Buying a business that is already up and running can potentially be a wiser choice for an entrepreneur than starting up a company from scratch. In exchange for the higher upfront costs, buyers of an existing business receive a business that’s already on its feet and has immediate cash flow. If investors play their cards right during a recession, they can pay low prices for small businesses that will drastically increase in value once the economy begins to recover. But there are special considerations to bear in mind when purchasing businesses during a recession and buyers need to be extra careful not to sink their money into a business that’s destined to go belly up.
“It may be the best time ever [to buy a business]. It’s a buyer friendly market, which we don’t see often…. People need to avoid this paralysis or fear just because of the ‘r’ word; it’s a very opportune time for people,” Richard Parker, founder of Diomo Corporation (Diomo.com) and author of eight programs on buying businesses and leading small market intermediaries, said.
Even if buyers shouldn’t let themselves be terrified, it’s important to remember that “the ‘r’ word” has had some real effects on the market that need to be taken into account. It may be difficult to find businesses that are still financially viable. Certain sectors have been hit harder than others; buyers would be wise to steer clear of businesses focused on real estate—such as construction or mortgages—for the time being. If investors are uncertain about a potential business purchase, they should take a look at its history in conjunction with its present state.
“A good business to buy in this economy is one that was making a lot of money and is still making a little money; [buyers will] be poised to make a lot of money again,” Andrew Cagnetta, CEO of Transworld Business Brokers, said. “You can always point to healthcare [as a good sector in which to buy]. That’s going to be good because we have an aging baby boomer population.”
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It’s important to realize that a business’s own cash flow is not the only factor that needs to be considered. If the business in question sells to other business, the buyer needs to investigate the financial health of those other businesses as well, according to Parker. Even an apparently thriving business could go be forced to close its doors if half its customers suddenly declare bankruptcy.
Small business buyers may want to take the opportunity to cut costs so that their business can weather the economic storm. “Everybody is looking for business. It’s an opportune time to look over contracts and be flexible with them. I’ve seen some landlords already starting to renegotiate rents, wanting to keep their tenants in their spaces. Suppliers are being a little bit more generous with terms but, at the same time, if they think you’re going out of business they might start wanting C.O.D. Make sure prices aren’t going to change,” Cagnetta said.
Financing may also be a hurdle for business buyers; loans with reasonable terms can be hard come by these days. The Small Business Administration (SBA) backed 18 percent fewer 7(a) loans in the quarter ending on March 31 than it did at the same time last year, according to BusinessWeek. This is the result of banks increasing their credit standards for these SBA-backed loans and consequently rejecting businesses that would have been approved a year ago. Women, veterans and rural entrepreneurs have seen the sharpest decline in approvals, according to the article. Because of this, potential business buyers may find themselves forced to seek alternative forms of financing.
“Seller financing may not only be the sole option: It’s an absolute must in today’s market. You’ve got to get the seller to have something in the game to validate everything they’ve represented. Moreover, in many cases it’s the only way to get a deal done,” Parker said. “We’re seeing well over 90 percent of our clients negotiating seller financing and earn outs.” An “earn out” is a purchase agreement where the seller receives less upfront, and gets additional money based on the business’s performance.
Alternatively, “if you have cash and you’re willing to buy a business, it’s a great time,” according to Cagnetta.
Investors can find a vast number of helpful resources on the Web if they wish to look further into buying a business. Websites such as BusinessesForSale.com and BizQuest.com offer sale statistics that can help potential buyers get a feel for the market. Parker said he recommends seeking out businesses for sale through newspapers, networking and making direct and indirect solicitations in addition to making use of the Internet. Educational resources are also available through local small business development centers.