Buying a Small Business: What To Ask First
Roe Belzer
The business world is at a tipping point: Retiring baby boomers will dispose of 12 million businesses in the next two decades. At the same time, individuals across generations are seeking new challenges, new locations, work that aligns with their values and myriad other reasons to restructure their careers. For many, this means purchasing a small business.
From CPA firms to contracting businesses, physician practices and dental offices to restaurants and everything in between, companies are up for acquisition. This trend presents significant opportunities for prospective buyers, but it also necessitates a thorough understanding of how to evaluate the readiness of both the business and the buyer.
As a prospective buyer, these nuances are crucial to a smooth transition and the business's continued success. When evaluating a potential acquisition, buyers should look beyond financial statements to assess whether all elements are in place for a seamless handover.
This article explores four key questions buyers will want to consider before purchasing a small business, from their own financial readiness to industry conditions and potential disrupters.
Factors to Consider When Evaluating the Purchase of a Small Business
Do you have relevant experience?
Buying a business opens up a whole new world for a buyer. Unfortunately, when it’s not a good fit, the failure rate can be very high. It’s important to consider your direct or relatable experience that qualifies you to run a business in a given industry. If you are buying an engineering firm, how does your background support the future success of that business? Are you an engineer? Have you worked in an adjacent industry? What expertise are you bringing to the company to lead it going forward?
What are the company’s financials and why are they selling?
First and foremost, is the company profitable? Then, evaluate the revenue trends and whether they’re moving in the right direction. This assessment can reinforce or contradict your understanding of why the current owners are selling. Is the company failing, or is it simply a matter of the previous owners retiring and exercising their exit strategy?
Diving deeper, how are the sales and earnings, and how do those margins compare to the rest of the industry? With many potential buyers purchasing their first small business, there are many third parties that can help with this evaluation. Options range from the Small Business Administration to business valuation appraisers, lawyers and CPAs. Your Alliance Bank of Arizona relationship banker can offer valuable insights into your company's financial health, economic trends, and industry conditions, aiding in maximizing acquisition opportunities.
What is your financial readiness?
When evaluating small business acquisition financing, banks focus on three primary financial measures:
1. Cash Flow and Liquidity
Cash flow is a critical indicator of a business's health, reflecting management's ability to generate value through sound financial decisions. A bank's primary focus is assessing a company's cash flow to evaluate its ability to meet financial obligations, including debt repayment. Strong liquidity, represented by cash and cash equivalents, indicates a company's capacity to handle short-term liabilities and withstand both economic uncertainties and business fluctuations.
2. Collateral
Collateral, such as real estate, inventory, machinery, and equipment, can secure business financing. Banks assess these assets to determine how reliable these assets are to support repayment of the business loan should cash flow become insufficient.
3. Guarantor Support
As a final factor, banks evaluate personal guarantors — in this case, you as a buyer. For this piece, it’s important to consider your complete financial picture. What is your net worth? Does your FICO score reflect your responsible borrowing history? Do you have cash savings in the bank? Do you have real estate assets that could potentially be pledged as collateral. Do you have other businesses sources of income? Essentially, what is your ability to support the repayment of the business loan if the need arises?
Is the industry at risk of being disrupted?
For any small business, it’s important to think 10-15 years down the road and consider the risk of the industry being disrupted in that time frame. For example, the communications industry has moved from phone calls to video calls and AI technology that can transcribe conversations. Consider the term of your loan, and the health of the industry over the duration of that loan, to feel confident about the continued success of your small business and ability to repay the loan.
Financing Options for Acquiring a Small Business
Once you have decided to purchase a small business, multiple financing options exist. SBA 7(a) loans through Alliance Bank of Arizona can finance acquisitions up to $5 million, with down payments as low as 10%. Conventional loans provide more experienced sellers with an array of options in terms of structuring, whether by incorporating seller financing or other creative solutions such as using 401(k) or IRA money on a tax and penalty-free basis to raise capital for your next acquisition opportunity.
To learn more about how Alliance Bank of Arizona can help support your small business acquisition, connect with a small business banker today.
Alliance Bank of Arizona
Alliance Bank of Arizona, a division of Western Alliance Bank, Member FDIC, delivers relationship banking that puts clients at the center of everything. Founded in 2003, Alliance Bank of Arizona offers a full spectrum of tailored commercial banking solutions delivered with outstanding service. With offices in Greater Phoenix, Tucson and Flagstaff, Alliance Bank of Arizona is part of Western Alliance Bancorporation, the largest locally headquartered banking company in Arizona, with more than $80 billion in assets. Major accolades include being ranked as a top U.S. bank in 2024 by American Banker and Bank Director. As a regional bank with significant national capabilities, Alliance Bank of Arizona delivers the reach, resources and local market expertise that make a difference for customers.
