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Buying an Existing Company – The Risk and Reward

Module 10-: When you are planning to break into a new market as an entrepreneur, you have two options: either you start a new business from scratch or you buy an established business in that market. Which is the better of the two options? Well, most debates on that subject among business experts end up in a ‘stalemate’. So, it’s all about each individual’s goals and preferences.

Now, whether you are opting to start a business or buy an existing one, it involves some element of risk and reward. However, this post discusses the risks and rewards of buying an existing business. If you are planning to make the ‘smart’ decision to buy an established or distressed business, read on to understand the likely benefits you will gain from the decision as well as the risks it entails.

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The Risk of Buying a Business

1. Integral ownership-: The original owner of the business you are buying might be too vital to the business that he’s just inseparable from the business. Yes, this happens, especially in businesses that render services, and the implication is that the business starts to head for the rocks as soon as the seller withdraws his involvement. If you buy such a business, the only you can do to make it survive is to continue with the original owner on board, which is usually not possible.

2. Unfavorable effects of changes-: Not only humans are resistant to change; businesses are, too. Once you take over the control of a new business, you will need to make same changes, no matter how slight. But the truth is that it will take time before your employees and customers can get used to those changes. And it’s normal. They have known and worked with the business for years and are familiar with the culture and even the original management. So, a sudden change in those will sure have a negative effect on the new business. Sometimes, the change could cause permanent damages to a business.

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3. Hidden debts-: If you throw away common sense or your due diligence isn’t thorough enough, you will see only the tip of the iceberg. That is, you will know only little about the business you are buying—and that little is the sweet, bright side. But once you take over the business, the ugly, dark sides will become obvious to you. This is what happens to many entrepreneurs who only ask to see the profit and loss records and cashflow statement while leaving out the debts and loans.

4. Transferred losses and liabilities-: Buying a new business means you will be acquiring both the positives and negatives of the business. So, you will be taking charge of both the assets and losses of the business. Sometimes, you risk finding no way to control the losses, such that the business folds up eventually. Similarly, your due diligence might not reveal certain immense liabilities, such as equipment that require huge maintenance costs. Similarly, there may be huge costs associated with waste disposal and other activities of the company.

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5. Competition-: There’s hardly a way to measure the impact of the competition on a business. Even if you are able to achieve that now, things will have changed in the future because competition, like business itself, is a dynamic factor. If the business you are buying is ahead of its competitors, it might start lagging behind once you take over, for varying reasons. It has happened to even some of the world’s biggest brands.

The Reward of Buying a Business

a. Less overall risk-: Buying a business is usually cheaper that setting it up from scratch, so it’s less risky. For example, buying an established business with an asking price of $1 million and consistent annual cash flow of $350,000 is better than paying $250,000 to finance a startup, where projections may or may not be realized. In fact, a bank or other loan-issuing institution will more likely borrow you money to finance the purchase of an existing business.

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b. Established infrastructure-: When you buy a business, you can immediately focus your energy on running and growing it. The seller has already taking care of the major tasks associated with starting the business. They have already built the infrastructure with necessary operational facilities like computers, phone systems, machines, and furniture. This alone takes a lot of time and money, and it doesn’t always generate immediate cash flow.

c. Established stakeholders-: Employees and customers are the most vital elements of a business. When you buy a new business, you have these elements already taken care of. The seller has already hired dedicated and talented employees and has already built a large customer base. So, the cost of doing all these won’t be on your budget anymore, though marketing should a continuous thing.

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d. Instant returns-: One problem with starting a business from scratch is the long period it takes for sales and profit to start coming in at impressive rates. But this lag is eliminated when you buy an established business because you already have customers and employees. So, you can start earning from a purchased business immediately, unless you overhaul all aspects of the business completely.