Should I Buy a Business?

Do one thing: Keep your day job as long as possible before quitting to buy or start a business, until you’re sure that the business has legs. Spanx founder Sara Blakely kept selling fax machines as she launched what became the billion-dollar women’s undergarment line from her apartment. 

Do Your Homework 

Buying a company or starting a new business from scratch can be one of the scariest – and most rewarding – things you will ever do. Unfortunately, research shows that more businesses fail than succeed in the United States. According to the U.S. Bureau of Labor Statistics, this is how the life of a  small business shakes out in America: 

• 18% of small businesses fail within their first year
• 50% fail after five years 
• 65% shutter by their tenth year in business

Those unfortunate figures are why it’s so important to do some serious research – and seek counsel from wise people who have already walked the path – before you decide to buy a company. 

Brian Canning, CFP, AIFA, founder of Brave New Wealth in California, has helped clients choose between buying and building a business from scratch. Before jumping into buying someone else’s company, he says it’s smart to look past the profit and loss reports and take these four important factors into account.

Consider the Drivers of Value

Four basic factors drive value within any business you buy:

• Human factor (people)
• Structural factors (systems)
• Customers (responsible for the quality and quantity of your revenue)
• Social factors (your reputation or brand)

“If those (drivers of value) are durable and cash flow is real, not just modeled,” Canning says, “buying (a business) can shortcut years of trial and error, especially if your strengths add post-close value.”

Intangibles to Consider

Canning stresses that it’s vital to be diligent on both the financials and these intangibles:

• Customer concentration
• Owner dependence
• Issues that won’t show up on the statements, such as reputation

In other words, if the owner is the business, he says, you’re often not buying a company but buying a job.

Financing a Business Purchase

Many business purchases, Cannings says, mix a few different pieces of financing, including:

• Cash on hand
• Loans (often from the Small Business Administration)
• Seller financing (where the seller lends you money that you repay over time)
• Line of working capital from your credit union or bank (so you aren’t starved for cash after the closing). 

Choose carefully, making sure you understand the debt you’re taking on and the terms you agree to in repayment. One thing you don’t want to do is to take on loans so lofty that it’s difficult to repay them.  For similar reasons, you should be careful taking on investors.  Only add them, says Cannings, if they bring more than money to the table.  Experience, helpful relationships, and mentorship also matter. 

Stress-Test The Numbers 

Before buying a business, Canning runs his clients through a series of specific scenarios and questions, making sure they consider future challenges that could potentially impact their decisions. While each business is different, many factors remain the same. Before you buy a business, make sure you can answer these questions:  

1. Could you make payments if revenue dips 15 to 20% or if rates rise? 
2. Can you keep at least 3-6 months of payroll in reserve?
3. Would you be happy owning the business as-is for five years on current cash flows before you ‘fix’ it?

Pro tip: In many cases, debt doesn’t kill companies, says Canning. Overly rosy assumptions do. That’s why it is vital to underwrite the downside.

Buying a Business vs Starting a New One

Certified financial planner Jovan Johnson, CPA/PFS, co-owner of Piece of Wealth Planning LLC in Atlanta, says it’s wise to review the pros and cons of buying a business or birthing a new one with clients. 

Buying a Business

• Pros. Immediate cash flow, established team, clients, and structure, plus proven processes. This is often a faster, safer path to an owner’s paycheck, Canning notes.
• Cons. Inheriting key-person dependency, customer concentration, messy books, and potential culture issues.

Starting A New Business from Scratch

• Pros. Freedom and flexibility. You have a clean slate and total control if there are no investors.
• Cons. It’s a much longer and riskier ramp to revenue because you are building people, systems, brand, and customers from zero, Canning says.

The Bottom Line of Buying a Business

When it comes right down to it, there’s no black or white answer for the question of ‘should you buy a business,’ Johnson says. You always need to consider your budget, timeline, and overall goals. Ultimately, he says, it comes down to the individual. That means each aspiring entrepreneur needs to consider the type of person they are and decide if they are willing to do whatever it takes to make the business succeed.

With reporting by Casandra Andrews