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Buying an existing business: A smart idea for entrepreneurs?

04 April 2016 by National Bank
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Looking to start a business? Scooping up an existing one can be an attractive option that makes things a whole lot easier! Here are some tips for getting it right.

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Buying a business instead of starting from scratch is a savvy strategy according to Hugo Francoeur, director of the Propellor Team at SAJE Empowering Entrepreneurs, a consulting, coaching, and training firm. “Statistically, it’s less risky,” he notes. “Especially because you have actual historical data on which to base your financial forecasts and strategic analysis.”

A number of advantages

Buying an existing business also minimizes the learning curve. “An entrepreneur who’s starting from scratch has to build credibility with clients and suppliers. When this network has been in place for a while, the trust is there, and partners will continue to support you because they were already doing business with the company,” says Micheline Renault, CPA auditor, CA, and professor in the Accounting Department of the School of Management at Université du Québec à Montréal. This also makes the initiation period easier because the existing organization has a steady source of income—and therefore cash flow. “The entrepreneur can learn the ropes of managing the business under more favorable conditions," adds Renault.

Moreover, lenders are more comfortable with growth through acquisition. “The company’s ability to pay back a loan and its guarantees are critical. A startup business still has to prove itself, but one that has been in operation has built a foundation of credibility. It already has a business model and a network of clients, vendors, distributors, etc.,” notes Francoeur.

But buying a business isn’t always smooth sailing. Entrepreneurs may be in for a few unpleasant bumps in the road—for instance, commitments the company made before it was acquired. And if the employees were close to the previous owner, they may be somewhat resistant to the change. If the previous owner was also the founder, he or she may have a hard time handing the “baby” over to someone else. A solid agreement between the old and new owners can help smooth the way," says Hugo Francoeur.

One step at a time

A step-by-step approach is key to a successful acquisition. First and foremost, it’s a matter of choosing the right business. A good place to start is by searching directories of businesses for sale, e.g., the INDEX directory compiled by Centre de transfert d’entreprise du Québec, an organization that also offers entrepreneurs training and support through the acquisition process.

Step two: If the owner is interested in selling the business, you will need to sign a letter of intent and a confidentiality agreement to get access to the company’s books. What follows is a due diligence analysis of the company’s financial statements and tax and legal documents. This step usually requires input from an accountant, a chartered business valuator, and an attorney.

Renault notes that since the financial statements of small businesses are rarely audited, particular attention should be paid when analyzing these entities.

“You also have to make sure all of the business processes and operating methods are adequately documented. If the institutional knowledge only resides in employees' heads, and they decide to leave the organization, you’re going to have a real problem,” says Renault.

The next step is to design a recovery plan, line up financing, and get all of the documentation related to the business Only then can you carry out the transfer of ownership and management.

Pitfalls

“Numbers can be deceiving,” warns Renault. “They might look encouraging in the Excel spreadsheets, but some things may slip under the radar. For instance, has the company matured to the point that its growth potential is now limited? That can be a real challenge to the buyer, who will have to breathe new life into the business,” says Renault.

And, while it's important not to make any hasty decisions, you also can't drag your feet. “Some potential buyers let a great opportunity slip through their fingers because they take too long to get their letter of intent out. By the time they do, someone else has swooped in and bought the business," says Hugo Francoeur.

One last word of advice: You have to find a way to set yourself apart in the eyes of the seller. It’s important to establish credibility, make it clear that you’re serious, and come prepared. “The rapport between the seller and the buyer is also critical. I once saw a doctor refuse to sell his clinic to a company, opting to sell it—for less, I might add—to a young doctor instead because he reminded him of himself at that age. Money can’t buy everything,” says Francoeur.

 

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