07 December 2006

Are you thinking about buying a business?

I bought my first business for $22,500. The asking price was $25,000 and I negotiated the price down to $22,500. The owner agreed and I went to the bank and borrowed the money. The cheque was handed over and all of a sudden I was running my own dive shop and I have to say, I felt pretty pleased with myself.

Unfortunately I started making mistakes the minute the cheque was handed over. I borrowed just enough money to buy the business and not one cent more. I was immediately inundated with bills as a result of the sale. These bills included accountant fees, state taxes, legal fees etc which all came to about $5000, which of course I didn’t have. I also purchased a dive shop at the beginning of winter – the quietest time for this kind of business. Some of the equipment was old and needed to be replaced and the level of stock was very low. All in all I had got off to a pretty bad start. In many ways the business never really recovered because I was always seriously short of money.

If I could turn back the clock and use the experience that I now have how would I have approached this same situation?

Firstly I would have negotiated on the sale price much harder. The previous owner wasn’t making any money and in hindsight, I probably could have picked the business up for next to nothing.

The next thing that I would have done was to pay a mechanic or an engineer to check out all of the equipment to determine whether it was in good condition and what would need to be replaced.

Next I would have worked out how much it would cost me to operate this business for one full year, taking into consideration all expenses including my wages. Once this figure was determined I would add it to the negotiated cost of the business. Then I would add the cost of replacing any equipment that was not in good enough condition to last 12 months. Once a total figure had been determined I would add a 20% contingency to this and the new total is how much money I would have tried to borrow from the bank.

Obviously I would be asking for a lot more money but if I couldn’t get the total amount I would think long and hard about buying the business in the first place. People get caught up in the emotion of the moment when it comes to buying or starting a business. The excitement of this new venture often overshadows the normally strong sense of reason. There is a lot to be said for having time to cool off and really consider the decision.

There are two types of businesses in the world. Those that have experienced a lack of money and those that will experience a lack of money. Nine times out of ten a lack of money can be traced back to not having enough money from day one.

As you can tell with my example, I was in a position where I had to start making a profit from day one. Not just turning money over but making a profit. This is very hard to do. When starting or buying a business there are so many potential pitfalls that can affect income that there really are no certainties.

If starting a business you will need to make sure that there are people who are prepared to buy your products. It will take you a while to establish your own customers and to build the business up to a level where you are covering costs. While you are building the business up you will still need to pay for all of your fixed expenses and this gets back to the amount of money you have available when starting your business (start up capital).

If buying someone else’s business you are buying a cash flow and existing customers (goodwill). Unfortunately there is no guarantee that the customers will stay using the business when you take it over. You need to allow for the fact that you may lose a certain proportion of these customers. I have seen this happen many times where a business is sold and the customers leave in droves. Often the new owner goes broke in a relatively short amount of time. This normally indicates that they did not allow for the possible exodus of customers and they did not have enough capital behind them to cover these losses until they built up their own customers.

Owning and operating your own business can be incredibly rewarding. It is certainly a lot more enjoyable if you can reduce your stress level by having good financial planning and a realistic approach to how much money it will take to get you where you want to be. Making certain that you have enough money to start your business or to buy your business is essential.

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