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How to buy the right business

how to buy a business

Whether you want to expand an existing business by buying a competitor, or want to run an established business rather than starting your own, buying a company can seem daunting.

Unlike buying a house or a car, there are no guidebooks with reviews or suggested prices – it’s up to you to do your research and determine a reasonable price, and ensure you know exactly what you are buying.

Here’s a step-by-step guide that should make the process as painless as possible.

Set a budget

While you won’t have precise figures, you should get a ballpark idea of what you can afford, and how you will get the money – whether that’s from savings, a bank loan, investors or family.

Shop around

You can either focus on businesses that are actively looking for a buyer, or simply approach a business you like the look of.

If taking the first route, you can search online for businesses listed for sale, or use a business broker. Remember that brokers act much like an estate agent, so while they will give you lots of useful information about the business, it’s likely to be the edited highlights.

If making a speculative approach to a business owner, you will need to ask your own questions but be discreet!

Do your homework

If you’re looking to buy a business in a sector you don’t know already, you’ll need to do thorough research into the market and the competition.

Once you’ve identified your target business, you need to look under the bonnet. You can download a company’s annual accounts for free on the Companies House website. While balance sheets won’t tell you everything, they give you an early warning of skeletons in the closet. Clearly a negative balance sheet – in which the company’s liabilities exceed its assets – is a red flag.

Work out the value

Valuing a business is not an exact science and you should get expert help. There are different ways of valuing a company, but the most common method is to use a multiple of the business’ annual earnings.

The multiple used can vary from industry to industry, and is dependent on factors specific to each business. The multiple is applied to net earnings to give a valuation of the business.

Make an offer 

The next step is to make a non-binding offer to the business owner. This will need to be drafted by a lawyer into a “heads of terms” agreement, which will include key details such as the price, any exclusivity arrangements (i.e. allowing a period for due diligence to be completed during which the owner cannot negotiate with anyone else) and a proviso that any sale is subject to the successful completion of the due diligence process.

You’ll also need to decide how you structure the deal, whether you’re buying the company’s equity or just its trade and assets. Each option has very different tax implications, so you must take advice from an accountant before choosing.

Due diligence

This final stage is a crucial safety check. It’s a thorough analysis by an accountant of the company’s financial position.

If there are hidden dangers – such as outstanding liabilities that may be understated on the company’s balance sheet or assets which are overstated (such as non-recoverable trade debtors) – the due diligence process should reveal them.

You should also hire a lawyer to undertake legal due diligence, checking, for instance, the implications of the company’s employment contracts or any long-term lease agreements it is bound by.

Retain the former owner

It is often wise to include an “earn out” clause in the deal that ties the former owner into staying on as nominal leader of the business.

The continuity should keep clients loyal, and the golden handcuffs will prevent the former owner setting up elsewhere and taking clients with him/her. You can also include profit targets as part of the earn out deal to ensure they continue to drive the business in the way that made you want to buy it in the first place!

Helen James is a corporate finance principal at the chartered accountants HW Fisher & Company