The Risks Involved When Buying an Existing Business

By: Jim McDonald

When people imagine going into business for themselves, they often think in terms of starting a new business. The idea of starting a completely new business is exciting, and there's a fantastic feeling of accomplishment when you make something out of nothing. Unfortunately, starting a new business also involves a lot of risk. It's an accepted fact that most new businesses fail in the first few years. However, starting your own business is not the only option available. At any given time, there are many established businesses for sale. Buying an existing business may be the best way to avoid the risks of the early years and enjoy being your own boss.

There are lots of good reasons to buy an existing business. There is usually much less risk involved. By examining the financial statements of the business for sale, you know exactly what you're getting into. When starting a new business, you're usually forced to rely on projections. Existing businesses often have an ongoing positive cash flow. When you buy your own business, it comes with trained employees, trusted suppliers, established customers and maybe even referral business. However, buying an existing business is not completely risk-free. Here are a few things to watch out for.

Buying an existing business usually requires a much larger financial investment up front. There may be existing property, inventory and other real assets involved. In essence, you're also reimbursing the current business owner for future profits. So the amount of money involved in the purchase of an existing business will be much greater compared to the investment in starting a business. The good news is that the financing will probably be much easier because there's a track record for banks and investors to look at.

Not only will there be extra investment required, you'll also have to put up some extra fees as you research the business and complete the sale. Attorneys' fees, appraisal fees, accountants' fees and other costs could add up to a significant amount. But don't try to skip out on fees for these professionals. When you're buying an existing business, what you don't know could end up costing you even more.

Depending on the business and how it's been run, it may require some investment even beyond the purchase price to move it back toward profitability. Of course if the business is troubled in some way, this should be reflected in a more attractive purchase price.

Other risks involved when buying an existing business include leftover contracts or agreements that you may be required to honor after you take over. Some of these contracts might not be in the business' best interests, but remember that your integrity and reputation are on the line as well.

Speaking of reputation, what's the current reputation of the business you're intending to buy? Are they known for providing quality products at a fair price? If it's a service business, what's the quality of their service? Maybe you need to approach the business as a customer and view the transaction through a customer's eyes.

Anytime you're buying an existing business, you have to find out why the current owner is selling. Does he know something you don't? Is there some pending legislation or regulatory change that is going to make the business less viable? Or is the current owner simply ready to retire and move on to other endeavors? These are all questions that need answers before you complete the sale.

How does the current staff feel about the impending sale? What's their current morale level? It's essential that you establish good relations with the current employees as quickly as possible. Not only do they have valuable knowledge that they can pass on to you, it's also very possible that they could sabotage the business if bad feelings are involved.

Your best protection against the potential risks of buying an existing business is to never assume anything. Ask questions -- lots of questions. Spend time going through all the financial statements. You'll probably have to sign a confidentiality agreement before you look at the reports, but that's all standard and not a cause for worry. What you should be worried about is buying a business blindly.

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