So you want to be your own boss. I have adapted this segment from the IBBA (International Business Brokers Association). There are advantages and disadvantages to both buying and starting a business. With careful analysis, you can learn what many seasoned entrepreneurs have discovered…the risk-to-reward ratio is tipped in your favor when you purchase an existing business. Starting a business of your own can pay great dividends, but the risks involved are significant.
Most start-up businesses will falter and eventually die. According to Michael Gerber, author of The E-Myth Revisited, 40 percent of new businesses fail in the first year and 80 percent fail within five years. On the other hand, purchasing an existing business reduces an entrepreneur’s risk while creating opportunities for tremendous profit. There are a number of reasons to consider purchasing an existing business rather than starting one:
- Proven Concept. Buying an established business is less risky – as a buyer you already know the process or concept works. Financing a purchase is often easier than securing funding for a start-up business for that very reason—the business has a track record.
- Brand. You’re buying a brand name. The on-going benefits of any marketing or networking the prior owner has done will be transferred to you. When you have an established name in the community, it is easier to attract new clients than with an unproven start up. Sometimes there is a need to change the name, but that is another issue.
- Relationships. With the purchase of an existing business, you will also be buying an existing customer base and vendor base that took years to build. It’s very common for the seller to stay on and transition with the business for a negotiated amount of time to transfer those relationships to the buyer and for training in general.
- Focus. When you buy a business, you can start working immediately and focus on improving and growing the business immediately. The seller has already laid the foundation and taken care of the time-consuming, tedious start up work. Starting a new business means spending a lot of time and money on basic items like computers, telephones, furniture and policies that do not generate cash flow.
- People. In an acquisition, one of the most valuable and important assets you are buying is the people. It took the seller time to find those employees, develop them and assimilate them into the company culture. With the right team in place, just about anything is possible and you will have an easier time implementing growth strategies. Plus, with trained people in place you will have more liberty to take vacation, spend time with family, or work on other business ventures. When
start-up owners and independent contractors go on vacation, the business goes too.
- Cash Flow. Typically, the sale is structured so you can cover the debt service, take a reasonable salary, and have some left over to take the business to the next level. Startup owners, on the other hand, often “starve” at first. Some experts say start-ups aren’t expected to make money for the first three years.
- Risk. Even with all these advantages, some entrepreneurs believe it is cheaper, and therefore less risky, to start a business than to buy one. But risk is relative. A buyer may pay $1 million, for example, for an established business with strong cash flows of approximately $200,000 to $300,000. A lending institution funds the transaction because historical revenues show the cash flow can support the purchase price. For many people, however, that is far less risky than taking out a $300,000 loan with an unproven concept and projections that may or may not be realized.
Regardless of what path you choose, the idea of being in charge of your own destiny is always appealing. Risk is always involved. As long as proper due diligence is exercised when considering the purchase of a business, a potential buyer has a viable edge over the concept of starting from zero.