Chapter 1

Preparing to Buy a Business

IN THIS CHAPTER

Assessing your financial fitness

Replicating employer benefits in your own business

Making the time and financial commitment

Understanding the acquisition process and hiring professionals

Calculating a down payment amount and search expenses

Thinking or dreaming about owning your own business is easy and tempting to do. All it may take is knowing someone who is making decent money setting their own hours and perhaps even doing something they enjoy.

Starting a business from scratch of course is daunting and increases the obstacles and possibility for failure. Buying an existing business, possibly including a franchise, could be your ticket to small business ownership.

This chapter gives you the big picture of the acquisition process, what's involved, the pros you should consider having on your team, and how to budget for all this. But first, we help you assess - and if necessary, create a plan to improve - your financial fitness.

Figuring Your Financial Fitness

So you think you may want to buy a small business? We'd like to help you determine if that path makes sense for you; and if you can afford that, we'd like to help you turn that dream into reality.

You can't play if you can't pay. Buying a business requires solid financial fitness. Think of it as similar to buying a home if you've ever done that or considered that. You're going to need downpayment money and likely a loan to finance the bulk of the purchase price. And, in the early years of owning your business, you should be sure to have a decent financial cushion in place in case the business isn't performing at the level you expect it to.

If you're struggling to regularly save money, lack sufficient savings for a down payment, and are otherwise financially stressed, you may need to postpone setting the wheels in motion to buy a business.

Having your personal finances in order is one of the most under-recognized keys to achieving success in your small business. Just one significant money oversight or mistake can derail your entrepreneurial dreams or venture.

The following sections describe the important financial tasks you need to undertake before buying a business.

Assess your financial position and goals

Where do you stand in terms of retirement planning? How much do you want to have saved to pay for your children's educational costs? What kind of a home do you want to buy?

These and other important questions can help shape your personal financial plans. Sound financial planning isn't about faithfully balancing your checkbook or investing in stocks based on a friend's tip. Rather, smart financial management is about taking a hard look at where you are, figuring out where you want to go, and making sure that you're prepared for occasional adverse conditions along the way - a process, incidentally, that isn't unlike what you'll be doing when you run your own business.

Measuring your net worth

The first step in assessing your financial position is giving yourself a financial physical. Start with measuring your net worth, a term that defines the difference between your financial assets and your financial liabilities.

Begin by totaling up your financial assets (all your various bank accounts, stocks, mutual funds, and so on) and subtracting from that the sum total of all your liabilities (credit card debt, auto loans, student loans, and so on). Note: Because most people don't view their home as a retirement asset, we've left your home's value and mortgage out of your net worth calculations. (Personal property - furniture, cars, and so on - doesn't count as a financial asset.) However, you may include your home if you want, especially if you're willing to tap your home's equity to accomplish goals such as retiring.

Now, don't jump to conclusions based on the size of the resulting number. If you're young and still breaking into your working years, your net worth is bound to be relatively low - perhaps even negative. Relax. Sure, you have work to do, but you have plenty of time ahead of you.

Ideally, as you approach the age of 40, your net worth should be greater than a year's worth of gross income; if your net worth equals more than a few years of income, you're well on the road toward meeting larger financial goals, such as retirement.

Of course, the key to increasing your net worth is making sure that more money comes in than goes out. To achieve typical financial goals such as retirement, you need to save about 10 percent of your gross (pretax) income. If you have big dreams or you're behind in the game, you may need to save 15 percent or more.

If you know you're already saving enough, or if you know it won't be that hard to start saving enough, then don't bother tracking your spending. On the other hand, if you have no idea how you'll start saving that much, you need to determine where you're spending your money. (See the later section "Shrink your spending" for insight on how to start saving.)

Telling good debt from bad debt

After you calculate your net worth, categorize your liabilities as either good debt or bad debt:

• Good debt refers to money borrowed for a long-term investment that appreciates over time, such as a home, an education that bolsters your career prospects, investment real estate, or a small business.
• Bad debt (also called consumer debt) is money borrowed for a consumer purchase, such as a car, a designer suit, or a vacation to Cancun.

Why is bad debt bad? Because it's costly to carry, and if you carry too much, it becomes like a financial cancer. If the outstanding balance of all your credit cards and auto loans divided by your annual gross income exceeds 25 percent of your income, you've entered a danger zone, where your debt can start to snowball out of control.

Don't even consider buying a small business until you've paid off all your consumer debt. Not only are the interest rates on consumer debt relatively high, but the things you buy with consumer debt also lose their value over time. A financially healthy amount of bad debt - like a healthy amount of cigarette smoking - is none.

Reducing debt

If you have outstanding consumer debt, pay it off sooner rather than later. If you must tap into savings to pay down your consumer debts, then do it. Many people resist digging into savings, feeling as if they're losing hard-earned money. Remember that your net worth - the difference between your assets and liabilities - determines the growth of your money. Paying off an outstanding credit card balance with an interest rate of 18 percent is like finding an investment with a guaranteed return of 18 percent - tax-free. (Note: We recognize that some small-business owners finance their small businesses via credit cards, and in some cases, because this debt would be investment debt and investment debt is "good debt," we feel this situation may be acceptable. We discuss business financing options in Chapter 7.)

If you don't have any available savings with which to pay off your high-interest-rate debts, you'll have to climb out of debt gradually over time. The fact that you're in hock and without savings is likely a sign that you've been living beyond your means. Devote 10 to 15 percent of your income toward paying down your consumer loans. If you have no idea where you'll get this money, detail your spending by expense category, such as rent, eating out, clothing, and so on. You'll probably find that your spending doesn't reflect what's important to you, and you'll see fat to trim. (This process is similar to budgeting and expense management in business; not being able to manage your personal expenses may be a telltale sign of your inability to manage a business.)

While paying down your debt, always look for ways to lower your interest rate. Apply for low-interest-rate cards to which you can transfer balances from your highest-interest-rate cards. Haggling with your current credit card company for a lower interest rate sometimes works. Also, think about borrowing against the equity in your home, against your employer-sponsored retirement account, or from family - all options that should lower your interest rate significantly.

If you're having a hard time kicking the credit card habit, get out your scissors and cut up your cards. You can still enjoy the convenience of purchasing with plastic by using a Visa or MasterCard debit card, which is linked directly to your checking account. The major benefit of using a debit card rather than a credit card is that you can't spend beyond your means. Merchants who take Visa or MasterCard credit cards also accept these companies' debit cards.

Buying insurance

Before you address your longer-term financial goals, you need to make sure that you're properly covered by insurance. Without proper insurance coverage, an illness or an accident can quickly turn into a devastating financial storm.

Buy long-term disability insurance if you...