Buying a Business Checklist

Buying a business is a huge undertaking. You’ll want to make sure the business you choose is the right fit, that it’s on an upward trajectory, and that you won’t be taking on any unnecessary risk.

Your dream of being your own boss and running the business how you want might be emotional. But buying a business must be based on cold, hard facts.

Our checklist for buying a business will walk you through the process of objectively evaluating a business, negotiating the purchase, and closing the deal.

Step 1. Assess Your Needs

The business you buy should align with your interests, expertise, and budget.

• Before you start searching for a business to buy, take stock of your skills and abilities. You wouldn’t apply for a job that requires skills outside your expertise, and buying a business is no different. The better your skills, experience, and abilities fit the business, the better your chances of success.
• Set a budget. At this stage, you’ll want a rough idea of the size of the business you want and the amount you’re willing to pay. You can look into financing options after you’ve chosen a target business.
• Research the industry. It’s important to understand the industry you’re interested in. Research the size of the players, the challenges, and the prospects for future growth to determine whether the business you want to buy will meet your financial and professional goals.

Step 2. Conduct a Search

• Consider using a buy-side business broker. A business broker can identify a larger pool of potential businesses, including those that might not be listed for sale. Buying a business that’s not actively listed for sale can help you avoid competitive bidding wars and uncover hidden opportunities.
• Conduct your own search. You can search for business opportunities on your own by

• Networking with suppliers, professional service providers, and other business owners
• Using an online business marketplace

Suppliers; professional service providers like attorneys, accountants, and insurance agents; and other business owners are likely to have inside information about business owners who might be interested in selling. They could also give you the inside scoop about the health and stability of the business.

Step 3. Conduct Due Diligence

• Prepare a letter of intent. Once you’ve identified the business you want to buy, you must submit a letter of intent (LOI) to the seller. The letter of intent outlines the scope and terms of the sale. However, most LOIs are written so that they are non-binding. They serve as a starting point for negotiating the final deal.
• Assemble a team. Conversations with the seller have been informal up to this point, but with a signed LOI in place, the sale process begins in earnest. As the buyer, you’ll want to assemble your team, including an attorney, accountant, CPAs, business broker, financial advisor, and any other professionals you need to assist in the due diligence process.
• Be thorough. Due diligence is your opportunity to examine and verify all aspects of the business operations, including:

• Company records
• Financial information
• Tax records
• Legal agreements, investigations, litigation, and liens
• Insurance policies
• Intellectual property rights
• Real estate
• Human resources
• Customer information
• Compliance programs

In addition to thoroughly examining all business operations, you’ll want to explore why the owner is selling the business. A weak rationale for the business sale can be a red flag that the business has serious underlying issues and challenges.

Review Company and Public Records

Company records include internal and external documents about the company, such as:

• Articles of incorporation or organization
• Current investors and shareholders
• Years of operation
• Organizational chart
• Certificate of good standing filed with the Secretary of State
• Lists of products and service lines
• Business locations
• Annual reports and meeting minutes when applicable.

This step allows you to examine the company’s structure and ensure it complies with government regulations. If the business is required to hold board or shareholder meetings and keep minutes, the minutes will reveal management’s thinking and approach to decision making.

Examine Financial Information

Financial information includes:

• Audited financial statements, including income statements, balance sheets, and cash flow statements for at least the prior three years
• Credit reports on the company and the business owner
• Accounts receivable and accounts payable records
• Debts and liabilities and debt schedules
• Inventory lists for tangible assets like equipment and real estate and intangible assets like trademarks and copyrights and internet domain information
• An expense analysis
• Gross profit margin analysis, including rates of return for each product
• General ledger
• Capital budget

Analyzing the business’s financial position is among the most important steps in due diligence. It will help establish a business valuation and point out potential opportunities and challenges you’ll face as the new owner.

Review Tax Returns

Make sure you review federal, state, and municipal tax returns for at least the prior three years, as well as filings for sales tax and employment taxes. Make sure tax payments are current. Compare tax filings against financial statements to verify information.

Review Legal Documents

Legal documents include:

• Material contracts such as supplier contracts, customer contracts, loans, credit agreements, equipment leases, as well as vendor and employment agreements
• Property leases
• Tax settlements and tax liens, as well as any outstanding investigations
• Pending litigation
• UCC filings that would restrict the seller’s ability to transfer the business

Check the terms and conditions of contracts and transferability rights. In addition to pending litigation, checking previous litigation might help you avoid legal issues in the future.

Review Insurance Policies

Insurance policies must be current and include all relevant coverages. Check for any past or outstanding insurance claims against the existing business that might impact you as the new business owner.

Verify Intellectual Property Rights

Intellectual property includes:

• Patents
• Trademarks
• Copyrights
• Trade secrets

Patents and trademarks must be registered and approved to be valid. In addition to reviewing the documentation for IP, look for any licensing agreements the seller may have with third parties so you understand your rights and obligations.

Examine Real Estate Leases

Review real estate leases to ensure they are transferable and understand any financial obligations you might have in a transfer. Make sure the business owner is also the rightful holder of the title to any property included in the sale.

Review Human Resources

Pay special attention to the wages or salaries paid to key employees, as well as any existing employment contracts. Your review should also include employee benefits programs and the structure and financing of retirement plans.

Review Customer Lists

Customer lists should show a diversified customer base. If the majority of sales come from just a few customers, the business will be more vulnerable to economic downturns and future revenues will be less predictable.

Review Compliance Programs

Even a small business may be subject to compliance regulations. Make sure that the business is compliant with zoning laws and has no pending complaints with agencies such as OSHA or the EEOC.

Step 4. Conduct a Business Valuation

Though technically a part of the due diligence process, the business valuation deserves special consideration because it will help determine a fair market value for the company and ensure that you’re not overpaying for the business acquisition.

Consider Hiring a Professional Business Appraiser

Verify the valuation provided by the seller. It can be worth the added expense to hire a professional business appraiser to be certain that you and the seller are on the same page. You’ll likely also need a professional business appraisal for financing if you apply for a traditional bank loan.

Choosing a Valuation Method

There’s no single correct valuation method for buying a business. The valuation method you use depends on the type of business you want to buy, the industry where it operates, and other factors.

The three methods most commonly used to value a business are:

1. Asset approach
2. Income approach
3. Market approach

An asset approach totals the value of the business’s physical assets and subtracts any liabilities. This approach works best for businesses with substantial physical assets like equipment. It doesn’t account for intangibles, such as brand recognition or customer relationships. Businesses that rely heavily on intangible assets are likely to be valued lower than their actual worth.

An income approach uses a business’s cash flow to project future earnings. Future earnings are then assigned a present-day value to create a valuation. This approach works best for businesses that generate substantial earnings. A variation on the income approach, discounted cash flow, works best for startups not currently generating significant income.

A market approach is based on the purchase prices of similar businesses that recently sold. A small business that’s privately held might find it difficult to use the market approach because sales data for comparable businesses is not generally made public.

Step 5. Secure Financing

Your financing options depend on many factors, including your credit history and business experience.

Entrepreneurs typically finance a small business acquisition using one or more of these methods:

• Loans and investments from friends and family
• Their own funds
• Seller financing
• Conventional bank loans
• SBA loans

You should have your financing ducks in a row before you begin negotiations to purchase the business. Keep in mind that you’ll also need a down payment. The larger the down payment, the easier it will be to get funding and a favorable interest rate.

Step 6. Negotiating the Sale

Any purchase price discussions that took place before due diligence are open to negotiation after you have thoroughly reviewed the business. Apply what you learned during due diligence to negotiate the price and make an offer.

Consider Hiring a Business Broker

Business brokers negotiate for a living. Regardless of your skills, having a business broker on your side during negotiations will likely help you to get the most favorable deal.

Be Prepared to Walk Away

Negotiating a business sale requires compromise. If the seller is unwilling to give up on a deal point, use it to secure something of equal or more value to you. That said, you should be willing to walk away from a deal that’s simply too rich for your blood or requires concessions you believe are too risky.

Step 7. Closing the Sale

Closing a business sale involves many documents that formalize the agreement and protect buyers and sellers.

At this point, you’ll want to have an attorney ensure that the paperwork is in order and protects you from disputes that might arise down the road.

Documents Required to Close a Sale

• Purchase agreement that outlines all the terms of the sale
• Bill of sale as evidence of the transfer of ownership
• Non-compete agreement to prevent the seller from opening a competing business for a specified period of time
• Warranties and representations to confirm the information provided by the seller
• Consultation agreement if the seller is staying on for a transitionary period
• Promissory note if the seller is financing a portion of the sale

Each sale is different, and additional documentation might be required, which is another reason it’s important to engage an attorney during this stage of the process.

Having a team of experts on your side throughout the process of buying is invaluable for ensuring a smooth and successful acquisition. Visit BizQuest’s Broker Directory to find a buy-side business broker to help navigate the nuances involved when buying a business. Find your next opportunity for entrepreneurship by searching businesses for sale on BizQuest.