4 Surprises When Buying a Small Business
Buyers typically encounter four surprises the first time they buy a business.
You will pay more than the purchase price - Yes, you will have to pay the purchase price at closing, but you will need more money than that to buy the business. You probably will need money to conduct inspections (e.g., environmental, building, HVAC, equipment, etc.). You will need to pay your lawyer and your accountant for their services. If you are borrowing money to finance the purchase, you will need to pay your lender for loan costs (e.g., origination fees, points, appraisal, and even the lender's attorney's fees). If the business leases space, you will need to reimburse the seller for the amount of the security deposit, and you also may need to pay the landlord a fee to transfer the lease to you. Finally, if you are setting up a new corporation or limited liability company to own the business, you will pay for that work. You might need an additional $5,000 $10,000 (or more) to buy the business. And that estimate doesn't include working capital you will need to continue operating the business during the time period after you close and before you start to bring in cash.
It will be difficult to find money for your deal - Many buyers don't have the cash to pay the purchase price and closing costs to buy a business. Of course, buyers have to put some of their own cash into the deal, but they are surprised to learn how difficult it is to find money to supplement the cash they have. You might consider a bank loan. Many lenders are reluctant to lend money to buy a business. Even if you can convince a bank to loan you the money, they probably will loan you only 80% of the purchase price. You will have to come up with the other 20%, plus the money you need to pay for lender's costs, closing costs, and initial working capital. You might consider trying to raise money from investors. For example, you might sell a partial ownership interest in the business to raise money. First, you have to find people with money who want to invest. Then you have to do a separate deal to get that investment money. Then you will need to live with your investors - there's rarely such thing as a "silent partner." You need to be especially careful when raising money from investors because these deals are heavily regulated by the federal and state government. You need to make sure your investment deals comply with those regulations so you're not on the hook for returning investment money and paying your investor's attorney's fees if the deal goes south. Getting investment money also takes time to work through your deals with your investors. You might consider asking the seller to take a promissory note for a portion of the purchase price. This is called "seller-financing." Many sellers are not willing to do seller-financing because they want all the purchase price money at the closing. They don't want to take the risk that you won't pay the promissory note. They don't want to have to collect if you default. Even if a seller is willing to take a promissory note, the note usually will be for only a small portion of the purchase price, the interest rate likely will be higher than what you would get from a bank, and the term probably will be short. You might consider using your retirement money. Maybe you can take a loan from your IRA or 401(k)? Maybe you can cash out your retirement account? Maybe you can rollover your retirement account into a new retirement account that will own your new business? All of these sources trigger significant tax and legal risks. You should not consider using these resources without first consulting with an accountant and a lawyer who can help you understand the tax and legal consequences and how to structure the deal to soften the impact on you. There are other possibilities, too, like credit card advances and hard money lenders, but those options are super risky.
You will need a lot of legal documents - Why can't we just shake on it? Some verbal agreements are enforceable, but may be difficult to prove. If the buyer and the seller disagree, it will be one person's word against the other's. You don't want to waste your time, energy, and money fighting about the terms of your deal after you buy the business. Buying or selling the assets of a business requires a number of legal documents. The list of legal documents might include a Letter of Intent, Purchase Agreement, Bill of Sale, Vehicle or Equipment Titles, Lease Assignment, Assignment of Contracts (e.g., with key customers and vendors), an Assignment of Intellectual Property (to transfer trademarks, copyrights, domain names, etc.), Corporate or LLC Resolutions, a Promissory Note (if there is seller financing), Guaranties, and a whole packet of bank loan documents, if you are borrowing money. Each of these documents has a special purpose and protect both the buyer and the seller.
It will take longer than you think - How long does it take to do a deal from start to closing? You need to factor in time to find your target, negotiate the significant terms of the deal, draft and negotiate the purchase agreement and other legal documents, conduct your due diligence, obtain your financing, and work with landlords and other vendors or suppliers. It could take a month or a year, depending on what needs to be done and who needs to do it. Landlords, lenders, and lawyers are the wild cards that can slow down the deal. Give yourself, your lender, the lawyers, and the landlord ample time to get the deal closed properly. Be realistic about how much time each needs to do the job well. Giving each enough time to work will benefit you in the end.