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Why Buying a Business May be Better than Starting One

Buying a business is an anxious process.  You are laying out a ton of money that in the best-case scenario you won’t see back again for years, and you are handing the money to the previous owner who knows more about the business than you, but nonetheless has decided to sell it.  You should be anxious!

Furthermore, most owners of small businesses put a ridiculously high price tag on their company.  And it is only after the business remains unsold for a period of time that they get serious about considering more reasonable offers.

Budget

How much should you pay for a small business?  There is no simple answer to this question, but I at one point I stuck my neck out and wrote an article offering some very simple, fast and hard guidelines for valuing a small business.   However, at other times I have written other articles on alternative valuation methods including using book value, multiple of earnings, discounted cash flow or book value.  I have even taken a shot at how to value an unprofitable business.

Thinking beyond price, you first want to find a good business.  Then secondly you want to try to buy it at a good price.  Don’t be too concerned about the asking price.  Often businesses are sold for fraction of the asking price with markdowns of 25 and even 50% not being uncommon.

Furthermore, the seller is usually focused on the “headline” sales price.  This is because it can be a source of pride to them.  You on the other hand should be more focused on the true value of the transaction.  For example, may you agree to buy a business for $100,000 but you might only pay $50,000 in cash now and the rest at the rate of $10,000 a year for 5 years.  This transaction is worth much less than the headline price, but the seller can still tell his friends and himself that he sold the business for the full $100,000.

Maybe the seller thinks that the business is about to take off and experience great growth and hence it should deserve a higher price.  Great then maybe you pay a base price of $50,000 for the business and then a $50,000 bonus if it hits the growth projection that the seller says it should reach in two years.

Buying a business can be a great way to jumpstart the process of making money in your own business.  Furthermore, I believe that if you put the same kind of energy and mindset into buying a business that you do a start-up, you may likely do extremely well.

Start-up

What do I mean by the same energy as a start-up?  I especially mean that you think through everything from scratch.  That doesn’t mean that you don’t learn how the current owner is running the business.  On the contrary I would go crazy learning everything about how the current owner is running the business.  And I especially would learn everything that the current owner knows about his or her customers and competitors and the marketplace.

But then I would put together what I call a zero-budget business plan.  By this I mean that I am not necessarily going to do things the same way the current owner is.  Instead I will think through the market, the customers, and the benefits of the product or service to the customer.  I will search and think about customer needs that are not being met or are not being met well.  I will think about how the market could be segmented and how I can serve it better.

How well can you do if you approach an existing business with the mindset of a startup?  Let me just give you my experience.  When I was at Harvard Business School, they licensed out concessions, or small businesses, to students each year.  I licensed the publication of the school directory, essentially a phone book with extra features, which was supported by advertising.  In previous years, the students operating the school directory were enjoying net income in the range of $5,000 to $7,000, not bad for that point in time for a part-time business of several months duration.

Previous to operating the school directory I had been running startup businesses so I approached the operation of the directory like a startup business.  I made changes and did things differently.  For example, unlike the previous operators who did all the selling themselves, I also hired college students to supplement my personal sales efforts.  The results were incredible.  Revenue went up three-fold and net income surged to $30,000, a record for any student concession in the history of Harvard Business School.

When you buy a business many of the basics are in place, and you don’t have to spend time re-inventing the wheel.  With a new business, it is amazing how many little things you have to do and how they drain your energy.  But when you buy a business, most of the little set-up things are done, and instead you can put most of your energy into making changes and running the business better.

I believe a great way to accelerate the growth of a business you are buying, and at the same time to decrease the downside risk, is to get the owner of the business to stay on board for a significant transition period such as 6 months, a year or more.  Sure, they are not going to work as hard as when they owned the business.  And you may not think they have the same business acumen or drive that you do.

But you might be surprised how much knowledge they have about their business and their market.  So, by having them stick around you can speed up how quickly you become an expert in the business and in the market.  Also by having them stick around, they can help you with the day to day operations of the business, giving you more time to work on improving and growing the business.

I don’t want to sugarcoat the possible pitfalls in buying a business, and there are plenty, and I don’t have time to get into them in this article.  But if you aggressively negotiate a fair price for an existing business, if you do careful due diligence before buying it, and if you approach running it with the energy and mindset of a start-up, then you will have a great chance of being hugely successful, much more so than the previous history of the business might have indicated.