One option in going into business is to buy a going operation. The advantage over starting from scratch is, of course, that there are more facts to work with than a business which exists only on paper. To turn this into an advantage, the prospective buyer of a small business must know how to gather the data relevant to the decision, and how to use them to make the right choice.

The buyer should begin by trying to predict with some confidence the future of the business:

What factors affect sales? How are these market factors varying? What sales should I expect over the next few years?

What makes up the cost of sales? How will these cost factors apply to expected sales? What gross profit can I expect?

What expenses are required to run this business? How can I affect these expenses? What net profit will my approach provide?

What assets does the business need? What does it already have, and what is the condition of these assets? Therefore, what asset improvements will I have to make?

How much cash will the business generate? What immediate cash outlay must I make? What will be the ongoing cash needs of the business? What additional cash resource, if any, must I have?

Value

A seller often thinks of value as representing the money he/she has invested through years of ownership. A buyer more often thinks of value in terms of a fair price for tangible items such as equipment and inventory. These factors are important, but they have value only to the extent that they contribute to future profits. An owner may have invested $40,000, the tangible assets may have a current worth of $20,000, but it is the profit potential that establishes the value of the total business.

The business must be looked upon as an investment option. What would the amount of capital required by the business produce in other applications, bank instruments, treasury bonds, the stock market?

The value of the business is theoretically that amount that provides a rate of return commensurate with the risk involved. Another consideration is the continuity of the business, that is, am I buying an ongoing business, or just a building full of equipment and inventory?

The selling price of businesses is often different from its value because non-investment factors enter on the part of one or both negotiators. These could include the buyer's strong desire for self-employment, strong attraction to the industry, etc. It could reflect the seller's anxiousness to retire, or the availability of a more attractive opportunity, etc.

Negotiation

If a deal is struck, the price generally represents the result of considerable negotiation and compromise. Here are some suggestions for negotiation:

Discussion between buyer and seller should focus on the future profit performance of the firm. There is certainly room for disagreement on this issue, but introduction of extraneous issues can complicate an already difficult process.

Every profit projection includes some assumptions and risks. Generally, the less firmly based the assumption and the more apparent the risk, the less value an expected profit can support. Consequently, identifying and analyzing risks involved in future operations can make discussions between buyer and seller more significant.

(Assuming we are advising the buyer). Be sure to have a top price in mind, and do not exceed it unless you call a "time-out" to review how you arrived at that number.

Not all compromise is in direct monetary terms. You may be willing to pay more for more favorable payment terms, etc,

This discussion is not meant to imply that you can keep emotional issues out of your consideration of buying a business. You are way ahead, however, when you work from an objective value of the company, and are aware of when you are applying subjective factors.