A second-generation entrepreneur in the construction industry is not inclined to join the family business. He would rather start his own. However, his previous start up venture failed, and this time around he would like to buy a running business.
A seed production company is looking to leverage its expertise in agri-related businesses and is interested in buying companies in the food processing industry.
A Mumbai based waste management company is looking to acquire similar companies in South India to increase its market.
Just three examples, but which show the variety of reasons entrepreneurs may want to buy businesses – gaining access to clients, boosting their current business, and simply, improving their chances of success.
Let’s take a closer look at the reasons for buying a business…
- The existing business comes with its infrastructure/team and clients, thus saving you the time it would take to build all these. Given that chances of survival and success of a new businesses are less than 10 per cent in India, buying an existing business may be a less risky proposition.
- In some industries, obtaining regulatory approvals or large contracts may be cumbersome and time-consuming. Here, a new company is better off buying an existing business. For example, for an entrepreneur looking to start an environment testing lab, acquisition of a National Accreditation Board for Testing and Calibration Laboratories (NABL) certified lab1 would be attractive, as such certification takes more than a year to obtain. Similarly, businesses that have long term contracts with large institutions such as Indian Railways or defence organisations would be attractive as the process of empanelment with these organisations can be very cumbersome.
- You may not have the know-how required run a new line of business and buying a business would give you access to the expertise. For example, you could be interested in renewables such as wind energy, biogas, which require very specialized expertise.
- The new business complements your existing business and you can sell its products to your existing customers. For example, you could be in the business of selling irrigation equipment to farmers and would like to acquire businesses that sell organic fertilisers.
The process of buying a business can be long and overwhelming, requiring a long search process, followed by legal, financial due diligence and obtaining financing for the acquisition. The following steps may help you to move forward quickly.
- Understand your motive for purchasing a new business: The motives for investing in a business can vary from the need to own and operate a business to earning a steady income and appreciation in the value of your investment. The desire to own and operate a business can be very strong, if you come from a business family and are not keen on joining a family business. In such a case, the business must be selected based on your strengths, location, budget etc., as described in the document. If you are looking at purchasing a business as an investment, the task is much simpler because the angel investing eco system is getting organised in India and is facilitated through several angel networks, colleges and incubators.
- Select the sectors you are looking to invest in: Knowing what business is right for you is perhaps the most important aspect of investing in a business. Having clarity on the sector as well as your expertise is a good first step in the process of selecting a business, as it would help you narrow down your choices and simplify the process of evaluation.
The key to identifying right business starts with understanding your expertise, experience, and interest which can add value to the business. For example, say you have experience in selling pharmaceuticals – you may want to look at companies in nutraceutical/pharma sectors, so that you can leverage your familiarity with the sector. Are you are interested in solving problems related to the environment? Does lack of access to drinking water in India seem like an opportunity to you? Then, you may want to explore companies that are in the business of water recycling.
- Assess your budget: Buying a business can be the most important financial decision in your life, not only because of considerable expense at the time of buying but also while running and growing the business. Therefore, it is important to assess the total outlay/budget that you can keep aside for the transaction and evaluate your funding options. If you are planning to liquidate your other assets to finance the purchase, you should estimate the time required for liquidation as well as value of the assets.
Financing by a bank would depend on your credit profile, nature of business being bought and ability of the business to generate enough cash so that it can service the debt. Banks would find it easier to finance the purchase, if the consideration is towards assets whose value can be ascertained easily. For example, if you are purchasing a food product company and the majority of purchase value is towards the brand, banks may not be willing to fund such a transaction.
- Find a relevant business: This is the most difficult part, as many businesses that may be looking to sell do not openly talk about it, fearing loss of reputation. However, once you have decided on the sector, you can reach out to various stakeholders including machinery suppliers, technical consultants, bankers etc., who may be aware of businesses that are available for sale.
You can also directly contact businesses that you are interested in. The database of such businesses can be found from the local industry associations. Additionally, there are a number of online market places for local businesses that are on sale.
- Evaluate the business: It is important to evaluate the reason for the owner to sell the business. Is it because they are unable to mobilise additional capital to meet their growth needs, or because market prospects for their products/services are declining? Sometimes founders want to focus their energies on other ventures or retire from the business. The key questions that you need to get addressed should include:
- Is the product/service relevant to the market in the short-medium and long run?
- What is the cost of manufacturing and sale of goods as compared to its selling price?
- What skills does it need to run the business; are those exclusively with the owner, and will you be able to get those skills in the market?
- What will you bring that will make the business more profitable?
- Does the business come with land and are you interested in buying the land?
- What are the liabilities of the business – sometimes the liabilities may not reflect on the company’s books as the owner may have taken unsecured loans (from friends/family) and promised them a share in the business.
- Do you want to buy a business or just its assets? Typically, if a business has huge liabilities and is being sued by its creditors, its assets would be sold separately. For example, many banks sell the assets of their borrowers that have turned into non-performing assets.
Additionally, you can develop your own filters for evaluating a business – for example you can consider businesses that have been existing for at least three years, sell their products to other businesses (and not in the retail market) and do not have more than 50 employees.
- Value the business: Valuation of a business would depend on a number of factors, but most important would be its ability to generate cash flows in the future and the amount of capital it needs to grow the business to the next level. The value would also be a function of its customer base and share of revenue from repeat orders. For example, a cold storage company with regular rental income from its existing projects is less risky than a recycled plastic pallet manufacturing facility that sells its pallets to only one large customer.
The value/price of the opportunity is also a function of who among buyer and seller needs the deal to take place urgently.
- Obtain financing and close the deal: Once you have informally agreed to buying a business, a letter of intent specifying your desire to buy the business, subject to completion of due diligence is typically provided. This covers several aspects such as compliance to various laws and verification of financial statements.
In the meanwhile, financing for the sale must be arranged through a bank loan or your own resources. Even if bank financing is available, you would still need to contribute at least 25-35% of the purchase consideration.
On completion of due diligence, a sale deed is signed indicating transfer of the business to the buyer and sale consideration. You may also want to insist on a non-compete agreement and minimum handholding for a year by the existing owner.
Buying a business is very different from buying real estate, where negotiation is largely restricted to property value. The process of purchase of a business requires wide-ranging skills including understanding seller motivation/expectations, business valuation, negotiation and obtaining financing. We suggest that you hire professional services to successfully close the deal.
How can we help?
We are an advisory firm for small and medium enterprises in green industries. We can help you evaluate the viability of your proposed green venture and assist you in raising funds for growing your business. If you are looking to purchase or sell your business, we can help you identify the right buyer/seller and hand hold you throughout the transaction.If interested, please get in touch with us at firstname.lastname@example.org We look forward to helping you negotiate your path to a successful SME business!