05/11/2010 02:35 pm ET Updated Aug 09, 2011

Buying A Business: 5 Things You Need To Know

With increasing signs that the economy is improving, and the credit markets beginning to loosen up again, the business-for-sale market is sure to see an uptick. In fact, the number of businesses sold during the first quarter of 2010 rose 6.3 percent over the fourth quarter of last year, according to BizBuySell, an online marketplace for business postings. Sometimes, buying an existing business can be a lot easier than starting one from scratch. What are the best ways to get started? Here are five things you need to know.

1. Know what kind of business is right for you.
Business buyers tend to "fall in love with the profits, not the product," says Barbara Taylor, co-owner of Synergy Business Services, a full service business brokerage firm in Bentonville, Ark. While the financial performance of any business is a paramount concern for any buyer, it could be just as important to find a business you are passionate about. To help you through the screening process, Taylor says, ask yourself some basic questions:

  • What kind of lifestyle do you want? If you'd prefer to relax in the evenings and on weekends, then a business with retail hours may not be the right choice.
  • How much do you need to pay yourself in owner's salary? If you're buying a business to replace income from an employer, then you'll probably want to replace your former paycheck at a minimum.
  • In what industries do you have particular expertise or interest? Many people will be relying on your ability to successfully run the business as the new owner, including the employees, suppliers, the seller, if they carry back a portion of the purchase price, as well as you and your family. Aligning your experience with the industry of the business lets you focus on daily operations and flattens the learning curve.
  • What skills do you bring to the business? Consider what skills will need to be covered by the talents of other people within -- or outside of -- the organization. It's an added bonus if your skill set will help take the business to the next level.

2. Line up your financing ahead of time.
Given the crackdown on easy credit, it's likely, if not certain, that you will be asked to verify your financial ability to purchase a business upfront -- particularly if a business broker or intermediary represents the seller. "No one wants to waste time with a buyer who can't close the deal, nor do you want to waste precious time investigating a business that you ultimately can't buy," Taylor says. With that advice in mind, here are some questions you should ask yourself:

  • What amount do you have for a down payment?
  • What sources will the down payment come from (cash from you, remainder from a bank loan or family member)?
  • What additional sources of funding do you plan to use (self directed funds from retirement account, sale of stock, home equity)?
  • Will you be asking for seller financing? If so, what terms will you be asking for?
  • Can you furnish a statement of personal net worth and resume?

3. Assemble a team of professionals.
Buying a business, regardless of its size, can be a complex process. "You will want to enlist the help of a qualified attorney and a certified public accountant, as well as any other trusted advisers," Taylor says. For instance, make sure your attorney includes corporate transactions among his or her practice specialties. You will be relying on legal counsel to draft documents like a Term Sheet for submitting an offer, and an Asset (or Stock) Purchase Agreement for purchasing the business. There may be other documents such as leases, patents, and contracts with customers and suppliers that you will want legal counsel to review as well. In terms of the numbers and financial side of your vetting process, select a certified public accountant who has experience in analyzing several years' worth of financial statements and tax returns provided by the seller. Your accountant should also understand any tax consequences associated with the purchase and structure of the deal.

4. Place a value on the business.
There will be differing views on what the business is worth. Regardless of whether the seller has a desired asking price, you will want to come to your own conclusions about the value of the business, Taylor says. "At the end of the day, a business is worth what a willing and able buyer -- given all the available information -- will pay," she says. So be ready to negotiate and bridge the inevitable gap between what you think the business is worth and what the seller wants. Most businesses for sale on the small-business marketplace use an asking price that is based on a multiple of Seller's Discretionary Earnings (also referred to as Cash Flow or Owner's Benefit). You and your accountant will need to audit the books to derive the amount of the S.D.E., which is typically arrived at by taking pre-tax earnings and adding back owner's salary, interest expense, discretionary expenses like owner's auto and travel, non-recurring expenses, and non-cash expenses like depreciation. The multiple you apply to the S.D.E. can by found by using comparables or data from other transactions from the same industry.

5. Start looking and spread the word.
To see what businesses might be available to you, visit the primary business-for-sale websites, such as BizBuySell or BizQuest. You can also identify the top business brokerage firms in your area by attending events at your local Chamber of Commerce or other business organizations. You can look through their available listings, which will likely be online. You should also spread the word that you're looking to buy a particular type of business. "Telling people that you're 'looking for a business to buy' really tells them nothing," Taylor says. She suggests saying something more along the lines of, "I'm looking to buy an established business that does specialty subcontracting work for commercial construction projects with no more than 50 employees and at least $1.5 million in annual sales," which narrows the field considerably, and lets people know what to look for. When you know what your key filters are, you can then send a detailed e-mail or letter to local business brokers outlining your background and interest, parameters for a suitable business, available funds for a purchase, and timeline for taking possession. After that, the key is to do your homework to find the best fit for you. "The more you know about the process of buying a business," Taylor says, "the more successful the outcome."

The original version of this article appeared on AOL Small Business on 5/11/10.