Buying A Business

Buying an established business may be more costly, but it's less risky than starting a new one. There is a lot to be said for a proven idea and taking over an existing customer base and location.

Once you decide on the business or industry that you want to buy into, do your homework. Minimize your risk by looking for any possible undisclosed problems or hidden liabilities. Here are a few issues to watch out for:

  • Outstanding tax liabilities (personal property, business fixtures & equipment, inventory, etc.)
  • Tax liens
  • Potential tax audits and bills from previous years that you may acquire
  • Undisclosed debts
  • Overstated earnings
  • Poor employee relations
  • Company reputation in the area or industry and with vendors
  • Overvalued inventory that is possibly defective or dated
  • Pending lawsuits
  • Uncollectible accounts receivables
  • Land contamination
  • Competition moving into the area
  • Transfer taxes or fees (Franchises will quite often have a transfer fee)

There are also various factors to consider when determining the high - low value of a business for sale:

High Value

  • High sustainable cash flow
  • Room for growth
  • Anticipated industry growth
  • Competitive advantage (location, area, etc.)
  • Business niche
  • History and reputation of business
  • Low failure rate in industry
  • Modern, well maintained facility

Low Value

  • Concentration on a few major customers/clients
  • Reliance on owner
  • Poor financials
  • Distressed circumstances
  • Few assets
  • Product or service sensitivity
  • Poor outlook for industry: regulations, price cutting, foreign competition, discount stores, etc.

If you are purchasing a business for more than its "tangible" assets, it would be advisable to consult with a professional business appraiser that has the expertise in valuing a business in the same industry.

Writting A Business Plan

A business plan is crucial in the success of your business. It shows the strategy of communication, management, and planning you intend to implement. As the old saying goes, "if you fail to plan, you plan to fail."

A couple of questions that you need to ask yourself before you begin are:

  • Who will your customers be for your product or service?
  • How do you intend to reach them?
  • What means of financial resources do you plan to start your business with?

In writing a business plan, the body can be divided into four distinct sections:

  • Description of business
  • Marketing
  • Finances
  • Management

The most common elements every business plan should contain are in the following outline:

Cover sheet
Statement of purpose
Table of Contents
Overview of the business that includes:

  1. Business Overview
    • Marketing
    • Competition
    • Operating procedures
    • Personnel
    • Business insurance
  2. Financial Information/projections
    • Loan Applications
    • Capital equipment and supply list
    • Balance Sheet
    • Breakeven analysis
    • Three year summary of pro-forma income projections
      - 1st year by month
      - 2nd & 3rd year by quarters
    • Assumptions upon which projections were based
    • Pro-forma cash flow
  3. Supporting Documents/Management
    • Three years of principals' tax returns
    • Personal financial statements (banks have these forms)
    • Copy of franchise contracts and supporting documents (if applicable)
    • Copy of proposed lease or purchase agreement for building space
    • Copy of licenses and other legal documents
    • Copies of resumes of all principals
    • Copies of letters of intent from suppliers, etc.

Business Structure

The decision of how to legally structure your business will depend upon your needs, personal management style, and financing requirements. The original form you choose may only be temporary. As the business grows and expands, you may find the need to change legal forms. This is a very important decision with serious tax and legal implications. If you are unsure about this decision you should consult an attorney and/or an accountant. The most common forms of business ownership are sole proprietorship, general partnership, limited partnership, corporation (both regular and " S "), and statutory close corporation. Another form of organization that has become increasingly popular for small businesses is the limited liability company (LLC).

1. Sole Proprietorship
A sole proprietorship is a popular business form due to its simplicity to operate, ease to setup and nominal cost, and it is the least regulated. It is limited to a single owner (or owner and spouse), who has total control of and responsibility for the business. The sole owner must contribute or borrow all of the capital needed to start the business. Any outside funding sources must be in the form of loans. The profit or loss of the business is taxed as personal income and is included on the owner's individual tax return. The sole proprietor has full legal liability for debts and claims against the business.

Advantages:

  1. Easy to organize and flexible
  2. Owner has control and responsibility
  3. Minimum legal restrictions
  4. Income taxed as personal income
  5. Owners may freely mix business or personal assets
  6. Minimal start up costs

Disadvantages:

  1. Owner is personally liable for debts or claims
  2. Business terminates with the owner
  3. Limited ability to raise capital

2. Partnership
A partnership is a voluntary association of two or more persons acting as co-owners of the business. This form of business combines assets and talents of the partners to conduct the business operations. Each partner can act as an agent for the partnership through business operations, incurring debt, etc. The partners' personal assets are at risk for all claims and debts of the partnership.

Although a partnership is relatively easy to set up, a Partnership Agreement should be prepared by an attorney to establish the rights and duties of the individual partners. Because a partnership generally terminates when any partner dies or withdraws or when a new partner is admitted, the partnership agreement also describes how the termination will be handled.

Advantages:

  1. Simple to organize
  2. Combined funding and talents of partners
  3. Flexibility in profit or loss sharing
  4. Income taxed as personal income

Disadvantages:

  1. Unlimited legal liability for all partnership debts and claims
  2. Partnership terminates upon death, withdrawal, or addition of partner
  3. Individual partners act as agents for the partnership

A limited partnership is a special form of partnership that is not usually used for small businesses. A limited partnership is owned by limited partners and at least one general partner. The liability of the limited partners for claims and debts against the partnership is fixed at the amount they have invested in the partnership. The personal assets of the limited partners are not at risk. In return, limited partners can have NO input in the day-to-day operations of the business. Because a limited partnership is regulated by securities laws, formation can be complicated and requires an attorney and an accountant.

3. Corporation
A corporation is a separate legal entity. The owners of a corporation are known as stockholders. Each owner invests money or other assets in the new business in return for shares of stock at a predetermined price. The stockholders are at risk only for the amount of money they have invested in the stock of the corporation. The personal assets of the stockholders are not at risk. Because corporations are considered legal entities (or "artificial persons"), the corporation files income tax returns and pays taxes. The corporation may also sue and be sued.

A Subchapter S (or "S") corporation is a special form of a regular corporation. It is incorporated as a regular (or "C") corporation, but asks for special permission from the Internal Revenue Service to be taxed as a partnership. In other words, a C corporation and an S corporation are the same legally - they are organized in the same way and have the same legal characteristics. But an S corporation is often more attractive to the small business owners because of its appealing tax benefits and yet still provides business owners with the liability protection of a corporation. The company files an information return and the income or loss "flows through" to the shareholders where it is taxed as personal income.

Advantages:

  1. Limited liability for managers and stockholders
  2. Ownership is transferable
  3. Corporation does not terminate when ownership changes
  4. May choose a fiscal year end other than December 31 ("C" corp. only)
  5. "S" Corporation income or loss is passed through to stockholders and taxed at the individual level
  6. "S" Corporations eliminates the double taxation of standard Corporations

Disadvantages:

  1. Costly and complicated to establish
  2. Double taxation for standard corporations
  3. Extensive record keeping necessary
  4. One class of stock for "S" corporations

4. Statutory Close Corporation
This is most beneficial to businesses with 1-2 owners. The statutory close corporation is usually a small, closely held corporation, professional corporation, or wholly owned Subsidiary Corporation. The statute allows the corporation to do away with bylaws, board of directors, and annual shareholder meetings, but requires a shareholder management agreement and perhaps other operating agreements. Basically, the statutory close corporation allows the elimination of some of the paperwork requirements that are burdensome to the smaller business. However, since the requirements are reduced, it is imperative that all the remaining requirements outlined in the Articles of Incorporation be followed, in order to maintain the liability protection afforded the business owner under the corporate form.

5. Limited Liability Company
An LLC is a cross between a partnership and a corporation. It offers the liability protection benefits of the corporation without the corporation's burdensome formalities. The simplicity of the LLC has made it a popular business form for smaller companies. It allows its investors, which are also called "members," to contribute money or other consideration to the company. These members share in profits and losses and can participate in its management. Generally, each member has one vote, and members decide most matters by a majority vote.

The LLC is created by two documents, "Articles of Organization" and "Operating Agreement". The articles of organization are similar to corporate articles of incorporation and must be prepared and signed by the "organizers" of the LLC. The articles of organization must be approved by and filed with the Secretary of State. The LLC must have a registered office and a registered agent. The registered agent is the person who receives legal documents required to be served on LLCs. The registered agent should be either an individual or a corporation.

The operating agreement is the governing instrument of the LLC and must be adopted by all members. It can contain any provision not inconsistent with law. The operating agreement is similar to the by-laws of a corporation. Generally, the operating agreement should contain provisions related to the conduct of the business and affairs of the LLC, including the rights and powers of the LLC, its members, managers, agents, and/or employees.

An LLC is considered a separate person and as such is entitled to own property. As a person, the LLC can sue and be sued.

Advantages:

  1. Limited liability for members, which means they are personally protected from any liability of the LLC and judgments, as well as the LLC itself
  2. No membership requirements
  3. Potential for single taxation status as a partnership
  4. Acquisition of capital, a member can contribute capital or loan money, or other assets into the business. You can repay yourself plus interest
  5. Can have unlimited number of members - if the LLC has just one owner, it will be taxed as a sole proprietorship
  6. Less administrative burden than a corporation
  7. Members' compensation or wages are either through distributions of profits or guaranteed payments. Guaranteed payments represent earned income to members, thereby qualifying them to enjoy the benefits of tax-favored fringe benefits

Disadvantages:

  1. The managing members' bottom line profit from the LLC is considered earned income, and therefore is subject to self-employment tax
  2. As a member of an LLC, you are not allowed to pay yourself wages
  3. Sharing control and earnings
  4. Not all states allow the organization of LLCs for certain professional vocations