Why Buy a Business Instead of Starting One?

Author: nfriend@franchise101.net

Date: JUL 20th, 2009

Topic: Industry Experts

The term “entrepreneur” was initially used to describe an individual who created a business venture.  More recently, the term has been applied to any business owner.  There is often a significant difference in the abilities between someone who “builds” a business and someone who “manages” a business.  Put simply, there are “builders” and “custodians” and if you understand which group you fit into, this will determine in large part whether you should start or run a business.  

People who have management skills tend to buy businesses rather than start them as their skill set is in managing people, money, processes, and systems.  Entrepreneurs like the thrill of being first in the marketplace, the prospect of a big financial upside, and the recognition that comes with.  On the other hand, buying a business is usually faster, cheaper, safer and easier to finance as you take over a customer base, cash flow, profit and proven systems (assuming the company is profitable).

It is important to keep in mind that it could take you a year to buy a business from the time you carry out a self-assessment, define your criteria for a business, locate a business, negotiate the purchase, arrange financing, structure the deal and close the sale.  Compare that to how long it takes most start-up businesses to generate cash flows and become profitable.  A rule of thumb is a business buyer will usually invest money equal to about twice their expected annual owner salary.  The balance of the investment will be borrowed, either from family and friends, the bank or through seller financing.

Starting a business from scratch requires investment in leasehold improvements, equipment, inventory and working capital.  However, to compare “apples with apples”, the true cost of a start-up business must also include forgone wages.  The owner who leaves their job to start a business and work “free” for an extended time period has a true cost higher than just the cash outflow.

Apart from the ability factor, the other main motivation to start a new venture, rather than buy a business, is the potential.  The potential and financial upside of a start-up can be enormous.  Of course, the risk is also very high.  It is extremely difficult for an acquisition to match the growth potential of a start-up that is on the cutting edge of the market.  The good news is that there are plenty of companies that can provide you with an excellent income, secure lifestyle and increase your net worth.  These businesses have manageable risks, which although they may have a smaller upside also have a smaller downside.

The Advantages of Buying a Business

  • As an operating business will have a track record you will be able to evaluate its revenues and profit picture.  Based on this information, you will be able to reasonably forecast what the business will do for you.  With a start-up you have to rely on general industry information to project revenues and profits.
  • Unless the business is having difficulties, it should be at or close to, operating at the break-even point or be generating some level of profitability.  Any start-up business is going to take some time to reach break-even or profitability and substantial losses may be incurred in the process.
  • Lenders are more likely to approve financing for an established business than a start-up, as they will have greater confidence in a business with a track record.  In addition, the seller may be willing to provide you with all or part of the financing.
  • If the business has been operating for some time it should be relatively free of the types of problems that are associated with a start-up.  You will benefit from their learning curve, which should save you money and reduce your stress level.
  • The cost of a new business may be less than it would cost to acquire the same tangible assets for a new business.

 

The Advantages of Starting a Business

  • You won’t have to pay a seller for “goodwill” associated with the business.
  • Within certain limits, you will be able to create the type of business that matches your criteria.
  • A start-up commences with a clean sheet and doesn’t have any reputation problems that may be inherent with an established business.

Norman P. Friend
President
Franchise 101 Incorporated