The pros and cons of buying a business
Here are a few important things to consider before you buy an existing business.
By: Henry Ong | Oct 18, 2013 10:00 am
Many successful entrepreneurs are described as people who started their business from nothing and grew it to what it is now. Indeed, it takes time—normally several years as the entrepreneur struggles to survive trials—before a business can get truly established in the market. Still, this is not always the route to get into a business. There is a shorter way: buying an existing one.
One obvious advantage in buying an existing business is that someone else had already done the hard work of putting up the company for you. There is already a functioning organizational structure, and you only need to evaluate its operations and procedures carefully to make them even more efficient.
But buying a controlling interest in an existing company is not a surefire guarantee to success. There are pros and cons you need to consider before making the purchase.
To begin with, when a business you want to buy is stable and is generating good cash flow, the selling price will normally be high; you will most likely pay a premium to acquire it. In contrast, you may find a better buying opportunity in a business with market potential that is losing financially due to mismanagement. This type of business may have some intangible assets such as a promising product or a good brand, but since it has been incurring financial losses, you may be able to acquire it at a very good bargain. In this kind of transaction, however, you need to have a good strategic plan for turning the business around after acquiring it.
When you purchase a going concern, you enjoy instant market share and immediate access to an existing customer base. This is particularly strategic if you are already in a similar business; acquiring your competitor expands your market share immediately and enables you to cross-sell to a new customer list that you have not been serving previously. It could also happen that the business you acquired has a location that is strategic for your future expansion. This is particularly true if almost—if not all—of the other good locations in the area are already taken.
Then, for cost-cutting purposes, you will need to evaluate the personnel in an existing business. There will be some you will need to lay off due to redundancy or incompetence, but there will be others you will need to retain because they have the right skills and experience for the business. As the new boss of the company, of course, you will have the authority to promote or reassign the best people for particular positions.
The company you acquired is likely to already have the necessary licenses and contracts for doing the business, so you need not go through the application process all over again. The licenses can be in the form of copyrights or trademarks that you can expand or sell, and the contracts can be in the form of franchises or vendor agreements. It would be advantageous to you if the existing relationship allows you to enjoy vendor accommodation with regard to credit terms; this is especially true if the existing vendors already understand the business. However, you have to be careful with existing contracts that go with the business you have purchased. Some of them may be outright disadvantageous, so you will need to find a way to terminate them to reduce your risk.
With an existing organizational structure, you can assume that control systems are also in place for accounting, inventory, and personnel. Although you may not find those systems in a documented manual, particularly in the case of small businesses, there will usually be some internal policies that are verbally or informally agreed upon by company personnel. You may want to review these policies and improve them with the help of a financial consultant.
Now, after looking at all the positive aspects of buying an existing business, let us now explore the downside. To begin with, it is possible that the existing business has a terrible public image because of poor service or poor product quality. It is also possible that its existing contracts are so restrictive as to prevent you from closing down certain product lines or certain stores that are losing. You may also inherit the bad relationship of the previous owners with their banks, thus making it difficult for you to negotiate on friendlier terms.
Also, when buying an existing business, you face the risk of misrepresentation; indeed, you normally would not know the defects of the business until after the purchase. To minimize this risk, it is advisable to conduct due diligence on all aspects of the business before buying it. In particular, you should be on the lookout for contractual obligations that may not have been disclosed by the seller, and for undeclared external factors that may affect the business, such as the entry of new competitors, the weakening demand for the product due to the influx of cheap goods or the advent of new technology, or any new regulations enacted by the government that is unfavorable to the business. Indeed, to know whatever potential problems the business you are buying may have, you will need to familiarize yourself with the industry where it belongs.
Before even thinking of buying an existing business, of course, you will need to analyze your personal criteria, qualifications, skills, and abilities. Ask yourself the following questions: How much are you willing to pay for a business? Do you have the needed skills and experience to run it? How much risk are you willing to take? After answering all of these questions, you can start looking for a suitable business to buy. Your best sources of leads will be your banker, lawyer, and accountants. They can refer you to likely prospects, but don’t expect immediate results. It may take time before you can find the right business to buy. Be patient and wait until the time is just right.