Chapter 15

Purchasing a Small Business

In This Chapter

Evaluating the pros and cons of buying a small business

Considering the skills you need to buy a small business

Selecting the right business for yourself

Examining franchises and multilevel marketing companies

Checking out and negotiating a successful purchase

Each year, hundreds of thousands of small businesses are sold to new owners. This chapter is for those of you who want to run or invest in an existing small business but don’t want to start the business yourself. And of course, this chapter can show you how to make good money and have fun along the way!

Examining the Advantages of Buying

I don’t want to scare you off if you want to start a business. However, buying someone else’s business works better for some people. The following list reflects the main advantages of buying a business:

• You avoid startup hassles and headaches. Starting a business from scratch requires dealing with many issues. For instance, in the early years, along with formulating a business plan, you must also develop a marketing plan, find customers, locate space, hire employees, and incorporate. If you buy a good existing business, you buy into an ongoing enterprise with customers, assets, and hopefully profits (although you still need to fix any problems the business may have).

  Consider the learning curve for the type of business you’re contemplating purchasing. Buying an existing business makes more sense if the business is complicated. For example, purchasing a business that manufactures musical instruments may make more sense than starting one on your own. Unless you’ve built musical instruments before and understand the intricacies of the production process, starting such a business from scratch is quite risky and perhaps foolhardy. (Purchasing an existing business also makes sense if, for example, you don’t want to build a stable of customers from scratch.)

• You reduce risk. Although investing in something with a solid track record is still far from a sure thing, your risk may be significantly lower than the risk involved in a startup. After a business has an operating history and offers a product or service with a demonstrated market, some of the risk in the company is removed. Looking at historic financial statements also helps you make more accurate financial forecasts than you could make with a startup venture.
• You enhance your ability to attract investor or lender money. You should have less difficulty raising money from investors and lenders for your existing business than with a startup. Why? You’ll likely find it easier to attract investors to something that’s more than an idea. And for the amount that they invest, investors demand a smaller piece of an existing business than they would with an investment in an idea.
• You can enter industries where buying an existing business is your only ticket in. You can enter some industries only through your purchase of a business that already exists. For instance, if you want to be involved in a bottling or car dealership business, you’re mostly limited to purchasing existing businesses.
• You can find businesses where you can add value. Some entrepreneurs who start businesses don’t see the potential for growth or don’t want to grow their businesses — they may be burned out, content with their current profit, or simply ready to retire. Finding businesses where the potential exists to improve operating efficiency and to expand into new markets isn’t too hard. Finding small companies that are undervalued relative to the potential that they can offer is easier for a business-minded person.

  Just because you think you see potential to improve a business doesn’t mean you should pay a high price based on your high expectations. You can be wrong — you may be looking at the business through rose-colored glasses. Even if you’re correct about the potential, don’t pay the current owner for the hard work and ingenuity that you’ll bring to the business if you purchase it. Offer a fair price based on the conditions and value of the business now — I explain how to figure this value in the section “Evaluating a Small Business” later in this chapter.

Understanding the Drawbacks of Buying

Not everyone enjoys running or cooking, and similarly, some people don’t enjoy the negatives that come with buying an existing business. If the following issues don’t turn you off, purchasing an existing business may be right for you:

• You buy the baggage. When you buy an existing business, the bad comes with the good, and all businesses include their share of the bad. The business may employ problem employees, for example, or it may have a less-than-stellar reputation in the marketplace. Even if the employees are good, they and the company culture may not mesh with where you want to take the company in the future.

  Do you have the ability to motivate people to change — or to fire them if they aren’t willing or able to adapt to your agenda? Do you have the patience to work at improving the company’s products and reputation? You need these types of skills and traits to run and add value to a company. Some people enjoy and thrive on such challenges, and others find such pressures hard to swallow. Think back on your other work experiences for information about what challenges you’ve tackled and how you felt about them.

• You need to do a lot of inspection. If you think that buying a company is easier than starting one, think again. You must know what you’re buying before you buy it. So you need to do a thorough inspection. For example, you need to rip apart financial statements to ascertain whether the company is really as profitable as it appears and to determine its financial health.

  After you close the deal and the money is transferred, you can’t change your mind. Unless a seller commits fraud or lies, which is difficult and costly for a buyer to legally prove, it’s “buyer beware” about the quality of the business you’re buying. (In “Evaluating a Small Business,” later in this chapter, I cover the homework that you need to do before you buy.)

• You need more capital. Existing businesses have value, which is why you generally need more money to buy a business than you do to start one. If you’re short on cash, starting a company is generally a lower-cost path.
• Lower risk means lower returns. If you purchase a good business and run it well, you can make decent money. In some cases, you can make a lot of money. But you generally have less potential for hitting it big with an existing business than you do with a business you start. Those who have built the greatest wealth from small businesses are generally those who have started them rather than those who have purchased existing ones.
• You don’t get the satisfaction of creating a business. Entrepreneurs who build their own businesses get a different experience from those who buy someone else’s enterprise. You can make your mark on a business that you buy, but doing so takes a number of years. Even then, the business is never completely your own creation.

Prerequisites to Buying a Business

Not everyone is cut out to succeed when buying an existing business. Meeting a couple of prerequisites improves your chances of success, as the following sections explain.

Business experience

You definitely need business experience to succeed when buying an existing business. If you were an economics or business major in college and took accounting and other quantitatively oriented courses, you’re off to a good start.

Even better than academic learning, however, is work experience in the type of business that you want to buy. If you want to run a restaurant, go to work in a good one. Consider the experience as paid on-the-job training for running your own restaurant.

If you’ve worked as a consultant on business-management issues with a variety of industries, you also have a good background. However, the danger in having done only consulting is that you’re usually not on the front lines where operational issues arise.

Should none of the previous examples apply to you, I won’t say that you’re doomed to fail if you buy a business, but I will say that the odds are against you.

If you don’t have business experience, you’ll likely do far better in your first business venture after some remedial work. Get some hands-on experience, which is more valuable than any degree or credential that you can earn through course work. No substitute exists for the real-life experiences of marketing to and interacting with customers, grappling with financial statements, dealing with competitive threats, and doing the business of business. However, I don’t endorse skipping academic course work. You may, in fact, be required to get a credential to be able to do the work that you want to do. If you don’t need a specific credential, taking selected courses and reading good business books (I recommend some in Chapter 18) can boost your knowledge.

Financial resources

To purchase a business, as with real estate, you need to make a down payment on the purchase price. Bankers and business sellers who make loans to business buyers normally require down payments of 25 to 30 percent to protect their loans. Small-business buyers who make sizeable down payments are less likely to walk away from a loan obligation if the business gets into financial trouble.

If you lack sufficient capital for a down payment, try asking family or friends to invest. You can also set your sights on a less expensive business or seek business owners willing to accept a smaller down payment. If you can find a business for sale where the owner wants less than 20 percent down, you may be on to something good. Be careful, though, because an owner who accepts such a small down payment may be having a difficult time selling because of problems inherent in the business or because the business is overpriced.

You can purchase some existing small businesses with a loan from the selling owner. Also, check for loans with banks in your area that specialize in small-business loans. (See Chapter 14 for other financing ideas.)

Focusing Your Search for a Business to Buy

Unless you’re extraordinarily lucky, finding a good business to buy takes a great deal of time. If you spend time outside of your work hours, finding a quality business that’s right for you can easily take a year or two. Even if you can afford to look full time, finding and closing on a business can still take you many months.

Above all else, it pays to be persistent, patient, and willing to spend time on things that don’t lead to immediate results. You must be willing to sort through some rubbish. If you require immediate gratification in terms of completing a deal, you can make yourself miserable in your search or rush into a bad deal.

Unless you set some boundaries for your business search, you’re going to end up spinning your wheels (and likely end up with the wrong type of business for yourself). You don’t need to be rigid or to precisely define every detail of the business that you want to purchase, but you do need to set some parameters so you can start laying the groundwork to purchase.

Each person has unique shopping criteria. The following list exemplifies some useful ones to narrow your search:

• Size/purchase price: The money you have available to invest in a business determines the size of business you can afford. As a rough rule, figure that you can afford to pay a purchase price of about three times the amount of cash you have earmarked for the business. For example, if you have $50,000 in the till, you should look at buying a business for about $150,000. Because many business sellers overprice their businesses, you can probably look at businesses listed at a price above $150,000, perhaps as high as $200,000.
• Location: If you’re already rooted and don’t want to move or deal with a long commute, the business’s location further narrows the field. Although you may be willing to look at a broader territory, maybe even nationally if you’re willing to relocate, evaluating businesses long-distance is difficult and costly. Unless you want a highly specialized type of company, try to keep your business search local.
• Industry: Industry-specific expertise that you want to use in the business you buy can help whittle the pool of businesses down further. If you don’t have industry-specific expertise, I highly recommend that you focus on some specific niches in industries that interest you or in which you have some knowledge or expertise. Focusing on an industry helps you conduct a more thorough search and find higher-quality companies. The industry knowledge that you accumulate in your search process can pay big dividends during your years of ownership in the business.

  If you have a hard time brainstorming about specific industries, use this trick to jump-start your creativity: Take a walk through the Yellow Pages! Many business types known to exist in your area are listed alphabetically. Remember that a separate Yellow Pages directory exists for businesses that sell mainly to consumers; a business-to-business Yellow Pages directory lists businesses whose customers are primarily other businesses. Look at either or both, depending on the types of businesses that interest you. You also may want to buy a business in a sector that’s experiencing fast growth so you, too, can ride the wave. Check out Inc. magazine’s annual Inc. 5,000 list of the fastest-growing private companies in America.

• Opportunity to add value: Some buyers want to purchase a business with untapped opportunities or problems that need to be fixed. As with real estate, however, many people are happier leaving the fixer-uppers to the contractors. Some businesses without major problems can offer significant untapped potential.

After you define your shopping criteria, you’re ready to go to the marketplace of businesses for sale. I recommend that you type up your criteria on a single page so you can hand it to others who may put you in touch with businesses for sale. The following sections give you the best techniques for identifying solid businesses that meet your needs.

Perusing publications

If you’re focused on specific industry sectors, you may be surprised to find out that all sorts of specialty newsletters and magazines are published. Just think of the fun you can have reading publications such as Alternative Energy Retailer, Specialty Foods Merchandising, Coal Mining Newsletter, Advanced Battery Technology, or Gas Turbine World! Specialty publications get you into the thick of an industry and also contain ads for businesses for sale or business brokers who work in the industry.

Conducting literature searches of general interest business publications can help you identify articles on your industry of interest. Online computer searches can help you find articles as well. Websites worth examining include www.bizbuysell.com and www.sba.gov.

A useful reference publication that you can find in public libraries with decent business sections is a two-volume set titled Small Business Sourcebook (Gale). Organized alphabetically by industry, this reference contains listings of publications, trade associations, and other information sources.

Networking with advisors

Speak with accountants, attorneys, bankers, and business consultants who specialize in working with small businesses. These advisors are sometimes the first to hear of a small-business owner’s desire to sell. Advisors may also suggest good businesses that aren’t for sale but whose owners may consider selling (see the next section).

Knocking on some doors

Some business owners who haven’t listed their businesses for sale may be thinking about selling, so if you approach enough owners, you may find some of these not-yet-on-the-market businesses with owners interested in selling. You can increase the possibility of finding your desired business and may get a good deal on such a business because you can negotiate with such a seller from the beneficial position of not having to compete with other potential buyers.

Instead of calling on the phone or literally knocking on the business’s door, start your communications by mail. Sending a concise letter of introduction explaining what kind of business you’re looking for and what a wonderful person you are demonstrates that you’re investing some time in this endeavor. Follow up with a call a week or so after you send the letter.

Working with business brokers

Numerous small businesses for sale list their enterprises through business brokers. Just as a real estate agent makes a living selling real estate, a business broker makes a living selling businesses.

Business brokers generally sell smaller small businesses — those with less than $1 million in annual sales. These businesses tend to be family-owned companies or sole proprietorships, such as restaurants, dry cleaners, other retailers, and service firms. About half of such small businesses are sold through brokers. Most business brokerage firms sell different types of businesses. Some firms, however, specialize in one industry or a few industries.

One advantage of working with brokers to buy a business is that a broker can expose you to other businesses you may not have considered (a doughnut shop, for example, instead of a restaurant). Brokers can also share their knowledge with you — like the fact that you need to get up at 4 a.m. to make doughnuts.

The pitfalls of working with brokers include the following:

• Commission conflicts: Brokers aren’t your business advisors; they’re salespeople. That fact doesn’t necessarily make them corrupt or dishonest, but it does mean that their interests aren’t aligned with yours. Their goal is to do a deal and to do the deal as soon as possible. And the more you pay for your business, the more they make. Business brokers typically get paid 10 to 12 percent of the sales price of a business. Technically, the seller pays this fee, but as with real estate deals done through brokers, the buyer actually pays. Remember, if a broker isn’t involved, the seller can sell for a lower price and still clear more money, and the buyer is better off, too.
• Undesirable businesses: Problem businesses are everywhere, but a fair number end up with brokers when the owners encounter trouble selling on their own.
• Packaging: This problem relates to the preceding two. Brokers (who are on commission) help not-so-hot businesses look better than they really are. Doing so may involve lying, but more typically, it involves stretching the truth, omitting negatives, and hyping potential. (Owners who sell their businesses themselves may do these things as well.)

  You (and your advisors) need to perform due diligence on any business that you may buy. Never, ever trust or use the selling package that a broker prepares for a business as your sole source of information. Remember: Brokers as well as sellers may stretch the truth, lie, and commit fraud.

• Access to limited inventory: Unlike real estate brokers (who can access all homes listed with brokers for sale in an area through a shared listing service), a business broker can generally tell you only about his office’s listings. (Confidentiality is an issue because a shared listing service increases the number of people who can find out that a business is for sale and the particulars of the sale. This information may cause some customers to find another company to do business with and may lead some key employees to leave as well.)

  If you want to work with a business broker, use more than one. Working with a larger business brokerage firm or one that specializes in listing the type of business that you’re looking for can maximize the number of possible prospects that you see. Some state associations of business brokers share their listings. However, even in such states, some of the larger brokerages opt not to include themselves because they benefit less from sharing their information.

• Few licensing requirements: The business brokerage field isn’t tightly regulated. The majority of states have no requirements — anyone can hang out a shingle and work as a business broker. Some states allow those with securities brokerage licenses to operate as business brokers, whereas most states require real estate licenses.

Ask tax, legal, and business consultants for names of good brokers they may know. If you find a broker you’d like to work with, first check references from other buyers who have worked with that broker. Be sure the broker works full time and has solid experience. (Some business brokers dabble in the field part time and make a living in other ways.)

Ask the broker you’re interested in for the names of several buyers of similar businesses whom she’s worked with over the past six months. By narrowing down the field to the past six months and your particular business interest, the broker can’t just refer you to the three best deals of her career. Also, check whether anyone has filed complaints against the brokerage with the local Better Business Bureau, or BBB (although the BBB favors member companies and is less likely to entertain and retain complaints against members), and the state regulatory departments (real estate, attorney general, department of corporations, and so on) that oversee business brokers.

Considering a Franchise or Multilevel Marketing Company

Among the types of businesses that you may buy are franchises and multilevel marketing companies. Both of these types of businesses offer more of a prepackaged and defined system for running a business. Although both types may be worth your exploration, significant pitfalls can trip you up, especially with multilevel marketing companies.

Finding a franchise

Some companies expand their locations through selling replicas, or franchises, of their business. Purchasing a good franchise can be your ticket into the world of small-business ownership. When you purchase a franchise, you buy the local rights to a specified geographic territory to sell the company’s products or services under the company’s name and to use the company’s system of operation. In addition to an upfront franchisee fee, franchisers also typically charge an ongoing royalty.

Franchising makes up a huge part of the business world. Companies that franchise — such as McDonald’s, Pizza Hut, H&R Block, Jiffy Lube, 7-Eleven stores, Gymboree, Century 21 Real Estate, Holiday Inn, Avis, Subway, and Foot Locker — account for more than $1 trillion in sales annually.

Franchise advantages

When you purchase a new franchise, you don’t automatically have customers. As with starting a business, you must find your patrons. However, the parent company should have a track record and multiple locations with customers. (You can also purchase existing franchises from owners who want to sell, and these businesses come complete with customers.)

So why would you want to pay a good chunk of money to buy a business without customers?

• Proven business: A company that has been in business for a number of years and has successful franchisees proves the demand for the company’s products and services and shows that the company’s system for providing those products and services works. The company has worked out the bugs and has hopefully solved common problems. As a franchise owner, you benefit from and share in the experience that the parent company has gained over the years.
• Name-brand recognition: Some consumers recognize the company name of a larger and successful franchise company and may be more inclined to purchase its products and services. For example, some consumers feel more comfortable getting an oil change at franchiser Jiffy Lube rather than from a local Ollie’s Oil Changers. The comfort that comes from dealing with Jiffy Lube may stem from the influence of advertisements, recommendations of friends, or your own familiarity with their services in another part of the country. Most freestanding small businesses for sale in a community lack this name-brand recognition.
• Centralized purchasing power: You would hope and expect that Jiffy Lube, as a corporation made up of hundreds of locations, buys oil and other car supplies at a low price. (Volume purchasing generally leads to bigger discounts.) In addition to possibly saving franchisees money on supplies, the parent company can take the hassle out of figuring out where and how to purchase supplies. Again, most unattached small businesses that you could buy won’t offer this advantage. However, quality business associations can provide some of these benefits.

Franchise pitfalls

As with purchasing other small businesses, pitfalls abound in buying a franchise. Franchises aren’t for everyone. Here are some common problems that may cause you to reconsider buying a franchise:

• You’re not the franchise type. When you buy a franchise, you buy into an established system. People who like structure and following established rules and systems adapt more easily to the franchise life. But if you’re the creative sort who likes to experiment and change things, you may be an unhappy franchisee. Unlike starting your own business, where you can get into the game without investing lots of your time and money, buying a franchise that you end up not enjoying can make for an expensive learning experience.
• You may be locked in to buying overpriced supplies. Centralized, bulk purchasing through the corporate headquarters supposedly saves franchisees time and money on supplies and other expenditures. Some franchisers, however, take advantage of franchisees through large markups on proprietary items that franchisees must buy from the franchisers.
• The franchise is unproven. If the company’s concept hasn’t stood the test of time, don’t make yourself a guinea pig. Some franchisers show more interest in simply selling franchises to collect the upfront franchise money. Reputable franchisers want to help their franchisees succeed so they can collect an ongoing royalty from the franchisees’ sales.
• The franchise is a pyramid scheme. Unscrupulous, short-term-focused business owners sometimes attempt to franchise their businesses and sell as many franchises as they can as quickly as possible. Some push their franchisees to sell franchises. The business soon focuses on selling franchises rather than operating a business that sells a product or service well. In rare cases, franchisers engage in fraud and sell next to nothing, except the hopes of getting rich quick.

Evaluating a franchise

Make sure you do plenty of homework before you agree to buy a franchise. You may be tempted to cut corners when reviewing a franchise from a long-established company. Don’t. You may not be right for the specific franchise, or perhaps the “successful” company has mostly been good at keeping problems under wraps.

In “Evaluating a Small Business,” later in this chapter, I explain the homework you should complete prior to buying an existing business. That section is especially important if you want to purchase an existing franchise from another franchisee.

Considering a multilevel marketing company

A twist, and in most cases a bad one, on the franchising idea is multilevel marketing (MLM) companies. Sometimes known as network companies, MLM companies can be thought of as a poor person’s franchise. I know dozens of people, from clients I’ve worked with to students I’ve taught in my courses, who have been sorely disappointed with the money and time they’ve spent on MLM companies.

In companies that use multilevel marketing, representatives who work as independent contractors recruit new representatives, known in the industry as your downline, as well as solicit customers. For those weary of traditional jobs, the appeal of multilevel marketing is obvious. You can work at home, part time if you want. You have no employees. You don’t need any experience. Yet you’re told you can still make big bucks ($10,000, $25,000, $50,000, or more per month). If your parents raised you right, however, you should be skeptical of deals like these.

A big problem to watch out for when dealing with MLM companies is the business equivalent of the pyramid scheme — businesses that exist to sign up other people. Beware of MLM companies that advocate the following: “Sell directly to those that you have direct influence over. The system works great because you don’t need to resell month after month. It’s an opportunity for anybody — it’s up to that person how much work he wants to put into it.”

Any MLM company examination should start with the company’s product or service. How does its product or service stack up to the competition on price and quality? Contact the Better Business Bureau in the city where the MLM company is headquartered to see what kinds of complaints are on file.

The bottom line on any network marketing “opportunity” is to remember that it’s a job. No company is going to pay you a lot of money for little work. As with any other small-business venture, if you hope to earn a decent income, multilevel marketing opportunities require at least three to five years of low income to build up your business. Most people who pay to buy into networks make little money, and many quit and move on.

Also, think twice before you sign up relatives, friends, and co-workers — they’re often the first people network marketers encourage you to sell to. A danger in doing business with those people whom you have influence over is that you put your reputation and integrity on the line. You could be putting your friendships and family relations on the line as well.

Remember that due diligence requires digging for facts and talking to people who don’t have a bias or reason to sell to you. Do the homework that I recommend in the later section “Evaluating a Small Business.” Be skeptical of multilevel marketing systems, unless the company has a long track record and many people who are happy. In other words, assume that an MLM company isn’t worth pursuing until your extensive due diligence proves otherwise.

Evaluating a Small Business

If you put in many hours, you may eventually come across a business that interests and intrigues you so much that you consider purchasing it. As with purchasing a piece of real estate, major hurdles stand between you and ownership of the business. You need to inspect what you want to buy, negotiate a deal, and finalize a contract. When done correctly, these processes take a lot of time.

Doing due diligence

The American legal system presumes a person is innocent until a jury proves that person is guilty beyond a reasonable doubt. When you purchase a business, however, you must assume that the selling business owner is guilty of making the business appear better than what it is (and possibly of lying) until you prove otherwise with due diligence.

I don’t want to sound cynical, but a business owner can use more than a few tricks to make a business look more profitable, financially healthier, and more desirable than it really is. You can’t decide how much inspection or due diligence to conduct on a business based on your gut feelings.

Because you can’t guess which surprises hide in a business, you must dig for them. Until you prove to yourself beyond a reasonable doubt that these surprises don’t exist, don’t go through with a business purchase.

When you find a business you may want to purchase, you absolutely, positively must do your homework before you buy. However, just as with purchasing a home, you don’t want to expend buckets of money and time on detailed inspections until you can reach an agreement with the seller. What if the seller is unrealistic about what the business is worth? You need to perform the most serious, time-consuming, and costly due diligence after the seller has accepted your offer to purchase the business. Make such inspections a contingency in your purchase contract.

Ultimately, if you’re going to buy a business, you need to follow a plan similar to but likely shorter than the business plan I present in Chapter 13. Addressing such issues in a plan goes a long way toward helping you perform your due diligence.

Following are some additional questions you should answer about a business you’re contemplating purchasing (address as many of the questions as possible before you make your offer):

• Why is the owner selling? Ask the owner or the owner’s advisors why the owner wants to sell and why now. The answer may shed insight on the owner’s motivations and need to sell. Some owners want to bail when they see things getting worse.
• What is the value of the assets that you want to buy? This value includes not only equipment but also “soft” assets, such as the firm’s name and reputation with customers and suppliers, customer lists, patents, and so on. Interview key employees, customers, suppliers, advisors, and competitors. Ask key customers and key employees whether they would still be loyal to the business if you took it over.
• What do the financial statements reveal? Search for the same things that you would look for in a company whose stock you’re considering purchasing. (See Chapter 6 for information on how to read financial statements and what to look for.) Don’t take the financial statements at face value simply because they’re audited. The accountant who did the audit may be incompetent or chummy with the seller.

  One way to check for shenanigans is to ask the seller for a copy of the business’s tax returns. Owners are more likely to try to minimize reported revenue and maximize expenses on their tax return to keep from paying more tax. After your purchase offer is accepted, ask a tax advisor experienced in such matters to do an audit (see the “Questioning profits” sidebar in this chapter for more information).

• If the company leases its space, what does the lease contract say? A soon-to-expire lease at a low rate can ruin a business’s profit margins. With a retail location, the ability to maintain a good location is also vital. Check comparables — that is, what other similar locations lease for — to see whether the current lease rate is fair, and talk to the building owner to determine his plans for the building. Ask for and review (with the help of a legal advisor) the current owner’s lease contract.
• What liabilities, including those that may be hidden “off” the balance sheet, are you buying with a business? Limit liabilities, such as environmental contaminations, through a contract. Conduct legal searches for liens, litigation, and tax problems.
• What does a background check turn up on the owners and key employees? Do they have good business experience, or do they have criminal records and a trail of unpaid debts?

Determining a business’s value

After you find what you think is a good business and do your homework, you’re ready to make an offer. Negotiating done well takes time and patience. Unless you’re legally savvy, find an attorney who focuses her practice on small-business dealings. Have that attorney review and work with your contract. Also consider obtaining input from a qualified tax advisor.

Good advisors can help you inspect what you’re buying and look for red flags in the company’s financial statements. Advisors can also help structure the purchase to protect what you’re buying and to gain you maximum tax benefits. If you work with a business broker, use an attorney and accountant as well.

The price that a business is listed for is often in excess of — and sometimes grossly so — the business’s true worth. A smart homebuyer or real estate investor looks at comparable properties when he’s ready to make an offer. So you should do the same and look at what similar businesses have sold for as a starting point for valuing a business that you want to buy.

When you look at sales prices of comparable businesses, calculate how many times the companies’ earnings that these businesses sold for. (In Chapter 5, I discuss how the price/earnings ratio works for evaluating the value of larger, publicly traded companies.) Because they’re less well established and riskier from an investment standpoint, small, privately held businesses sell for a lower multiple of earnings than comparable but larger companies.

Some advisors and business brokers advocate calculating how many times revenue a company should sell for to determine the value of the business. Revenue is a poor proxy for profitability: Two businesses in the same field can have identical revenue yet quite different profitability because of how well they’re run, the pricing of their products and services, and the types of customers they attract.

In addition to looking at the sales price of other businesses relative to earnings, you can consider the value of a company’s assets. The so-called book value of a company’s assets is what the assets are worth per the company’s balance sheet. Check these figures to ensure that their asset values are correct. Another, more conservative way to value such assets is to consider the liquidation or replacement cost.