Buying a Business: First Things First

Before you even consider buying a business you have some decisions to make and some homework to do:

1.     Should you buy an existing business or start from scratch?

2.     Do you want a franchise or an independent business?

3.     Should you lease your location or buy the real estate?

4.     How are you going to pay for the business?

5.     How much do you need (want) to make?

6.     What type of business are you interested in?

7.     Where do you want the business located?

Buy existing business or start new?

There are many reasons to buy an existing business rather than start new, and very few reasons not to.

The primary reason to buy an existing business is to acquire the location.  If you go out to find a location for your business you will soon come to the conclusion that all the good locations are gone.  Your choice is to accept a less-than-desirable location or go to a newly developing area.  Either of these choices will cost you money in lost revenue.

The next reason to buy existing is that the store is already built.  You don't need to suffer the cost of construction, the time and money to get permits from public agencies, the time and aggravation to get approval from the landlord and franchisor.  It will take a lot of time, and time is money.

The next reason to buy existing rather than start from scratch is the "going business" value.  When you start a business where it hasn't existed before you need to attract customers.  It may take quite a while to get your "customer count" up to a level which will allow the business to break even.  This means that you will lose money every day until you reach the break-even point.  To try to shorten this time, you will spend more on advertising.  Think of it as a double whammy.  You lose because you're below break-even and you spend more to try to get to break-even.

Example:

In order to make a good comparison we will look at two businesses that we will call Business "A" and Business "B." 

Business "A" is an existing retail store valued at $500,000.00 which produces $200,000.00 income (salary and profit combined) for the owner.  It has $100,000.00 in hard assets.  Because the business is existing the hard assets are valued at approximately 50% of their actual cost to purchase and install.

Note: "Store" is used to describe any retail establishment (plant, equipment, and leasehold improvements) from a corner convenience store, fast food restaurant, elegant dining restaurant, to a major retail operation such as a Home Depot or a Ford dealership.

In order for Business "A" to produce $200,000.00 income for the owner, it has to have gross sales of approximately $1,000,000.00.  In very broad strokes this is:

        $1,000,000.00         Sales

        -    500,000.00         Cost of Goods Sold (COGS)

        ____________

        $   500,000.00         Gross Profit

        -    100,000.00         Rent

        -    150,000.00         Wages

        -     12,000.00          Advertising and Marketing

        -     38,000.00          Everything Else

        ____________

        $   200,000.00         Left for Owner/Manager

Business "B" is a start-up retail store exactly like "A."  The store needs to be built and equipped, signage installed, employees hired, and a complete business system put in place.

We will assume that it will take 24 months for "B" to achieve the same monthly sales of $83.333.00 ($83,333.333 per month times 12 months equals $1,000,000.00 annual sales) as "A." In order to ramp up the sales "B" will have to spend two or three times as much on advertising and marketing as "A." For our example we will call it 2-1/2 times or $2,500.00 per month for advertising while everything else will remain the same.

Sales will probably grow at a geometric rate (a normal curve) but for ease of analysis we will assume that sales increase as a straight line from $-0- at the end of the first month to $83,333.00 at the end of the 24^th month for total sales of $1,000,000.00 for the first 2 years combined:

        $1,000,000.00         Gross sales       (2 years)

         -   500,000.00         COGS

        ____________

        $   500,000.00         Gross Profit

        -   200,000.00          Rent                   (2 years)

        -   300,000.00          Wages               (2 years)

        -    60,000.00           Advertising         (2 years)

        -    76,000.00           Everything Else (2 years)

        ___________

        ($  136,000.00)        Loss                  (2 years)

Now to recap these numbers to show your actual investment (cash flow) over the two year period:

        $  500,000.00          Purchase Price of "A"

         -  400,000.00          Profit                  (2 years)

        ___________

        $  100,000.00          Net Investment

        $  200,000.00          Cost to Build "B"

        +  136,000.00          Loss                  (2 years)

        ___________         

        $  336,000.00          Total Cost of Start-up

As you can see from these numbers, it will actually cost you an additional $236,000.00 to start the business from scratch than it would to buy the existing business.

Note:  This is only an example.  Don't use these numbers or analysis as an actual profit and loss statement or an expectation of actual results.  Every situation is unique.  Your results will vary.

Another benefit of buying an existing business is the "knowledge base."  This is everything the Seller knows about running the business including where to buy things, how to price what you sell, people to call when you need help, and how to run the business on a daily basis.  He will have all the necessary forms, contracts, invoices, receipts, and possibly a point-of-sale system.  You need all of this from Day One.

Sometimes the most valuable resource of an existing business is its relationship with a key supplier who won't do business with just anybody.  Many manufacturers sell their products through a dealer network and give those dealers exclusive geographical areas.  When you buy an existing business that has one of these dealerships you may have found the only way to get that dealership in your target area.

Another benefit of an existing business is that it has employees.  A start-up business has to hire people to do everything that is needed for all the hours that it will be open before it even opens for the first day.  It can be a real challenge.

More to come. Stay tuned.