrowed down your options, it’s time to start looking for specific businesses. Generally, there are two ways you can go about your search (though nothing’s stopping you from trying both!):

On-market deals

On-market deals are publicly listed businesses the owner is actively looking to sell. For example, they may list their company for sale via:

  • Social media in startup or small business groups
  • Signs in their window
  • Classified ads (usually under “business opportunities” or “businesses for sale”)
  • Online marketplaces such as BizBuySell, BizQuest, and Business Broker Network. These can be especially handy, as many display high-level financials such as cash flow and revenue to help you weed out businesses you’re not interested in.
  • Business brokers, which are individuals or businesses that specialize in helping people buy and sell businesses. Brokers can help you find businesses based on your interest, screen overpriced or questionable companies, and may even be able to find you opportunities before they’re listed. However, keep in mind that they usually represent the seller and work on commission, so they may not have your best interest at heart.

Off-market deals

Off-market deals are businesses where the owner may not be actively looking to sell. As such, they can be harder to find, but there may be fewer lemons in the pool, as these owners presumably have a reason for wanting to keep the business.

You may be able to find these kinds of opportunities by reaching out to your personal network (e.g. friends, family, LinkedIn) or intentionally getting to know other business owners or local attorneys and CPAs.

Step 3: Getting to know the owner(s)

Once you identify a business you want to buy, it’s time to get to know the owner. Remember, you want something from them, so it’s important to show respect and not come in with a long list of everything you’d change. They worked hard to get the business up and running and are probably still fond of it even if they’re ready to sell.

If you can, try to figure out why they’re selling the business. For example, is the owner burnt out and ready for retirement? Have they lost interest, or are they simply ready to do something else? Or is there a more concerning reason, such as a lack of success or fundamental flaw in the business?

Of course, they could tell you anything, so don’t just take their word for it, but the closer you get to their real motivation, the more leverage you may have when it’s time to make them an offer. 

This step is also a great opportunity to glean high-level insights about the company. Get as much information as the owner is willing to share—who their audience is, how they make money, how the business has evolved over time, what the competitive landscape looks like, what challenges they’ve encountered and how they solved them, and more. Every detail can help you build a better case for either buying or passing on the company. Plus, the owner may appreciate that you want to set the business up for success.

Step 4: Get your team together

Next, it’s time to find your team. You may have the chops to run a business, but buying a business is a long, complicated process, and a good team can make things a lot easier.

At a very minimum, you’ll probably want a lawyer and accountant experienced with business purchases. This duo usually works together to evaluate and/or create key paperwork throughout the process, such as the letter of intent (LOI), confidentiality agreement, non-compete agreement, and purchase agreement.

They also bring unique skills to the table:

Lawyer

A lawyer can reduce your personal liability and help with business-related tasks such as:

  • Communicating with the seller and their team
  • Pulling and researching documentation and filings
  • Evaluating documents such as contracts and leases and looking for red flags (for example, making sure you won’t be held responsible for amounts the seller owes, such as taxes)
  • Making sure the business is zoned appropriately
  • Post-acquisition tasks, such as filling out the asset acquisition statement (IRS Form 8594), updating the business information on the appropriate secretary of state website to reflect the new ownership, getting you a new EIN, making sure any permits and licenses are updated, renewed, and transferred to you, and disclosing the transfer of ownership to the business’s creditors.

It may also make sense to designate your lawyer as the registered agent to receive documents so you can keep everything organized.

Accountant

An accountant, on the other hand, can help with the numbers side of things, such as:

  • Figuring out the full cost of purchasing and operating the business
  • Evaluating the financial statements, tax returns, and overall financial health of the business during the due diligence step
  • Estimating your potential profit
  • Bookkeeping 

Business broker

Business brokers don’t just help find businesses—they can also help with a lot of other tasks, such as:

  • Structuring the deal
  • Processing legal documents
  • Determining a fair valuation
  • Drafting the LOI
  • Lining up your escrow account
  • Negotiating

In short, a business broker can help smooth the process, cut through red tape, ensure you don’t miss anything, and ultimately save you time and money.

Insurance advisor

An insurance advisor can guide you through your business policy options, help you choose the best policy to protect your assets, and walk you through other policies you might need.

Lending partner

Unless you have enough money socked away to purchase the business in cash, you’ll likely need to explore some funding options. Your lending partner usually joins your team later in the process, though, as you generally can’t lock in financing until the lender has more information about the business, how much you want to borrow, how you plan on using the funds, and how risky it is to lend to you.

Step 5: Due diligence

Buying a business will likely be one of the most important (and expensive) purchases you’ll ever make, so it’s important to do as much research as possible beforehand. After all, there might be a reason why the seller is selling. The business may look good from the outside but could be in worse shape once you dig into the details.

While the FTC’s Business Opportunity Rule may require the seller to give you certain information, such as their basic identifying information, earnings claims, legal actions, and references, you may want to dig even deeper.

The goal of due diligence is to make sure you really understand the business, so after you sign the confidentiality agreement, ask a ton of questions, get as much information as possible, and start identifying areas for improvement. This step is crucial, as it should tell you whether the company is worth buying and, if so, how much you may want to offer.

Some of the areas you might want to dig into include:

The basics

At a very minimum, you should understand how the company makes money. What is the business’s product or service? What’s the cost of goods sold vs. how much the company charges? What does the business plan look like? Here, it can help to ask if the seller will let you observe the business for a few days so you can see how it operates.

It’s also important to get a feel for the business’s reputation, which can impact your ability to hire good workers, sell the product, score partnerships and press opportunities, and more. In addition to checking out third-party sites such as the BBB, Yelp, Glassdoor, and any mentions in the press, it can also help to interview people familiar with the business, such as current and former employees, industry experts, vendors, investors, competitors, local realtors, and the local Chamber of Commerce.

You may also want to ask for basic business documents, such as:

  • Partnership agreements
  • Leases
  • Sales contracts
  • Sales and return records
  • Employee agreements
  • Insurance documents
  • Permits and licenses
  • Organizational documents, such as articles of organization or articles of incorporation, business licenses, and the business’s certificate of good standing

If the business owns or operates in a physical building, your lawyer will also likely want to examine the local zoning requirements, environmental regulations, and latest health and building inspections to ensure everything is up to code.

Financials

The company’s financials will likely be the main reason you decide to make an offer or walk away. After all, you do want to see a return on your investment.

To evaluate how the company is doing financially, it’s important to ask for some key financial documents, including:

  • 3-5 years of financial statements 
  • Cash flow statements
  • Annual reports
  • Profit & loss statements
  • Balance sheets
  • Business tax returns
  • Income statements
  • General ledgers
  • Accounts payable and accounts receivable records
  • Revenue broken out by customer
  • Business debt records
  • Sales records
  • Debt disclosures
  • List of assets
  • List of operating expenses

As your team reviews these documents, they’ll likely be checking for fraud, improper money management, and other red flags. They can also compare these numbers to industry standards and create financial models that forecast various scenarios (for example, how long the business would survive with no new customers) so you can get a better idea of whether the business is a good purchase.

Market

This area should give you a better idea of what the business is up against and what the future might hold. For example, you might want to dig into:

  • Overall industry: where it’s going, and how the business can adapt
  • Competitive landscape: how much market share the business holds, how the business’s product or service compares to similar companies, and what sets the business apart
  • Customers: who’s buying, how much they’re willing to pay, why they’re buying (do they actually like the product, or are they friends with the owner?), when they like to shop (when is peak season?), what they buy (what are the company’s most popular items?), and when and why they churn
  • Growth opportunities: how you can increase profits, and where you can expand

Marketing

Unless the company has a solid base of customers and/or a strong word-of-mouth marketing program, it probably needs to spend money acquiring new customers. Dig a little into what marketing tactics have worked and failed in the past, the historical cost per acquisition numbers, the company’s targeting and positioning history, and more.

Owner

Here, you’re looking more for red flags than anything. If the owner has a shady reputation, it may tarnish the brand’s reputation, and if they have unpaid bills, you could be on the hook depending on the terms of the business purchase agreement. You don’t need to hire a private detective and uncover everything you can about the owner’s life, but don’t focus 100% of your attention on the business itself and forget about the individual most associated with the business.

As you can see, there’s a lot to cover during the due diligence step, which is why you need a good team. Don’t take any information or data you see at face value—your accountant and counsel should be able to help you dig into the numbers and legal documents and spot oddities and any potential issues.

Step 6: Valuation

Once you’ve done your research and determined you want to proceed, it’s time to figure out how much you think the business is worth.

While you obviously don’t want to spend more money than you have to, you also don’t want to insult the owner with your offer. To determine a fair price, it may help to research benchmarks, such as the median sale price of businesses in your industry. Deloitte and BizBuySell both release regular reports filled with insightful data, and Robert Morris & Associates and Dun & Bradstreet also offer industry ratios you can reference.

The tricky thing about this step is there isn’t one way to value a company. In fact, there are many common methods, including:

  • Multipliers approach: you multiply either the business’s monthly gross sales, monthly gross sales plus inventory, or after-tax profits by a certain amount (often industry ballparks).
  • Book value (aka assets approach): you determine the business’s net value by subtracting its liabilities (debt, taxes, liens, judgments, lawsuits, etc.) from its assets (inventory, equipment, real estate, accounts receivable, etc.).
  • Return on investment (ROI): you estimate the business’s potential to earn money on your initial investment. According to Entrepreneur, “small businesses should return anywhere between 15 and 30 percent on investment (after taxes).”
  • Capitalized earnings: you consider the risk of investing in this business compared to investing in something else, such as government bonds. With this method, the valuation price equals your projected annual future earnings divided by your capitalization rate. Generally, a good capitalization rate is between 20 and 40 percent.
  • Earnings approach: you value the company based on past, present, and future profits. Note: this method may not be the best if the business doesn’t have stable profits.
  • Market approach: you base the company’s value on comparable businesses.
  • Cash flow approach: you base the company’s value on how much of a loan the business’s cash flow can support.

Remember: financial models can be helpful, but be careful not to be over-optimistic. This is why it’s important to work with a knowledgeable accountant who can choose the most appropriate method for this particular business and help you come up with a reasonable valuation. 

Step 7: Negotiation

After you figure out how much you think the business is worth, it’s time to make an offer!

At this stage, the offer is usually unbinding, and you can expect the other side to negotiate. Don’t let them rip you off, though—you want a return on your investment, so it’s in your best interest to try to talk the price down as much as possible to minimize your risk.

During the negotiation process, it can help to:

  • Understand their thinking. If their counter seems unreasonable, try asking how they arrived at their price and make sure it’s based on real numbers, not just speculation.
  • Be prepared. You should be able to explain your offer. If you’ve studied the numbers and can back your offer with solid reasoning, you may have more leverage..
  • Know why the owner is selling. If you understand their motivation, you may be able to figure out what levers you can pull. For example, if they need money quickly for some reason, they may be willing to throw in more assets, such as equipment, company vehicles, etc. to sweeten the deal and encourage a quick sale.
  • Get creative. Don’t just negotiate on price. You can also negotiate on other details around how the detail is structured, such as how you’ll pay (sellers often ask for at least 30-50% in cash) and what kind of sale it’ll be. For example, sometimes sellers may give you a discount if you agree to a stock sale, which is where you take overall outstanding legal liabilities—versus an asset acquisition, which is where you only purchase the assets you want.

Step 8: Financing

If you need business financing, the good news is that banks and investors are usually more willing to give entrepreneurs funding to buy a business than to start a business since established businesses generally have proven track records, making them less risky.

Business financing options generally include:

  • Personal assets: This includes your net worth, personal credit, second mortgage, etc.
  • Banks or credit unions: Many offer traditional term loans, lines of credit, and other types of business financing.
  • SBA loans: These loans are partially backed by the SBA to lower risk and incentivize lenders to lend. As such, they often come with favorable terms, but the application process can take a long time and they can be hard to qualify for.
  • Online crowdfunding and peer lending (P2P) platforms: These lenders pool money from many different lenders. Options include Kickstarter, Lending Club, Funding Circle, and Kabbage.
  • Rollover for Business Startups (ROBS): This option allows you to tap into your eligible retirement funds tax-free and penalty-free and invest the money into a business.
  • Employee Stock Ownership Plan (ESOP): This option involves selling stock to employees to raise funds. Note: if you go this route, you may want to offer non-voting stock so you retain as much ownership as possible.
  • Seller financing: Here, you pay the owner for the business over time instead of all at once. Keep in mind that if the owner agrees to accept staggered payments, they may ask for more money or charge you interest. However, they may be more flexible than traditional lenders. For example, it may be worth asking if they’ll accept smaller payments the first year so you can stabilize your finances, then increase payments after that.
  • Co-op: This essentially means buying the business with someone else. If you go this route, you’ll probably want a partnership agreement with a buyout clause (if you eventually want to own the business by yourself).

As you explore your financing options, remember to shop around and ask for more than you think you need. At a very minimum, you’ll want to make sure you have enough cash to cover both the down payment and future capital expenses—such as salaries, marketing, and general working capital—until you can get your bearings.

Step 9: Letter of Intent (LOI)

Once you and the seller agree on a price point, but before officially closing, it’s time to take the relationship to the next level with a letter of intent (LOI).

During negotiations, you and the seller discuss a lot of things. The LOI is a nonbinding preliminary agreement between both parties that outlines everything you’ve discussed and says you both want to go through with the deal. It usually includes the proposed price along with general terms and conditions. Additionally, it usually gives you exclusive rights to buy the business for a certain amount of time, meaning no one else can purchase it during that time frame.

The LOI can help reduce miscommunication down the road and establish rules around things like confidentiality. It also helps focus both parties, identify neglected details, and encourage both sides to deal with each other honestly and fairly.

Note: sometimes the LOI can turn into the purchase agreement, so you may want to have your lawyer draft it and double-check to ensure you agree with its contents.

Also, keep in mind that once you sign it, you may need to submit a good faith deposit to show you’re serious. This deposit might not be refundable, so don’t sign it flippantly.

Step 10: Close

Once you agree on the details and have the funds, it’s time to make the sale official!

Typically, this step involves a few substeps, including:

  1. The lawyers pore over the business purchase agreement (also called an asset purchase agreement, or APA), which details every aspect of the transaction, including the final purchase price, payment terms, and what assets and liabilities are being transferred—both tangible (e.g. equipment, inventory, debt, etc.) and intangible (intellectual property, brand, customer loyalty, etc.). It also usually contains some protections for both you (the buyer) and the seller. For example, it may state that assets come “as is,” that the seller can’t compete with you, and that you’re not obligated to follow through with the purchase if you discover the owner lied or failed to report essential details about the business.
  2. Once the agreement is signed, the funds go into escrow.
  3. Both parties sign the closing documents, such as the bill of sale and forms transferring ownership of patents, trademarks, and copyrights.
  4. The funds are leased to the seller, and you officially own the company!

Bottom line

Buying a business can take a long time, but it’s essential to not rush the process. Ultimately, this purchase shouldn’t be a gamble; it should be something you’re excited about and confident will be a good investment. If it’s not, don’t be afraid to walk away—it’s better to have wasted time than end up with a purchase you regret. Good luck, and happy buying!

Updated: October 12, 2021

Jenna Lee
Jenna Lee Jenna Lee has been writing about finance for over six years. Her work has been featured on U.S. News and World Report, The Huffington Post, Credit Karma, and more.
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