Many buyers of small business are dismayed by the money they have to pay to buy an existing business. They think that they can build the same business from scratch at a much lower cost. And this is true. To understand why this is the case you need to know the concept of book value of a business versus its market value. Book value refers to the money you can get if you sell all of the business assets in the market. The market value is usually higher than book value and is a result of goodwill that is associated with the existing business. It is this goodwill that the buyers of existing business are paying extra for. The goodwill is a result of all the work that existing owner has done to bring the business to its current level.
While it is true that you can build a business from scratch at a lower cost; it comes with its own set of problems. You have to understand both sides of the buy vs. build equation before making a decision. Below we have highlighted pros and cons of buying an existing business as opposed to building a new one. You can make your decision after studying this and looking at your own situation.
Pros
- By buying an existing business you avoid the mountain of hassle associated with building a new one. There is a tremendous amount of work that goes into building a business ranging from real estate, construction, legal, purchasing, products, marketing and so on. We know! We have been there!
- Existing business has proven itself in the market by operating for a number of years. In general, it is risky to bring a new concept or business to the market and make it successful. In addition to paying the goodwill you are paying someone to avoid this risk.
- You are able to get all the contacts the existing business owner has established. These range from suppliers, customers, marketing and so on.
- In many cases the previous owner will be willing to help you get up and running after you have bought the business. This handholding can be a big help in the early days.
- The biggest reason to buy an existing business is that it gives a low-risk and easier entry point for someone who has never owned a business.
Cons
- As we already mentioned earlier you have to pay more money towards goodwill when buying an existing business.
- There exists a danger of buying the business at its peak and paying lot more. After all, why the existing business owner would be selling if there is still potential left in the business. This goes against the conventional wisdom of buying low and selling high.
- You may end up with liabilities of previous owner if you are not careful. Be sure to seek lawyer’s advice before signing the closing papers to avoid this huge risk.
- You are likely to inherit the “bad will” along with “good will” when buying an existing business. If the previous owner had bad reputation with customers or suppliers they will become your problem afterwards.
- Finally, you just don’t know what you don’t know. There may be skeletons hidden in the closet that you will find out only after you have bought the business and operate for a while.
Our bottom line advice is this. If you do not have earlier experience in owning a business; go with buying an existing one. But make sure you seek advice from lawyers, accountants and any other friend who has been there. Also, do not become emotionally attached to the business you are planning to buy; otherwise you will end up paying more than it is worth.
Do you have experience in buying existing business or building a new one? What are your thoughts?
Great article thanks for sharing.