Starting a small business is an incredibly rewarding experience for any entrepreneur. It’s an opportunity for individuals to pursue their passion and build a profitable venture from the ground up. The biggest risk is failure. For those who aren’t quite sold on the idea of investing savings, getting into debt and jumping into a new market; on the off-chance that they won’t fail – you don’t have to. Enjoy the same entrepreneurial benefits of running your own small business by purchasing an existing one.
Acquiring an established small business is one way of getting around the painful startup grind, whilst still allowing entrepreneurs to combat a million and one other small-business challenges. From entering into the market of your choice as an established brand to securing a customer base and having easier access to funding; the reasons for buying a small business come in abundance and are truly compelling.
(Number of small business transactions 2017 – 2020. Image: BizBuySell)
BizBuySell’s 3rd quarter 2020 Insight Report shows a steady upward trend in the buying and selling of small businesses since the pandemic hit. In April, transactions illustrated a 51% year over year decline. This deficit shrunk to 21% in July and sits at just 5% fewer deals in September. For many, the wake of the pandemic is suggestive of a good time to buy a small business.
Why you should consider buying a small-business
There’s no doubt that launching a startup business is rewarding as it is challenging. The conception of a business plan, manufacturing, test marketing, and expansion requires varying levels of expertise and funding at each stage. The most attractive aspect of buying an established small business is that these stages are already taken care of.
Reduced startup costs
In both monetary terms and time, buying a small business significantly slashes the resources required to get a business off the ground. Starting from scratch would require money and time to open a store, purchase inventory, hire employees, find suppliers – long before you could open your doors to customers and begin turning over cash. Rather, when buying a business, many of the following components will have been established:
- Employees onboard and trained
- Existing relationships with suppliers
- Procedures and best practices will be set
- Existing knowledge base to draw upon
Depending on the maturity of the business, much of the startup work will have been done. Of Course, there may still be work to do to bring the business inline with your own vision. This could be an upgrade of equipment, hire additional staff, or relocate. However, these additional features will be on an ‘improvement’ basis rather than an ‘establishment’ one.
The market has been tested
Buying an established business should give you an idea of how well the market has received the products or services the business offers. Unless you, as a new business owner, have plans to drastically change the business, there are few reasons to delve into extensive market testing once you’ve acquired the company. The most important thing is to conduct your research early on. Knowing how well the business sits in the current market should, indeed, inform your final decision.
Access to an established brand
Establishing, maintaining and expanding your customer base has a lot to do with having a strong brand presence. Building a brand in an oversaturated market isn’t easy. Many entrepreneurs struggle to capture the attention of their target market and grow their brands during the startup phase. Buying an established business means that you’ll inherit its brand and market share – saving time and money.
Beware that the brand you inherit can be tarnished or might not live up to the expectations you set. Be prepared to indulge in some serious PR strategies if you’re inheriting a damaged brand.
Finding startup funding can be challenging, although not impossible. There are many options for entrepreneurs to find startup funding. However, it’s made a lot easier when an established, revenue making company is able to demonstrate profits and other financial statements to determine its health. This reduces risks for lenders and increases the likelihood that they will invest at favourable rates.
(Capital funding at different levels of maturity. Image: iStartup)
Rather than entering into the market as a new and lone entrepreneur, having to depend upon bootstrapping, friends, family, crowdfunding and early-stage venture capital (VC), jump straight into further VC rounds, bank support and potential IPOs as an established business.
Deciding on the industry for you
You’ve come to the conclusion that acquiring a business is right for you. Before we look at ways to find small businesses for sale, it’s important to think about the industry you’d like to operate in. This will help you to narrow down your searches when looking for a business for sale.
Chances are, your passions, interests and experiences will guide you to your chosen industry. However, if you’re stumped on which sector to enter, don’t be discouraged. There are a few things to consider that will help you reach the right decision.
What industries have you worked in before? That’s not to say that you necessarily have to buy a small business in the same industry but it helps to explore your transferable skills. For example, if you’ve worked in cafes, bars or restaurants, your experience will seamlessly be applied to the hospitality sector. There are also a host of experiences that could be applied to any potential small business that you are buying. For example, experience in accounting and finance would set you up for success in any business sector since accounts are an unavoidable component of any business.
Use your previous experiences to help you establish a shortlist of potential sectors. This should provide you with a clear idea of the range of industries in which you may or may not excel. It’s also a good idea to eliminate any sectors of which you know you dislike. Here are a few things to consider:
- Your industry experience
- Your skills and whether they are transferable
- Which sectors have you performed particularly well in
- Money and risk
Money and risk
It’s no secret that some sectors are more lucrative than others, and equally, some are more prone to risk. Lifestyle businesses like dry cleaners are often safe bets but will generate a modest income. Buying a restaurant, on the other hand, is a riskier investment which tends to work best if you have some experience in the hospitality industry as well as being passionate about it.
(Small business’s sale versus asking price. Image: FitSmallBusiness)
How much are you willing, and more importantly, able to invest? Your budget should help to filter out sectors above your threshold. Hotels and manufacturing are typically the most expensive. Do take note of emerging commercial trends. Healthcare, tech and construction are projected to grow for years to come.
How to find small businesses for sale
For all the compelling reasons to buy a small business, finding small businesses for sale isn’t as easy as it sounds. There are, however, quite a few reliable sources which can offer different advantages to entrepreneurs.
1. Small businesses for sale websites
There are plenty of websites that list small businesses for sale. Sites like BizBuySell.com, Bizquest.com and Franchisegator.com are each good places to start your search. One of the best things about this source of potential business for sale is that you can filter your search. Some useful filters include:
- Price – enter your budget range
- Location – filter results by a preferred location
- Cash flow – filter results by key financials
- Age of listing and price reduced – indicates the business owner is struggling to find a buyer or will be willing to compromise on price
- Leasehold or freehold property – buy outright or lease
- Franchise – buy into an established brand and receive training and support
- Owner financed – the seller accepts a portion of the asking price in instalments
(Filter results. Image: BizQuest)
2. Business brokers
Brokers typically act as intermediaries between sellers and buyers of private companies as they facilitate transactions. They will estimate the value of a business, advertise it and conduct interviews with prospective buyers.
Business brokers can provide valuable insight into the process of buying a small business, through guidance, advice and other resources like lawyers and accountants needed in the transaction. Since business brokers generally have years of experience in buying and selling businesses – they can provide expert guidance that will save you time and money.
A broker can connect buyers with motivated sellers and opportunities that meet their needs, skills sets, financial objectives and passions. If you opt for a business broker, do be sure to consider the following:
- Meet with several brokers and talk with them about their experience, training and areas of expertise. Discuss and if needed, negotiate rates and terms.
- Ask for references to get a better understanding of their previous work. If they’ve worked well in the past, they should have customers who are willing to provide a testimonial of their good work.
- Review their credentials and consider how long they’ve been a business broker. A good indicator is their attainment of a CBI designation (Certified Business Intermediary) that is awarded after completion of an International Business Brokerage Association course.
3. Commercial real estate agents
It’s not always the case when buying a small business that the new owner will have physical premises to accompany it. Think SaaS companies, recruitment agencies, and legal brands. These intellectual properties will have established their place in the market but will require a physical home. That’s where a commercial real estate agent comes in to play.
A commercial real estate agent is effectively the middleman between buyers and sellers of commercial property. Remember that a commercial real estate ‘broker’ differs from a real estate ‘agent’ in that the former can work independently.
Commercial real estate agents and brokers often have extensive knowledge across different industries. Therefore, they can guide a potential buyer toward the perfect location and property. They often get first dibs on commercial real estate put up for sale, making them a great place to look for small businesses to buy.
4. Lawyers and accountants
Both lawyers and accountants are critical players in most businesses. Since they work with and for the business, they are excellent sources of leads for companies that are either on the market or contemplating a sale. Reaching out, networking and building relationships with key players in prospective industries will help you become a first-to-know member of the business community.
How to evaluate a small business to buy
You know your skills and experience, decided on an industry, done your research and have found a potential small business to acquire – or have perhaps shortlisted a few – it’s now time to evaluate each business’ prospects for success or failure under your management. You should have a clear understanding of their current operational costs, revenue and profitability and have formed a blueprint for how you will contribute to elevating its success once you’ve become the small business owner. Where to start when valuing a small business, where to go, and does the evaluation process ever stop? The short answer is no. Here are the key aspects to consider when evaluating a small business to buy.
Measuring the value of a business
Some aspects of a business are easy to measure and value since they are inherently numerical. For instance, measuring the profitability of a company shouldn’t be challenging since we can use revenue minus costs formulas. However, intangible assets can be just as valuable – or indeed hurtful to a small business. Beyond stock, fixed assets and intellectual property, you should also consider:
- The business’s reputation
- The value of the business’s customers
- The business’s trademarks
- Circumstances around the sale – is it forced or voluntary?
- The age of the business – is it a startup with room to grow, or an established brand making losses?
- The value of its employees
- The current and projected demand for the product or services
Valuing a small business for sale
There are a number of valuation methods that should be conducted to gain a well-rounded appreciation for the small business’s financial health and long term profitability. These methods should also inform any potential buyer of a small business of his or her opportunity costs.
(Business valuations based on size. Image: SeedLegals)
Price to earnings ratio (P/E)
It’s not uncommon for businesses to be valued by their price to earnings ratio – or multiples of profit. The P/E ratio is a good way to measure a small business for sale; since it depends on an established track record of profits. P/E is ultimately driven by profits. For example, if a business has a forecast of high-profit growth, it would suggest a higher P/E ratio. If the business has a record of repeat high earnings, it should, in theory, have a high P/E ratio as well.
To measure the price to earnings ratio, simply divide the value of the business by its profits after tax. For example, using a P/E ratio of four for a business that makes profits of £500,000 after-tax, means it would, in theory, be valued at £2,000,000.
Different businesses in varying sectors will arrive at different P/E ratios. Tech startups are often considered high growth companies, and will therefore have relatively high P/E ratios. Businesses that aren’t necessarily considered high growth, like an estate agency, will have lower P/E ratios.
The best thing about this valuation method is that it’s usually given to you. You can find quoted companies’ historic P/E ratios in the financial section of the papers. Whilst there are no standardised P/E ratios that are applicable to all businesses, most business advisers would suggest a valuation of 4 – 10 P/E.
This is perhaps one of the most valuation methods for those looking at small businesses for sale. The reasons are twofold, first, are entry costs low enough for you to be swamped by a number of competitors, and two, are entry costs low enough for you to consider building your own business from scratch.
Entry cost essentially measures how much it would cost to set up a similar business to the one being valued. In order to do so, you’ll need to factor in everything that went into the business from its inception to where it is today. Combine all startup costs as well as its tangible assets to determine how much it would cost to develop the products or services, build a customer base, and train staff.
Once you’ve come to a total, you’ve got an entry cost and its valuation. Use this information to determine whether you could afford to do this yourself and whether the current financial health of the business reflects these startup costs.
The industry rule of thumb
It’s often the case that buying and selling businesses can be more common in particular industries. Meaning, those industries probably have certain rules of thumb that you can use as a guide when evaluating a potential small business to buy within that industry. These rules are likely to be based on a number of things other than profit.
In the retail industry, businesses are valued on factors that determine their popularity like how many customers it has, its number of outlets and its turnover. Prospective buyers should value a business based on how they expect to manage the business according to industry standards.
A business’s assets
Stable and established small businesses with a lot of tangible assets are often happy to be valued on these assets. Think businesses in property or manufacturing. These combined figures of the value of assets, however, are only part of the story and cannot completely reflect the value of the company.
With that said, they should still make an important contribution to a buyers evaluation of a small business for sale. To do an asset valuation, you will need to start by figuring out the Net Book Value (NBV). This is the combined value of assets recorded in the company’s accounts.
Once calculated, whatever the figure, a prospective buyer should take into account the economic reality surrounding the assets. Meaning, these figures should be adjusted to reflect what the assets are actually worth in the current climate. For example, old equipment depreciates in value, property constantly changes in value and stock is consistently falling in value – so refine these figures too.
Discounted cash flow
This method of valuing a business depends upon assumptions about its future. Needless to say, as a prospective future owner, it’s an important measure to conduct. It is most suitable for measuring the value of established, mature companies with stable and importantly – predictable cash flows. It’s unlikely that a relatively young startup will be able to generate a true value of its discounted cash flow.
Discounted cash flow essentially depict an estimation of what future cash flows would be worth today. Work out the discounted cash flow of a small business by adding the dividends forecast for the next 15 years or so, plus a residual value at the end of the period. Calculating today’s value of each future cash flow using a discounted rate accounts for the risk and time value of money. It’s based on the idea that £1 today is worth more than £1 tomorrow because of its earnings potential.
Typically, the discounted interest rate is anything between 15 – 25 per cent. For buyers, this measure can give a strong indication of the businesses future performance and allows them to prepare for these cash flows, should they acquire the small business today.
Evaluating what cannot be quantified
Ultimately, a small business is only worth what someone is willing to pay for it. This needn’t always reflect its tangible assets, price to earnings ratio or discounted cash flow. Intangible assets can often be difficult to quantify but could be more valuable than anything else. For many, intangible assets are the driving force behind wanting to acquire a small business.
For example, if a business has desirable relationships with customers or suppliers, it might be more valuable to a buyer. In the same vein, a company with few tangible assets, minimal members of staff and a weak forecasted cash flow might simultaneously have strong working relations with desirable connections. The brand, therefore, becomes more valuable.
On the other hand, should the buyer not have a stable team behind them to propel the business forward, a strong management team existing in the established business could indeed add value.
Each prospective buyer, in all cases, will have varying appetites for risk, but will also spot different levels of risk within prospective small businesses for sale; variably altering the value. The bottom line is that as a business owner, the goal is to pre-empt any risk and then minimise them. Striking a bargain is also on the minds of most entrepreneurs looking for a small business to acquire.