Many people who want to be small business owners don’t realize what a small business can make or how much it costs to run. Unforeseen pitfalls in a small business can mean the difference between staying in business and going broke.
From my experience as a former small business owner, the expenses to run it and my dishonest partner forced me to sell. I lost money, but I gained a wealth of knowledge about running a small business, dealing with a partner, and seeing for myself what this process entailed.
When I first inquired about the business, I fell in love with it. At the time I was looking to invest in something I could do part time and I knew the industry. For this article’s sake let’s say it was a milk delivery service.
Going on a recommendation from a family member, I went to visit the business. I met with the owner and he was looking for a partner to help him run it, since his former partner “was leaving the country,” that should have been a huge red flag, and I wish I would have ran away at that point. But, being the perseverant person I am, I looked around at the equipment, at the books, talked to some people and finally decided on buying 50% of the business.
As I mentioned earlier, the first red flag was the story on why the partner wanted to sell his half. I bought into the story of him leaving the country because he was an old man and not a native of the United States. I was naïve.
The problems started almost immediately with my partner. I noticed he was, for lack of a better word, incompetent. Not only that, he was disorganized and within a couple of months time, I would also catch him in the act of stealing. Essentially, almost everything that could go wrong did go wrong.
Here are a few tips on avoiding common pitfalls when purchasing an existing small business.
1. Don’t hurry up. Take your time looking around and talking to the owner. If you feel pressured to buy, walk away.
From the moment I inquired about the business, the owner kept pushing me to hurry up. Big red flag.
2. Don’t ever divulge to anyone how much money you have or want to spend on a business. Remember if the business costs 100k make sure you have at least 200k or a very good credit line. Surprise expenses will happen. Plus inventory depletion, vehicles, new hires, machinery, and the list can be very long.
I did not have much left after I purchased the business and wound up using credit cards for inventory, it almost buried me.
3. If part of the business entails machinery or something you are not familiar with, say a power plant or some other industrial machine make sure to bring someone who does. It could look fine to you but an expert will be able to tell if it is in good condition or not. This is especially important if the machine is mission critical to the business.
Always use a lawyer and have a solid contract. Make sure it includes a non-compete stipulation.
I would be remiss if I didn’t mention finances. Obviously, look at the books. If there is cash involved in the business assume some of it doesn’t get reported. Ask for receipts, invoices, orders, manufacturer info, etc. You can almost bet your life that the owner who wants to sell has inflated the revenue figures he mentions to you. If he tells you I make $10,000 a month ask if that is net or gross profit. Assume it is probably around $7000. Then look at the books again and have your own accountant look through the books. For certain businesses you have to get creative on figuring out the revenue. For example, if you are thinking of purchasing a coin laundry ask to see the water bill for the last six months; next divide the total gallons used in a month by the number of washing machines in the location and the average water usage for each and the cost per load. Next take into account the dryers, most people will wash and dry.
Another example would be, buying a restaurant. Let’s say you are interested in buying a restaurant, food can be hard to quantify so you can do what a friend of mine does; sit in the parking lot outside of the business he’s thinking of buying. He will sit a ways away for an entire day and count everyone that goes in and then multiplies that by a typical plate of food and drink. Sounds like a tedious task to do, but consider the alternative of pouring $200k into a money pit.
Finally, if at all possible, don’t get involved with a partner. Unless it’s absolutely necessary and you trust this person with your own life. Even then make sure everything is clearly written out in the contract. The best of friends can change on a dime. Just today a person I know is foreclosing on a house he only owned on paper. He signed for the house to help out a “friend,” now his credit is ruined and the friendship is over.
Having a small business can be very rewarding when done right. It does involve many long hours and you never really “leave” work as you do in a 9-5. There’s always going to be something on the back of your mind. But that’s par for the course. I think my experience can give the average Joe Shmoe , such as myself a look at some of the common pitfalls in buying an established business.
On a final note, consider these questions when thinking about buying an existing small business:
“How hard would it be for me to start a similar business from the ground up?”
“If he is making $xx,xxx amount every month, why is he selling?”
“How long is the lease on the property for?” (very important, you don’t want to move in and be told your lease isn’t being renewed)