I have an opportunity to buy a small business. What should I look for and what things should I check on before I make my decision?
The first thing you have to be absolutely certain of is that you’re going to wake up every morning and be excited you get to go to work again. Business owners must be passionate about their line of work because they’re going to be involved in each aspect of it every single day. Your vocation needs to be a vacation. Otherwise, it becomes a constant grind, and when that happens you’re in trouble.
As far as buying a business is concerned, you’ll want to take your time and really dig into things. In many ways, a business is only worth the income it creates, and just because it has a great location doesn’t mean you’ll make money. Who cares if they have a great name in the community if the business doesn’t generate an income? The same thing goes for having a brand everyone knows. If they’re not monetizing it, who cares? It all comes down to the net profit of the business.
Sometimes people buy businesses on multiples of gross sales before expenses. You may know enough about that particular business to understand that you run it for a certain number of percentage points of the gross. In that case, you’ll know what your profit will be. But most of the time when buying a small business, especially if you’re a rookie, you need to concentrate on gross revenue, expense details and the profit generated as a result.
Once you’ve done that, you’ll want to ask what you will make on your money. If you’re going to take on the risk of a small business, you want to be able to make at least 20 percent on it. In other words, if you buy a business for $100,000, it needs to make at least $20,000 a year.
The least it’s worth is called book value. Once you own the business, if you collected all the receivables, sold off all the equipment and inventory then closed the business, what would you have in your pocket? That’s the book value. If the current owner has $40,000 in inventory, $30,000 worth of equipment and $30,000 in receivables, the book value would be $100,000 just if you close it. Those are your floor and ceiling values. Somewhere in between you’ll find a fair price.
And remember this: If someone says a business does $65,000 a year, but they only pay taxes on $40,000, that means all they made was $40,000. If they don’t report it to the government, it doesn’t count. Don’t pull that under-the-table kind of stuff. A business is worth what is reported to the government, so take a good, hard look at the tax returns.