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 2nd edition

The Complete
Guide to Buying
a Business

by Attorney Fred S. Steingold

 always up to date
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point out situations in which we think that’s a good idea—consult
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 2nd edition

The Complete
Guide to Buying
a Business

by Attorney Fred S. Steingold

Second Edition September 2007
Editor Ilona Bray
Cover Design susan putney
Book Design Terri Hearsh
Proofreading robert wells
Production Sarah Hinman
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Index victoria baker
Printing consolidated printers, inc.

Steingold, Fred S.
The complete guide to buying a business / by Fred S. Steingold. -- 2nd ed.
p. cm.
Includes bibliographical references and index.
ISBN-13: 978-1-4133-0707-8 (pbk. : alk. paper)
ISBN-1: 1-4133-0707-8 (pbk. : alk. paper)
1. Business enterprises--Purchasing--Law and legislation--United States--
Popular works. 2. Small business--Law and legislation--United States--Popular
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Acknowledgments
I wish to thank Emily Doskow for her superb editing on the first edition.
Thanks also to:
Marcia Stewart for building a strong foundation for this book through
her skillful editing of The Complete Guide to Selling a Business
Jake Warner for his many helpful contributions and unflagging
encouragement
Mark Hartley, CPA, for his analysis of tax issues
Glen J. Cooper for his insights regarding business brokers
Terri Hearsh for her production magic
André Zivkovich and the Applications Development Departent for
creating the CD-ROM, and
Susan Putney for designing the attractive cover.
About the Author
Attorney Fred S. Steingold is an expert on business law, advising
entrepreneurs on how to start, buy, run, and sell businesses. He is
the author of Nolo’s Complete Guide to Selling a Business, Legal Guide
for Starting and Running a Small Business, and The Employer’s Legal
Handbook. His monthly column, “The Legal Advisor,” is carried by trade
publications around the country.
Table of Contents

Introduction
Your Companion for Buying a Business......................................................1
Is This Book for You?................................................................................................................................... 2
Will You Need to Hire Lawyers, Accountants, or Other Professionals?......................... 4

Part 1
Overview of the Process

1 Thinking About Buying a Business...............................................................7

Business-Buying Worries.......................................................................................................................... 9
Which Kind of Buyer Are You?.............................................................................................................. 9
Three Ways to Become a Business Owner................................................................................... 11
The Basics of Buying a Business..........................................................................................................16
Key Steps in Buying a Business............................................................................................................18

2 The Key Legal Issues in Buying a Business............................................... 25

Understand the Differences Between Buying a Business Entity
and Buying Just Its Assets..................................................................................................................26
Consider Forming a Corporation or LLC to Buy the Business...........................................29
Be Clear on What You’ll Buy and What the Seller Will Keep.............................................30
Pay Special Attention to the Transfer of Intellectual Property.........................................31
Know the Legal Consequences of Not Making Installment
Payments on Time.................................................................................................................................32
Assure That There Are No Liens on Business Assets..............................................................34
Protect Yourself From Competition by the Seller....................................................................34
Limit Your Legal Liability for Past Obligations of the Business.........................................35
Comply With State and Local Laws That May Affect Your Purchase............................38
3 Tax-Saving Strategies.....................................................................................41
Understanding Business Write-Offs................................................................................................42
Buying Assets vs. Buying the Entity..................................................................................................46
Allocating the Purchase Price in an Asset Sale..........................................................................48
Writing Off Purchase-Related Expenses........................................................................................53

4 Finding the Right Business for You........................................................... 57

Before You Begin........................................................................................................................................58
Attractive Businesses May Be Nearer Than You Think..........................................................59
You May Be a Strategic Buyer..............................................................................................................62
Finding a Business by Word of Mouth............................................................................................67
Finding a Business Through Advertising—Yours and Theirs..............................................67
Business Brokers Can Help Find Sellers..........................................................................................71
What Sellers Want to Know About You........................................................................................71

5 What’s the Business Worth?....................................................................... 75

There’s No Universal Pricing Formula: Many Factors Affect Price..................................76
Sales of Comparable Businesses.........................................................................................................78
The Asset-Based Approach...................................................................................................................79
The Income Valuation Approach......................................................................................................80
Industry Formulas and Rules of Thumb........................................................................................82
How Appraisers and Other Experts Can Help You Decide on a Fair Price.................83
Putting Together All the Information.............................................................................................85

6 Working With Lawyers, Accountants, and Brokers............................. 87

Lawyers............................................................................................................................................................89
Accountants..................................................................................................................................................93
Business Brokers..........................................................................................................................................95
Part 2
Getting Ready to Buy

7 Financing Your Purchase............................................................................. 99

Lump Sum Purchase..............................................................................................................................100
Installment Purchase.............................................................................................................................100
How Sellers Try to Protect Themselves in an Installment Sale....................................... 103
Show Me the Money: Where You Can Get Funds for a Lump Sum Purchase
or Hefty Down Payment.................................................................................................................106
The Difference Between Loans and Equity Investments....................................................110

8 Structuring Your Purchase........................................................................ 113

Asset Sale vs. Entity Sale.......................................................................................................................115
The Seller’s Future Role.........................................................................................................................121
Restrictions on the Seller: Noncompete Agreements........................................................ 125
The Future of Key Employees........................................................................................................... 126

9 The Investigation Stage: How Buyers and Sellers

Check Each Other Out............................................................................... 129
Your Investigation of the Seller’s Business..................................................................................131
Paperwork the Seller Should Provide........................................................................................... 133
The Role of Confidentiality Agreements.................................................................................... 147
Information to Garner From Other Sources............................................................................ 150
Why and How the Seller May Check You Out........................................................................ 152

10 Drafting a Letter of Intent......................................................................... 159

Why Use a Letter of Intent................................................................................................................. 160
What to Put in Your Letter of Intent.............................................................................................161
Why You Should Only Sign a Nonbinding Letter of Intent.............................................. 163
Format for a Letter of Intent............................................................................................................. 164
Part 3
Preparing the Sales Agreement

11 Preparing the Sales Agreement and Other Legal Documents........ 173

Overview of Your Sales Agreement...............................................................................................174
Related Legal Documents................................................................................................................... 179
Well-Drafted Documents Are Crucial......................................................................................... 180
Preparing Your Sales Agreement and Related Legal Documents................................. 181
How to Prepare Attachments to Your Sale Agreement....................................................... 183
Steps in Finalizing Your Sales Agreement and Other Documents............................... 184
Amending Your Sales Agreement.................................................................................................. 185

12 Who’s Selling, Who’s Buying—And What Is Being Purchased........ 189

Naming the Parties................................................................................................................................. 190
Identifying the Business and What You’re Buying in an Asset Sale............................. 194
Identifying the Business and What You’re Buying in an Entity Sale............................ 199

13 The Sales Price and Terms of Payment...................................................201

Sale Price: Asset Sale.............................................................................................................................. 202
Inventory: Asset Sale............................................................................................................................. 207
Dealing With the Purchase of Accounts Receivable: Asset Sale....................................209
Sale Price: Entity Sale..............................................................................................................................211
Deposit...........................................................................................................................................................212
Payment at Closing.................................................................................................................................213
Promissory Note.......................................................................................................................................215
Security for Future Payment: Asset Sale..................................................................................... 216
Security for Future Payment: Entity Sale.................................................................................... 218

14 Dealing With Liabilities and Representations..................................... 219

Liabilities in an Asset Sale................................................................................................................... 221
Liabilities in an Entity Sale.................................................................................................................. 225
Representations: What They Are and Why They Matter.................................................. 226
Seller’s Representations....................................................................................................................... 227
Buyer’s Representations....................................................................................................................... 232
15 Payment for Noncompete Agreements and
Consultant Deals..........................................................................................235
Seller’s Agreement Not to Compete With the Business After the Sale....................236
Seller’s Agreement to Work for Your Business After the Sale........................................ 239
Current Employees of the Business You Are Buying............................................................ 240

16 Other Important Legal Language for the Sales Agreement............ 241

Contingency Clause............................................................................................................................... 242
Closing Arrangements.......................................................................................................................... 243
Dispute Resolution Clause................................................................................................................. 245
Technical Contract Clauses............................................................................................................... 248
Additional Optional Clauses............................................................................................................. 252

17 Signatures on a Sales Agreement............................................................253

Required Signatures for Sole Proprietors on a Sales Agreement..................................254
Required Signatures for an Entity on a Sales Agreement.................................................. 255
A Spouse’s Signature on the Sales Agreement........................................................................ 257
Signature Clause in a Sales Agreement....................................................................................... 259
Typical Formats for Signing a Sales Agreement...................................................................... 259
Accepting Personal Responsibility for Commitments in a Sales Agreement......... 263
Signing the Sales Agreement............................................................................................................ 265

Part 4
Preparing the Promissory Note and Other Sales Documents

18 Promissory Notes and Other

Installment Payment Documents...........................................................269
The Promissory Note............................................................................................................................. 270
The Security Agreement.....................................................................................................................280
The UCC Financing Statement........................................................................................................290
Escrow Agreement for Entity Sale.................................................................................................290
19 Bill of Sale, Lease Assignment, and Other Documents for
Transferring the Business..........................................................................299
Bill of Sale: Asset Sale............................................................................................................................ 301
Bulk Sales Compliance..........................................................................................................................306
Assignments in an Asset Sale........................................................................................................... 310
Transferring an Entity............................................................................................................................319
Assignments in an Entity Sale.......................................................................................................... 322
Your Entity’s Approval of a Business Purchase....................................................................... 323

20 Documents for Noncompete and Future Work Commitments..... 327

Covenant Not to Compete................................................................................................................ 328
Contract for Employment.................................................................................................................. 334
Contract for an Independent Contractor................................................................................. 337

Part 5
Closing the Deal

21 Preparing for a Smooth Closing...............................................................345

Where and When to Hold the Closing and Who Should Attend................................346
Documents for Transferring Assets..............................................................................................348
Documents for Transferring an Entity......................................................................................... 350
Handling Last-Minute Problems..................................................................................................... 350
Looking Ahead.......................................................................................................................................... 352

22 Running a Small Business: Some Legal

and Tax Basics...............................................................................................353
Entity Concerns........................................................................................................................................ 354
Safe Business Practices for Your Corporation or LLC.......................................................... 357
Tax Basics..................................................................................................................................................... 359
Insuring Your Business.......................................................................................................................... 362
Negotiating a Favorable Lease.......................................................................................................... 362
The Road to Success..............................................................................................................................367
Appendixes
A How to Use the CD-ROM...........................................................................369
Installing the Form Files Onto Your Computer...................................................................... 370
Using the Word Processing Files to Create Documents.................................................... 371
Using Government Forms.................................................................................................................. 373
List of Forms on the CD-ROM......................................................................................................... 375

B Sample Sales Agreements..........................................................................377

Sample #1:. Asset Sale of a Restaurant by One Sole Proprietor
to Another..................................................................................................................... 378
Sample #2:. Entity Sale of a Bookstore by the Two Shareholders
to an Individual...........................................................................................................386
Sample #3:. Asset Sale of a Landscaping Business by a Single-Owner
LLC to a Partnership................................................................................................. 393

C Forms. ..............................................................................................................403
IRS Form 8594, Asset Acquisition Statement and Instructions
UCC Financing Statement and Addendum
.
Index................................................................................................................415
 I
Introduction

Your Companion for

Buying a Business
Is This Book for You?................................................................................................................................................... 2
Will You Need to Hire Lawyers, Accountants, or Other Professionals?.......................................... 4
2  |  The Complete Guide to Buying a Business

Y
ou may be thinking about leaving guidance, checklists, and all the forms you
a salaried job and becoming your need, from the moment you start to ­consider
own boss. Or maybe you already buying a business to the day of the closing—
own a small business and would like to and beyond.
expand by buying a similar operation or a
complementary business. Welcome to the
world of entrepreneurs. Is This Book for You?
Don’t be surprised if the process of buy-
This book focuses on the purchase of small
ing a business seems intimidating at first.
to midsized businesses. Though much of
In fact, you probably have lots of legal and
what you learn here will also be applicable
financial questions. Fortunately, whether
to buying larger enterprises, this book
you choose to handle the purchase wholly
definitely is not concerned with the sorts
by yourself or you plan to work with law-
of mergers and acquisitions that you read
yers, accountants, and other professionals,
about in The Wall Street Journal. It can help
this book can help. It provides step-by-step
you if you fit this profile:
guidance for doing it right—from evaluating
• You’re looking to buy a business
available businesses to negotiating favorable
that costs tens or even hundreds of
purchase terms.
thousands of dollars or even several
Each year, some 750,000 American
hundred thousand dollars, but
businesses change ownership. Most of
probably not more than $2 million.
these are small and midsized businesses:
• You anticipate owning the business
retail stores, beauty salons, quick-print
yourself or with one, two, or a handful
shops, restaurants, tax preparation services,
of others.
landscapers, electrical contracting firms,
• You’ll consider an attractive business
and modest manufacturing operations, to
regardless of whether it’s currently
mention just a few. But no matter what kind
set up as a sole proprietorship,
of business you’re looking for—a professional
partnership, corporation, or limited
services company, a neighborhood bagel
liability company (LLC).
shop, or a home-based website that sells
• You plan to play an active role in
imported garden tools—there’s likely to
running the business and perhaps to
be someone out there who’d like to sell
make it your main source of income.
such a business. The key is to find the
Does this sound like you? If it does, then
right business and buy it at a reasonable,
this book has exactly the information you
affordable price. This book will help you
need to move forward with a smooth and
get the job done with a minimum of hassle,
financially sound purchase.
worry, and ­expense. It provides step-by-step
 introduction  |  Your Companion FOR Buying A Business  |  3

Chapter Number What You’ll Learn

Part 1 (Chapters 1-6) How to:
• decide whether buying a business is right for you
• avoid acting on incomplete or inaccurate information
• take the practical and legal steps involved in buying
• find an available business that fits your needs
• figure out how big a business you can afford
• analyze the tax consequences
• set a realistic price range for a particular business, and
• choose and work with lawyers, accountants, and other professionals.
Part 2 (Chapters 7-10) How to:
• understand the alternatives for financing your purchase
• negotiate for the best possible price and terms
• structure your purchase
• put legal protections in place to help assure you get everything
you’ve bargained for
• investigate the business, and
• draft a letter of intent.
Part 3 (Chapters 11-17) How to put together a sales agreement, including:
• how you’ll pay (lump sum versus installment payments)
• which business liabilities the seller will remain responsible for
• the seller’s promise (if any) not to compete after the sale, and
• arrangements (if any) to hire the seller for limited-term employment
or consulting.
Part 4 (Chapters 18-20) How to create other needed sale documents, such as a:
• bill of sale
• promissory note
• security agreement, and
• covenant not to compete.
Part 5 (Chapters 21 and 22) How to conduct a smooth closing and take over the reins of your
new business.
4  |  The Complete Guide to Buying a Business

Will You Need to Hire review your sales agreement before you
sign it. Similarly, analyzing your individual
Lawyers, Accountants, or
tax exposure is a task best left to an
Other Professionals? experienced expert such as a CPA, after
Buying a business for a reasonable price you’ve reviewed the tax material in the
may not seem like a job you want to tackle book.
all on your own. But, fortunately, the By doing much of the work yourself
process can be broken down into small and understanding the issues before you
pieces, each of which you can understand hire professionals, the fees you pay for
and master. With this book, you should be professional services should be far lower
able to handle much of the work yourself. than what you’d pay if you used experts to
And if you call in a lawyer, accountant, handle the entire purchase of a business.
or appraiser as needed, you’ll be able to In fact, you stand to save thousands of
explain just what you need and why. dollars. Once you firmly grasp every step
This book will alert you to specific of the purchase process, you can act as a
situations in which you’re likely to benefit knowledgeable general contractor, with your
from professional help. For example, professional advisers serving as your cost-
because the business you’re buying and efficient subcontractors. This book will help
the deal you strike with the seller are you along that path. ●
unique, it’s a good idea to have a lawyer
 1
p a r t

Overview of the Process

 1
C H A P T E R

Thinking About Buying

a Business
Business-Buying Worries........................................................................................................................................... 9
Which Kind of Buyer Are You?.............................................................................................................................. 9
Buying a Business as a Livelihood.............................................................................................................. 9
Buying a Business as a Strategic Move..................................................................................................10
Buying a Business as an Investment.......................................................................................................11
Three Ways to Become a Business Owner....................................................................................................11
Starting a Business From Scratch.............................................................................................................12
Buying a Franchise...........................................................................................................................................13
Buying an Existing Business.........................................................................................................................15
The Basics of Buying a Business..........................................................................................................................16
Key Steps in Buying a Business............................................................................................................................18
Coming Up With a Budget..........................................................................................................................18
Deciding on a Business and Finding It..................................................................................................19
Analyzing the Seller’s Data..........................................................................................................................21
Figuring Out What a Business Is Worth...............................................................................................21
Negotiating the Deal......................................................................................................................................22
Signing a Sales Agreement .........................................................................................................................23
Closing Your Purchase...................................................................................................................................24
8  |  The Complete Guide to Buying a Business

A
lot of people talk about buying a
Be Cautious and Be Prepared
business, but relatively few ­actually
take the steps necessary to make Not everyone who wants to buy a business
it happen. By consulting this book, you’ve should. You need to consider carefully whether
taken the first step: learning about how the it will actually work for you. Many businesses
process works. This could be the beginning fail or run marginal operations. How do you
of an exciting and profitable adventure. avoid that and become one of the winners
instead? One way to be sure that you want
to go ahead, and increase your chances of
skip ahead
success, is to spend some time working in the
If you’ve already decided to buy a industry you might enter. So, for example,
business, you’re probably anxious to get on with if you think you want to open a restaurant,
it. That’s fine. Skim or skip this chapter and move get a job working in one and learn the ropes.
on to Chapter 2. You’ll see just how difficult it is—and, possibly,
realize that it is exactly where you want to
If, like many readers, your goal in buy- be—without taking on the risks right away.
ing a business is to earn a living working And it may be that you’ll decide that it’s not
for yourself, you may be motivated by the for you, and that it’s better to save your nest
opportunity to turn your back on being an egg and get a part-time job that will bring you
employee and answering to a boss. But be less stress, less risk, and less heartbreak if you
forewarned: Independence does come at don’t succeed.
a price. By buying a business, you may be
signing on for longer hours and more wor-
ries than you’ve ever ­experienced as a hired In this chapter, you’ll learn that not
hand. all buyers are cut from the same cloth;
Then again, if the business succeeds, the a number of different motivations and
financial and personal rewards are yours personality traits can lead someone to
to savor. And of course, when you own consider entrepreneurship. You’ll see where
your own business, no one can fire you. you fall in the range of people who consider
For many entrepreneurs, money may be a buying a business—and people who
significant motivator, but it’s not necessarily actually do become business owners. And
the most important. The simple joy of you’ll discover that if you decide owning a
shaping an enterprise—almost always a business is for you, buying an existing one
creative endeavor—may stimulate your is a great way to do it. You also have the
efforts far beyond the promise of financial options of starting a business from scratch or
independence. buying a franchise, and we’ll discuss those
options in this chapter. Each of these paths
 Chapter 1  |  Thinking About Buying a Business  |  9

to business ownership has good and not- Which Kind of Buyer Are You?
so-good features—but for many would-be
entrepreneurs, buying a business is clearly People who think about buying a business
the best choice. tend to fall into the three basic ­categories
described in this section. But while d ­ ifferent
buyers’ needs and goals aren’t the same, the
Business-Buying Worries process of buying a business—especially
the legal procedures—is surprisingly con-
Buying a business can be a heady experi- stant. So whichever category you fit into,
ence, but, in addition to the adrenaline rush, you can use this book as a roadmap to
you may also experience anxiety. You may guide you through the entire transaction.
have to get past a number of worries and Let’s look at the three types of buyers.
concerns, including these things you might
say to yourself:
• I can’t afford a promising business. Buying a Business as a Livelihood
• I may pay too much.
Many people buy a business where they in-
• The business may fail and I’ll lose all
tend to work each day, with the expectation
that I have.
that the business will pro­vide a steady source
• The seller may conceal crucial
of income. In a typical scenario, the buyer
information.
makes a down payment of between 10%
• Business trends will change and hurt
and 25% of the sale price. Then, as the new
the business I’m interested in.
owner, the buyer pays the seller the balance
• I’ll have to work too hard—or I’ll get
of the sale price in monthly ­installments
bored—and then I’ll have trouble
spread over a number of years. The buyer,
selling the business.
of course, will have other bills to pay each
• The sales agreement will contain
month—including rent, employee paychecks,
tricky clauses that will lead to my
utilities, insurance, and business taxes. What-
financial ruin.
ever is left over is income to the owner—
• The sales agreement will omit clauses
though many business owners wisely keep
that could protect me.
some money in reserve to help them ride out
• Professional fees will add greatly to
slow periods.
my costs.
• I’ll wind up paying more income tax
Example: Tired of working for someone
than I anticipated.
else, Andy looks for and finds an
These are all important issues to consider,
attractive antique furniture store to
but you needn’t lose sleep over them. This
buy. He’s especially pleased that the
book will provide realistic information to
business has built a loyal following in
help you deal with all these worries.
10  |  The Complete Guide to Buying a Business

the community over a 15-year period. Buying a Business as a Strategic Move

Andy plans to quit his job and run
the business, which he believes will Some people who buy a business are
generate enough ­income to support already in business and want to expand
him and his wife, Judy. He agrees to their current enterprise—both to increase
buy the business for $150,000. The their business and possibly to dominate a
seller is willing to ­accept a $30,000 local market. Such people are often called
down payment. Andy agrees to pay the strategic buyers because they’re carrying out
balance—­together with interest at a 6% a larger business strategy.
annual rate—in 60 monthly payments of Some of those who are looking to
$2,320 each. Two years after buying the ­expand a business may be in the market for
business, Andy is confident he made the same kind of business they’re ­already
the right decision. He thoroughly enjoys in. There are enormous advantages to this,
talking antiques with his customers, and the biggest one being that the buyer already
he looks forward to the buying trips knows a great deal about the business and
that he and Judy take twice a year to can value it appropriately at purchase and
replenish their inventory. Each month, operate it more easily after the purchase is
after paying the seller, the landlord, complete.
and two employees, Andy is able to
pay himself $6,000—and he knows Example: Emma owns a delivery
that because of his hard work, he’ll be service that primarily serves the east
able to sell the business some day at a side of town. If she had a few more
handsome profit. trucks and drivers, she could greatly
expand her clientele and serve the
Andy, of course, could have tried to get a entire city. She approaches Phil, a
bank loan to buy an inventory of antiques competitor who is reaching retirement
and start a business from scratch. But he felt age. They agree on terms that will
it was less risky to buy the existing business let Emma expand by buying Phil’s
and get the benefit of the goodwill that business. Emma will not only buy the
the owner had built up over the years. He additional trucks and drivers but will
also liked the fact the business had an ideal also benefit from the goodwill that Phil
location under a long-term lease that he has built up over the years through
could take over. consistently providing timely pick-ups
and deliveries. She’ll also protect herself
from competitors who might have
expanded in the same way had she not
done so first. As frosting on the cake,
 Chapter 1  |  Thinking About Buying a Business  |  11

Phil agrees to stay on for 90 days as a Example: Doris is convinced of the wis-
consultant so that the transition will go dom of having diversified investments.
smoothly. She already owns stocks, bonds, money-
market funds, and real estate, including
Others looking to expand an existing two small ­apartment buildings. Some of
business may be seeking something that’s not her ­investments—like the bonds—are
a mirror image of their existing business but relatively conservative. Others—like some
would neatly dovetail with it. of her high-tech stocks—are more specu-
lative. For­­additional balance in her port-
Example: Ernie and Paulette run a folio, Doris feels she’d like to buy a small
popular guitar studio. They realize business that can be run by a full-time
there’s a cap on how much they can manager. Because she believes that small
earn by giving lessons, because there businesses are more risky than most of
are just so many hours in the day. At a her other investments, she’s hoping to
meeting of music educators, they hear find a business that’s likely to return at
a rumor that a guitar and drum store in least 15% annually on the money she
a high-traffic shopping mall may be up pays for it.
for sale. They investigate and find that
the rumor is true. Ernie and Paulette This strategy, of course, is only available
check out the facilities and discover to folks with significant assets and the abil-
to their delight that not only does the ity to bear the risk.
store deal in name-brand instruments
but there is ample space in the premises
to install four soundproof instruction Three Ways to Become
rooms. They do the math and decide a Business Owner
they’ve come upon an opportunity
to greatly expand their income while If you decide you’d like to own a business,
continuing to work in a field they love. buying an existing one isn’t the only way to
accomplish your goal. You could, instead,
start a business from scratch or buy a na-
tionally branded franchise. As you’ll see be-
Buying a Business as an Investment low, each of these options has its own pros
and cons. For many would-be entrepreneurs,
Some people buy a small business simply as
buying an existing nonfranchise business is
a way to round out their portfolios.
the most attractive alternative. But this isn’t
always true, and it’s important to consider
all of your o
­ ptions before making such an
­important investment.
12  |  The Complete Guide to Buying a Business

Starting a Business From Scratch want it to be. The business will have your
personality indelibly imprinted in it. And if
Whatever type of business you’d like to the business prospers, you’ll feel the warm
own—retail, service, manufacturing, or glow of pride.
product distributorship—you always have Control. You’ll be the only one to make
the option of starting with a clean slate decisions about how to start and run your
and creating a brand-new enterprise to business. You won’t be obligated to stick
your exact specifications. Here are some with the practices of your predecessor or
considerations to be weighed in assessing toe the line for a franchisor.
this option.
The Cons
The Pros
Greater risk. Plunging into the great
Relatively low cost. You can typically start unknown carries greater risk than buying
a business for less than it would cost to an existing business that has a good track
buy one. If the business you’re thinking record. At the beginning, you’ll be engaging
of buying is the least bit profitable, the in an experiment to determine if your
seller will want money for goodwill: the concept will work. And even if customers
intangible value that goes beyond the worth flock to your new enterprise, you’ll have to
of the basic business assets. It represents, deal with loads of issues such as pricing,
for example, the value of a loyal customer hiring employees, setting up business
base and perhaps a good reputation in systems, and so on, that would already
the marketplace. By contrast, when you have been addressed if you bought a going
start a business from scratch, not only do concern.
you avoid paying for goodwill, but you Difficulty of raising funds. You may have a
can assemble the exact assets you think hard time finding a bank or other lender to
you’ll need. Goodwill is almost always give you the funds you need for a business
overvalued, at least by the seller—for start-up. Lenders are often leery of brand-
example, if you take on a popular restaurant new enterprises.
but your food doesn’t measure up to what Guesswork in making decisions. You’ll
customers are used to, loyalty will disappear need to make important business decisions
pretty quickly. By contrast, a new restaurant without experience of your own, or the
with great food will generate buzz (and its benefit of an existing business structure and
own goodwill) pretty quickly—and you possibly even the wisdom of the ­former
won’t have paid for the existing customer owner. For example, how should you
base. price your goods or services? What type
The joy of creation. You have the of inventory should you maintain? What
satisfaction of starting from scratch and type of advertising will best support your
making the business exactly what you business? This is the flip side of the positive
 Chapter 1  |  Thinking About Buying a Business  |  13

element of having total control; being time-draining diversion from running the
responsible for all the decisions means that business.
you must figure everything out yourself. No employees in place. Unless you’re going
No existing base of loyal customers or to be a one-person show, you’ll have to find
­clients. You’ll need to find ways to let and train competent employees, which can
people know you’re around. Then you’ll be a more demanding task than you might
have to painstakingly convert them to ­loyal imagine.
customers or clients who not only return Hooking up with suppliers. With no
to you time and again for your goods or established relationships, you’ll need to seek
services, but also tell others about you—the out reliable and cost-effective suppliers.
best way build your business. Even though the list of negatives might
No immediate cash flow. Since you have seem long, through hard work and good
no ready-made base of customers or clients, fortune, you might find that starting a
it can take time for money to start coming business from scratch will come closer to
in. And because you may be inexperienced meeting your needs than the other means of
at establishing systems, collecting debts, becoming a business owner.
and managing inventory, it can take an
even longer period for the business to start
generating a profit. Buying a Franchise
Finding a suitable location. If location is Many people get started in business by
important to your brand-new business—for buying a franchise from a franchisor.
example, if you need to be in a high- Some of these people are able to make
visibility, high-traffic location—you’ll have a go of it, but others find the experience
to spend time and exert effort in finding to be frustrating, disappointing, and even
just the right place to rent. Then comes financially disastrous. In large part, this
the chore of negotiating a favorable lease, is because most franchises are overpriced
and possibly the expense of renovating the when you figure in all the ongoing fees and
premises to suit your needs. If there’s an costs. For most people who plan to own a
existing business that has made a cheap or business, the franchise route is probably
offbeat location work, you’ll probably find the most problematic. But like the other
this impossible to replicate. methods of ownership, there are positive
No systems in place. You’ll have to set and negative factors for you to weigh.
up bookkeeping and accounting systems.
How difficult this is will depend on your Pros
experience and comfort with tasks like this.
Even though excellent software is available Name recognition. A well-run franchisor—
to help you do this yourself with at most using its own money plus advertising fees
a little bit of professional help, it can be a from franchisees—can pour money into
regional and national advertising to help
14  |  The Complete Guide to Buying a Business

consumers become familiar with the brand decent profit. In addition to the basic fee
name. By becoming a franchisee, you get to buy the franchise, you may have to
the benefit of this advertising. If the name pay the franchisor for required equipment
has a good reputation, you begin to benefit and supplies and for a portion of the
it from the very first day you open your advertising pool. Also, you may have to
doors for business. send the franchisor a healthy share of your
A precise plan for doing business. Typically, gross income each month. Franchise fees
the franchisor will provide you with can often add up to more than 10% of the
training and an operations manual. The business’s gross monthly income.
franchisor will probably help you find a Very little flexibility. If you buy a fran-
suitable location and order the necessary chise, you wind up marching to someone
equipment. And if you’re working with a else’s drummer. To the franchisor, it’s the
good franchise, you can often count on the franchise way or the highway. If you don’t
franchisor to offer advice if you run into a mind taking orders about every detail of the
jam. business, being a franchisee may work out
Credit is available. Franchisors frequently fine for you. But many ­entrepreneurs are
let you pay the bulk of start-up costs over a independent types who bristle at the regi-
period of years, making it unnecessary for mentation that often goes along with being
you to turn to a bank or other lender for a franchisee.
money. Long-term contracts. Buying a franchise
Territorial protection. You may have almost always means signing a long-term
exclusive rights to a franchised business contract in which every clause is tilted
within a defined geographical area. But strongly in favor of the franchisor. Rarely are
increasingly, territorial protections are you able to negotiate more equitable terms.
nonexistent. The franchise contract generally is offered
on a take-it-or-leave-it basis.
Cons Hard to escape. If the business doesn’t live
up to your expectations, it can be difficult
Lots of franchises are junk. Tens of thousands
to simply walk away, even if you’re willing
of different franchises are currently for sale.
to give up the money invested so far. Not
Many of these have little or no name recog-
only is it likely that you’ll have continuing
nition, high fees, and poor prospects. Start-
financial obligations to the franchisor, but
ing a similar business on your own would
selling the business to someone else will
be far cheaper and offer better chances of
be easier said than done. There may be few
success.
takers. And even if you find someone who
Relatively high costs. Franchisors take
is interested, that person may not be accept-
money from you in many, many ways,
able to the franchisor—who probably has
often making it very difficult for owners
reserved the right to approve or disapprove
of even well-known franchises to turn a
any sale of a franchise and to make changes
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