You should not buy a business if you have no prior knowledge of how it works, or it is something you aren’t familiar with. You don’t need to know everything, the current owner or franchise company can provide specific training. But you should understand the primary aspects of the business. For instance if you know nothing about toxic waste disposal, and don’t even have a working knowledge of what toxic waste is, this probably isn’t a good fit for you.

The current owner of a business or the franchise company will probably make running their business sound very easy. It is up to you to ask the right questions and understand your own limitations.

If you’re close to buying a small business, see here for a checklist to ensure you are asking the right questions and that you examine the right items and documents within the business.

The Transfer of Knowledge

If you are buying a business that is seasonal, in other words it has a specific few months during the year to make a profit, then you should contract for at least a full year of time and support from the current owner. If the business isn’t seasonal, then a minimum of three months support should be part of the contract to buy the business.

Make sure you specify in writing what type of support you are buying. Is it a monthly phone call, a couple of hours a week at the store, a set number of hours per month? If you don’t specify, they could take off for a month in Hawaii and call you at the end of your trip. If you can, arrange the contract so that you hold some portion of your down payment until the current owner has fulfilled the contracted support. This way if they don’t provide what they promise, you would have some money to seek a consultant if needed.

Know Your Limits

Before you start looking for a business to buy, certainly before you start negotiating for a business, you need to know what your limit is. Have a high end price in your head that takes into account what the business is worth, and what you can afford to pay. You don’t want to go into the business with no money to buy product, advertise, or make any needed upgrades or changes. It isn’t the buying of the business that is important, it’s making a viable income once you have the business.

Know What You Are Buying

Often when you buy a business you get the leases, the inventory, any open invoices that the company is liable for, as well as any lawsuits, tax liabilities, and more. This can be debts that the company has proof of, and any that might show up after you close on the deal. There are also ways to purchase only the assets and the owner’s shares in the company with out being responsible for liabilities.

If you purchase the business in this manner, then you can still be required to address and pay for any current or future lawsuits. Even if the current owner states in the purchase contract that he will be responsible for anything that happened before you bought the business, if something happens to him or he doesn’t have the means or money to address these lawsuits, then it still will come back to being your responsibility.

Make sure you take the time and effort to find out about potential problems before you close on the business. Check with the better business bureau, the owner’s liability insurance company, and even take the time to check if there are currently any liens on the business.

Know what you are buying may belong to the employees, especially if you are buying a service company. It is important to get a feel for who plans to stay, who plans to retire or take the customers and start their own business as your competitor. Often buying a service company can be just a bit risky. If customers hated the prior owner, it will take them some time to warm up to you. If they liked the prior owner, they may not be happy with the way you do things, and if you try to change something…your customers may all jump ship. It is really important to do your homework when you are buying a small business.

There are a number of advantages to purchasing an existing business rather than starting one on your own. For starters, as the business is already operating, you won’t have to wait weeks or months to get started. After the sale is complete, you can hit the ground running. You won’t need to do a lot of the prep work involved in starting a new business such as finding a concept, site and filing for permits, as this work has already been done.

If you purchase an existing business, you’ll be able to produce quick cash flow with existing inventory and accounts receivable. By getting quick cash flow, you can immediately begin paying back any loans you may have taken out to get the business off the ground.

By buying an existing business, you already have existing suppliers and customers. Instead of having to search for customers and suppliers, you can build upon existing relationships, making your operations more efficient. If your business has a good reputation, you’ll also inherit that, instead of having to slowly build up public trust.

Finding funding for purchasing an existing business will likely be easier to obtain, as the existing business is a known quantity and perceived by banks to be less of a risk than an untested and untried business concept.

Small business entrepreneurs can also benefit from purchasing a small business because it eliminates a potential competitor they may have had if they had tried to start a business with a similar concept from scratch.

That’s not to say that there aren’t downsides of purchasing an existing small business.

Buying an existing small business will often be more costly than starting one from scratch because the existing owner will want to profit from the sale, or may need additional money to settle the debts of the business before he or she cashes out.

When you buy an existing business, you inherit its reputation, and if that reputation is bad, you could have a difficult time in turning it around, particularly if you retain the same employees and follow the same business model as the former owner.

Other problems you may inherit include legal wrangles, uncollectible bills, problems with suppliers, facilities in need of repair or renovation, obsolete equipment, etc. You may also find it difficult to mesh with existing employees and managers, as your way of doing things is likely to be much different than the former owners’.

Do Your Homework

The potential drawbacks of buying a small business are why it is very important for entrepreneurs to carefully research the existing business they want to buy.

When asking for data on a potential buy, the existing owner will typically want you to sign a letter of intent – a non-binding agreement to buy the business – and a confidentiality agreement which will prohibit you from disclosing sensitive information. When requesting information from a potential buy, you’ll want to see:

Financial records such as balance sheets and records of accounts receivable and bank statements. You’ll probably want about three to five years worth of records to judge the financial health of the business.

Tax returns will help you get a better picture of the profitability of the business and whether any tax liability may be due.

Copies of permits or licenses the business may be required to have.

Customer lists, mailing lists or databases.

List of assets, such as property, equipment, leases, etc.

List of current agreements, contracts, etc. the business may have with suppliers or customers.

Information about key employees, including resumes and personnel records.

By requesting these documents, you can get a better idea of what you’re getting into if you buy an existing business and avoid potential pitfalls.

Also be sure to get full disclosure on whether the person you’re negotiating with is the sole owner of the business, or if other parties have ownership stake in the business. Many a business sale has been hung up in court because a silent or forgotten partner comes along and makes a claim.

Self-examination

Before pulling the trigger and committing to buying a small business, evaluate yourself too. Is this a business that you’re interested in? Can you comfortably afford the financing necessary to fund the purchase? Do you have the time to put into running the business? What is your back up plan in case something goes wrong?

Evaluating your own financial condition and motivations for purchasing a small business is important to making sure that purchasing a business is the right move for you. If you don’t have the experience or interest necessary to run the business, it may not be the right venture for you.

If you decide to buy the business, enlist an accountant of financial adviser to help structure the transfer. Your adviser may be able to help negotiate some favorable items in the sale agreement, such as getting the owner to agree to reimburse you for uncollected receivables. Other concerns you may want to address in the purchase is whether the current owner will be retained in an advisory capacity, non-compete agreements with the current owner, financing of the purchase, whether the purchase will be achieved through a cash payment, asset swap or other means, etc.

By carefully considering the pros and cons of buying an existing business, doing a thorough look at the business, and hiring a professional to orchestrate the sale, you can buy a business that can quickly start making money for its new owner – you.