Buying a Small Business - 3 Key Areas to Focus On During Your Search
Buying a small business is too important of a decision to be made on a whim. You may be interested in many potential businesses, but knowing how to narrow your selection to just a few viable prospects will help you be more efficient in finding a business worth buying.
Most business-for-sale listings do not reveal many details about the business. Many businesses are sold confidentially and you need to contact the broker to find out more. Once you meet, it’s important to ask the right questions and focus your attention on three key areas. This will help you quickly determine if the business will serve your needs and grow with you long term.
1. Focus on the Business Itself.
Don’t just focus on the financials of the business. If you’re not interested in the business itself, then the financials don’t matter. It’s important to take some time to consider what you’re looking for in a business, the nature of the business and the types of industries that interest you. You should assess the business and determine whether or not it’s something that suits you.
You’ll also want to find a business that you have the skills to manage and grow long term. Think about your current and future lifestyle and what kind of business will work best. If possible, ask the owner if you can observe him or her for a few days to see how the business operates. Don’t forget that any business that has been around for at least three years is probably profitable, and could be profitable for you too.
2. Focus on the Top Line of the Financials.
When it comes to buying a small business, focus on the gross sales of the financials. This will help you understand the type of profit the business is generating. Keep in mind that the financials you’re looking at have been done by an accountant whose goal is to help legally minimize taxes. If they show a loss, this does not mean the business isn’t profitable.
The general rule of thumb is that an owner could potentially earn anywhere from 10-20% of gross sales. Asking the owner how much he or she is making will help determine the business worth. If a business isn’t making any significant sales, you won’t be in business for long.
3. Focus on Your Action Plan.
While it’s important to focus on what the owner is currently doing, the majority of your decision should be based on what you can do with the business after you’ve purchased it. Focus on what the owner has done right and what improvements can be made.
Questions to consider before you purchase a business:
- What small tweaks could I make right now to improve the business?
- How scalable is this business?
- How will I plan on managing the business once I take over?
- How can I drive more sales to the business?
Weight Your Decision Making Accordingly
Remember, you’re buying future earning potential, so 70% of your focus should be on how you can improve the business and 30% of your focus should be on what the owner has already done with it. Yes, you’re purchasing a business based on its current value, but thinking about the future will help keep you in business for the long term.
Looking at all the possible businesses you could own is exciting, but you don’t want to waste your time sifting through ones that aren’t a good fit. Instead, narrow your focus on the most important aspects of a small business and then decide if it deserves further consideration. If indeed it does, your next step is to take a closer look at the business financial statements and determine its fair market value.