What to Consider When Starting or Buying a Business

Multiple question marks against a blue background. — (Image credit: Getty Images)

Our recent article Four Big Mistakes to Avoid if You’re Buying a Business was based on my interview with Josh Tolley, nationally syndicated talk show host and author of the recently published Acquisitional Wealth. Tolley’s message: Given the high risk of failure a new business faces, purchasing an established, profitable enterprise is often far better.

His advice touched a nerve. Many readers reached out to me to say something to the effect of, “The idea of buying a business never occurred to me.”

Hanford, Calif., business attorney Ron P. Jones, who has been a friend of this column for many years, sent a list of important “due diligence questions that anyone thinking of buying a business must have answered. Why not run these by Tolley?” he suggested.

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I did, and he was happy to answer Ron’s questions. He began with this cautionary note: Be curious, but don’t let the naysayers frighten you away.

“When buying an established business or going out on your own,” he said, “it is important to be curious and get answers to tough questions. However, when you repeatedly hear, ‘Yes, but what about these things? Did you think about these issues?’ do not let yourself become frozen with fear. Yes, there are many valid objections, but too much doubt — and a failure to realize that every business will encounter problems — can wreck motivation and creativity. So, use your common sense when told, ‘No! This isn’t a good idea!’ Perhaps it is a good idea, so obtain advice from several, knowledgeable sources and be alert to those who might be jealous of your efforts to grow.”

Tolley shares more insights

Here are the other questions Tolley answered:

How much knowledge and experience do I need in order to qualify for a Small Business Administration (SBA) loan to buy or start a business?

Tolley: You do not have to know everything. If you apply for an SBA loan, they want some relatable experience, but if you are buying a plumbing company, you don’t have to be a plumber. You do need some experience in management, with the trades, something relevant where the SBA will feel comfortable issuing a loan.

Also, this would be satisfied by elevating someone currently employed by that business to management so the SBA sees a person with experience in charge of the operational side of the business.

Should I be concerned about existing competition or new competitors coming into town?

Tolley: Absolutely! These questions are an important part of the vetting process where you are examining the business and its possible liabilities, including new competitors.

A public records search on the location is critical. For example, if you buy a restaurant, is your city looking into ripping up the road to lay new water and sewer pipes, which would prevent access and could destroy your business?

Is a labor union involved? Do they have any say in an acquisition? Is there a franchise agreement — that the seller hasn’t looked at for years — where a corporation requires it to be offered it to them first?

This is why business buyers and sellers never should do this on their own!

How do I find out where to order supplies, parts, inventory and like items and whether the costs vary over time or based on the time of year? Is there someone who can help ensure I’m not taken advantage of by vendors?

Tolley: If done correctly in the due diligence process, not only will you get that information from the sellers, but they should remain with the business for six to twelve months for that very purpose. When a finance company puts up the funds, typically they require sellers to stay for at least six months.

What financials should I review when buying a business? Should I see audited reports, or would the seller’s “chicken scratches” be enough?

Tolley: There are several types of financials that should be reviewed. Some are created by the business owner, also known as chicken scratches, as well as:

Professionally compiled financials
Financials adjusted from the seller’s perspective (add-backs, credits, debits) to get a more accurate picture
Analyses of price, value and worth

Too often, buyers focus on the price of an acquisition, rather than the business’ value or worth.

This is where the concept of goodwill enters into the equation, which can be manipulated to distort the selling price. Price, value and worth are so different that a business that is losing money on paper and priced at next to nothing could be worth a small fortune to the right buyer, especially when its particular inventory has great value in itself.

A business broker can help negotiate a much lower sale price if they are aware of how a buyer could use this inventory.

Tolley is deeply concerned about “insta-experts” who appear on social media and appeal to people who are desperate to get into business. Some “sell often plain worthless guides and business plans — for thousands of dollars — which lead to horrible financial carnage and families on the rocks.”

To combat this, his organization is holding eight-hour, free seminars around the country, where participants can learn how mergers and acquisitions work and what potential business buyers need to know before investing in a business. For more information, visit joshtolley.com or acquisitionalwealth.com.

If his seminars come to my town, I’ll be in the first row.

Dennis Beaver practices law in Bakersfield, Calif., and welcomes comments and questions from readers, which may be faxed to (661) 323-7993, or e-mailed to Lagombeaver1@gmail.com. And be sure to visit dennisbeaver.com.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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After attending Loyola University School of Law, H. Dennis Beaver joined California's Kern County District Attorney's Office, where he established a Consumer Fraud section. He is in the general practice of law and writes a syndicated newspaper column, You and the Law. Through his column, he offers readers in need of down-to-earth advice his help free of charge. "I know it sounds corny, but I just love to be able to use my education and experience to help, simply to help. When a reader contacts me, it is a gift."