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Starting a small business Part 5

November 26, 2012

Should I just buy an existing business instead of starting one?

Probably not.  Especially not if you’ve never owned a business before.

Intangible assets are the most valuable assets of an existing business and the toughest to value.  Intangible means assets that you can’t touch and include customer lists, patents, trademarks, brands and innovative (though not legally protected) ways of doing business.  Tangible assets are machines, furniture, land buildings, trucks, cash, inventory and so on.  Tangible assets are easier to value because there is a secondary market for just about everything – see Ebay.  The problem with intangible assets is that they are usually more valuable to the current owner than any successor owner.

Why?  Customers are usually tied to the owner on a personal loyalty level.  The customer trusts the business owner to provide the product or service at a good value.  The customer doesn’t know you and definitely doesn’t trust you.  Customer attrition rates, especially in a service business, are between 20-40% after a change in ownership.  So if your purchase price is one year’s sales, you will typically lose 20%-40% of that value during the first year.

Other intangible assets like patents, trademarks and brands are only worth the future income that they’ll  produce.  This is again a difficult calculation.  You need to understand the business and the competitive advantage provided by these assets.  How long does the patent protect you.  Is it enforceable?  Is the brand tied to the owner and face contact with the customers?  Do you have the experience, knowledge or talents to successfully exploit these intangible assets?

Employees are tangible, intangible assets.  You can theoretically but not legally touch them.  The employees may have the knowledge and experience to exploit the competitive advantages of the business.  But, take a look at Part 4 – employees suck.  Most employees are paid above their replacement value.  I’ve restructured plenty of these people out of companies acquired by my previous employer.  Employees are usually baggage.

Baggage is a big concern when buying a business.  Besides employees, you’ll have disgruntled customers or vendors.  You need to make sure that any assets are unencumbered.  You’ll need to make sure that the IRS and local tax authorities don’t have ongoing liens or investigations.  There could be product recalls or malpractice suits pending.  Environmental concerns can kill new business owners – you end up owning the last guy’s mistakes.

If you want to buy an existing business, do your due diligence and then low ball the price.  It is the only protection that you have.  Then work your ass off to reduce the number of customers that you’ll lose.

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