Buying a business

One way of getting started is to buy a business that has been operating for some time. The advantage is obvious - most of the start-up pains should be over and it should have an established customer base.

  • Considerations

    One way of getting started is to buy a business that has been operating for some time. The advantage is obvious - most of the start-up pains should be over and it should have an established customer base.

    But be careful: don't think that you won't have to write a business plan. On the contrary, it is a crucial way for you to get to know your business and to make sure it survives the change of owners.

    Also, do you know what you are buying? Nobody is going to sell a business that really makes a lot of easy money, even though it might be presented to you that way.

    If you feel that you can make more money than the previous owner because you are a better business person, it can be a good buy. But what if there are problems with poor location, a declining number of customers or a development that will affect the business negatively?

    Do a thorough investigation and hire a good lawyer to help you with the deal

  • The investigation

    An investigation into a business that you want to buy can be broken down into manageable parts. Once you've gone through all the steps listed here, you will have a fair idea of what you are buying. Although you can do most of the groundwork yourself, at some stage you will need the expertise of a lawyer and an accountant.

    Step 1
    Study the business' books. Insist on seeing audited financial statements. If they are older than three months, they must be viewed with care.

    Ask for interim figures - those for the period since the last audit. If possible, look at the bank statements for the same period. Also consider speaking to the seller's staff.

    Check carefully for trends in sales - are they increasing or going down. Work out gross profit margins. Make sure that you identify abnormal overheads when making your calculations.

    Goodwill is a vague term that is more or less understood by most people. Nevertheless, it is an important consideration when buying a business. When an accountant talks about goodwill, he means the difference between the book value of the assets (equipment and stock) and the selling price of the business.

    Step 2
    Study the lease agreement. If it expires within a few months you will probably be faced with an increase in rent. Speak to the landlord about this. Usually he must agree to the sale of the business. Where possible, speak to other tenants about the landlord.

    Step 3
    Make the seller sign a restraint of trade agreement to stop him from opening the same kind of business nearby soon after the sale. Don't set up an agreement without the help of your lawyer.

    Step 4
    Do not buy the business' creditors or debtors. Creditors are easily hidden and often tend to come out of the woodwork after the sale. Some of the debtors - those that owe the business money - may be bad.

    Step 5
    Consider the advantages of advertising the sale of the business in newspapers as well as in the Government Gazette 30 days before the actual sale. This is done under Section 34 of the Insolvency Act. There is a small chance that you may pick up important information.

    Step 6
    It would be unthinkable to buy a business without checking the stock. Old and damaged items must not be bought. The value of the stock must be calculated at cost price and a stock-take must be done on the day you take over the business. A minimum amount of stock must be agreed on and stated in the sales agreement.

    Step 7
    A list of all movable assets must form part of the agreement of sale and be checked the day you take over. The equipment must be checked by experts for faults before the sale.

    Step 8
    Staff members who are going to stay on after the sale, may have leave pay and other benefits owed to them. Remember to include these in your calculations and planning.

    Step 9
    To help your initial cash flow, convince the seller to accept staggered payments. Also make sure you negotiate a low, or at least reasonable, interest rate.

    Step 10
    Check with local authorities whether the business has the required licences and permits. Also check compliance with environmental standards and possible future rules, which are increasing every year. If a specific product is manufactured or sold, check its compliance with official standards.

    Step 11
    Are there any unfulfilled contracts? Are there any guarantees or obligations to others? Are there any pending damage claims, lawsuits or disputes? Are there any matters pending with government departments?

    Step 12
    It is advisable to consult a tax expert when buying a business. Tax advantages can be achieved when your business has the correct structure. For example, buying goodwill for R30 000 has no tax advantage, whereas spending R30 000 more on the equipment does.

    Step 13
    Speak to key personnel. After all, you are going to work very closely with them in future. They can tell you a lot about the business that the owner would not necessarily volunteer. And it is important to find out whether they are going to stay on.

    Step 14
    Suppliers are important sources of information that you can use to check the accuracy of the books. Also, you should check their willingness to extend credit to you.

    Step 15
    An important part of the risk of buying a business is your ability to sue the previous owner if he has misrepresented the health of the business. Be extra careful if he is about to emigrate, or if all his assets are tied up in trusts and other companies.

  • Calculating the price

    There are many ways of calculating the price of a business. Obviously, you would prefer using the one that gives you the lowest price, while the seller would push for the formula that gives him the highest price. In the end, it will be a matter of negotiation, intuition and even the emotional state of both you and the seller.

    Therefore, it is important to use a standard formula to establish the range in which a reasonable price for the business will fall.

    The following might help you calculate the business' worth:

    • Net worth of the business - liquidation value of the assets minus the liabilities
    • Your present earning power - annual earnings with an equal amount of net worth (say 15%)
    • Add a reasonable annual salary for owner or manager
    • Average earnings required (item 2 plus item 3)
    • Determine the average annual net earnings of the business (net profit before owner's salary) over the last few years
    • Extra earning power (item 5 minus item 4)
    • Ask yourself over how many years you are prepared to sacrifice the extra earning power of the business to pay for the goodwill (item 6 multiplied by item 3)
    • Final price (item 1 plus item 7).

Login or Register

Select your online banking platform

Standard Bank App