Buying a Business

Some people buy businesses through a business broker. Other common methods of acquiring a business are through newspaper ads, realtors, suggestions from your accountant or lawyer, and friends or relatives.

The first major consideration of buying a business is to verify that the business is performing as represented. I prefer to obtain three years of income tax returns. Owners are less likely to overstate taxable income than on a financial statement (although I have seen tax returns cleverly misstated). Also, the tax return is more likely to be accurate and properly put together than an in-house financial statement that the non-accountant business owner did himself or herself. I suggest looking at three years, since the most recent year may only be an aberration. Trends are difficult to fake, and show you not only the current situation, but in which direction the business is headed.

Since revenue is the biggest problem to document, you may want to total the monthly sales tax reports and compare that total to the revenue on the income tax return. Ask the seller about any discrepancies. Also inquire about major expenses, such as whether there is a lease, or if the rent is month-to-month.

Once you have reached a comfort level that the business is performing as represented, your focus should change to analyzing what cash flow you can extract to pay the acquisition loan payments and (hopefully) provide something for you to live on. Do not expect to earn enough immediately to fully fund your living expenses. Most of the profit for the first couple years will go to loan payments. It is up to you to cut wasteful expenses and aggressively promote the business to build revenues. During the first few months you should probably not make any changes until you fully understand how the business works and what the consequences of any change would be. So you should plan on having six months of living expenses set aside in either savings or borrowing power during the start-up period.

Net profit may not be what the tax return says. Remember that the seller’s goal is to cut taxes, not show a high profit. Therefore you should add back any owner salary (if a corporation), family salaries (unless they truly perform meaningful work that will need to be replaced), fringe benefits such as a car, health, life and disability insurance for the owner and family, retirement plan contributions, auto expense (reimbursements to owners), travel, entertainment and meals that are not part of a direct sales effort, and any hobbies or side activities that the seller is running through the business which have nothing to do with operating it.

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