Whether it's your very first or your fifth company, if you're looking to start a new business venture, you have two options: 1) build your own from scratch or 2) buy an existing one. And while many entrepreneurs dream of building their own company from the ground up, the reality is, launching a brand-new business can be incredibly difficult.
Building a business from scratch can involve years of working long hours for little to no financial reward. In fact, whether your company is ever able to generate a profit or not, starting your own business can consume your life like few other activities. What's more, no matter how much you sacrifice, there's no guarantee the venture still won't fail miserably.
On the other hand, buying an existing business and successfully making it your own can be somewhat less stressful. After all, you're buying an operation that has already proven successful, with an existing customer base, brand recognition, and cash flow.
That said, buying an existing business isn't without its own challenges. It will also require hard work and sacrifice, and no matter how successful the company was under its former owner, there's no guarantee you will experience the same prosperity. When buying an existing business, the difference between success and failure often comes down to your first major decision: purchasing the right company.
With so much riding on your decision, here are three big mistakes to avoid when shopping for and purchasing an existing business.
Not Doing Proper Research Before Buying
When purchasing an existing business, you need to go into the process with your eyes wide open to ensure that what you're investing in is everything it's claimed to be. Just because a business appears to be successful on the surface doesn't mean there aren't fatal flaws just below the waterline.
One of the first things you need to learn is why the business is being sold in the first place. The owner may claim to be retiring to spend more time with the family, but he or she might know that a competing operation is opening a megastore just down the street in a few months. You've got to gauge not only the company's current success, but also its potential for future success and growth. To this end, you'll need to get straight answers to a few essential questions:
- What assets does the business own?
- What debts or liabilities are associated with these assets?
- Is the company involved in any ongoing or pending lawsuits?
- Are there any liens against the business?
- Are there any unpaid vendors, suppliers, and/or contractors?
- Is the company's particular industry thriving or in decline?
Such due diligence should be done well before you begin negotiations with the seller, not a few weeks before closing. The more you know about the operation, the stronger your position will be as a buyer. When it comes to investigating the company's legal framework and liabilities, a Family Business Lawyer™ can help you learn everything you need to know to have the strongest position possible.
Buying a business using the wrong entity structure
Many budding entrepreneurs get so excited to own their own company, they fail to put the proper liability protections in place. For instance, if all of the contracts you're signing when you buy the operation are in your own name as a sole proprietor, you're putting everything you own at risk.
In fact, without the proper business entity in place to shield you from personal liability, you could end up losing your home, car, and savings to the company's creditors if the venture suffers a major loss or gets hit with a lawsuit. To prevent this, you need to have the appropriate legal structure in place before buying. You also have to be mindful of providing personal guarantees.
Business entities, such as limited liability companies (LLCs) and corporations, often provide the best protection, so even if the company totally fails, its creditors will be legally unable to come after your personal assets. To figure out what's best for your situation, you should meet with an experienced lawyer like us to help you select, put in place, and maintain the proper entity structure for the specific operation you're purchasing.
Not Properly Valuing The Business
Although improperly valuing a company is technically a lack of due diligence, business valuation is such a complex and nuanced part of the purchasing process, it deserves its own category. Indeed, every single other factor about the business can be totally perfect, but if you pay the wrong price for it, you could be setting yourself up for disaster.
Besides, even if the business you buy doesn't actually fail because of improper valuation, it makes zero sense to waste tens of thousands of dollars that could be used for much more valuable purposes over a simple mistake that's fairly easy to avoid.
Many times, a seller will come up with a totally unsubstantiated sales price just to test the waters. Other sellers base the price on a hidden motive: to pay off their own debts, to pay for their kids' college education, or as part of an upcoming divorce settlement. All of these factors have no bearing on the true value of the business.
Keep in mind that the seller's initial asking price has nothing to do with a proper valuation—that's on you. We can help you figure out how the company's tax and legal liabilities fit into the value equation, and then we can refer you to valuation experts to help with the other areas.
Get Professional Support
Owning a business is a huge responsibility no matter how you look at it. And when buying an existing operation, your first—and often most critical—responsibility is to make sure the company you purchase is actually worth the money, time, and energy you'll be investing. With so much on the line, you shouldn't try to do everything on your own.
If you want to do things the right way, we recommend that you hire a team of experts to help with the purchase of the business. As your Family Business Lawyer, we can assist you with all of the legal issues related to purchasing the business, and we can put you in touch with other professionals we trust to help round out the rest of your support team. Schedule an appointment with us today to get started.
This article is a service of Karl L. Chen, Family Business Lawyer™. We offer a complete spectrum of legal services for businesses and can help you make wise choices on how to deal with your business throughout life and in the event of your death. We also offer a LIFT Start-Up Session™ or a LIFT Audit for an ongoing business, which includes a review of all the legal, financial, and tax systems you need for your business. Call us today at 301-358-3981 to schedule.