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Advantages and disadvantages of buying an existing business

Here is a table setting out some of the advantages and disadvantages of purchasing an existing business (as compared with starting a new business from scratch).

You will note, incidentally, that many of the comments in the “disadvantages” column underscore the importance of carrying out a thorough due diligence investigation when buying an existing business.

Advantages

Disadvantages
Goodwill

One of the major advantages to purchasing an existing business is that you get the benefit of the customer base, name recognition and other goodwill of the existing business.

If, for any reason, the existing business has a poor reputation in some respect, then you may inherit this as well when you buy the business – especially if you continue to trade under the same name.

Employees

You may get a set of experienced and capable employees, eliminating or reducing the need for you to interview and hire a lot of new employees.

You may get employees who are not necessarily people you would have selected.  You might also inherit problems with employees, such as disputes with particular individuals, unreasonable expectations as to pay and working conditions, or trade union issues.

Supplier relationships

You could get the advantage of favourable credit terms from suppliers who have a long-standing relationship with the business. In addition, suppliers may have a good understanding of the specifications for goods supplied and the other needs of the business.

There may be supplier relationships that are not so good, or key suppliers that have had bad experiences with the business in the past and therefore offer worse credit terms than they would offer to a start-up. Or suppliers offering good terms might want to re-negotiate on the change of ownership.

Banking and other financing arrangements

Although banks frequently will require that a business re-negotiate its credit arrangements on a change of ownership (even where the transaction is a share purchase rather than an asset purchase), the fact that the business has an earnings track record will likely make it easier to get better financing arrangements than a start-up business could obtain.

You could find that the business has a poor reputation amongst lenders.

Other credit arrangements (equipment hire-purchase, etc)

As with banking arrangements, the fact that an existing business has a track record may help you in procuring equipment financing, invoice discounting and other arrangements. In some circumstances, you may be able to keep existing arrangements in place after you buy the business.

The business could have a black mark with certain finance providers.

Liabilities: trade creditors

If the business has a good record of paying trade creditors, you will get the benefit of that.

If the business has a record or late payment, disputes and default in payment to trade creditors, you will inherit it.

Liabilities: debts, pending litigation

If you are purchasing the business in an asset deal (rather than buying a company) and have carried out good due diligence, you should be able to insulate yourself from any liabilities associated with the business prior to your period of ownership. To give the buyer added protection, sometimes a business purchase agreement will require the seller to indemnify the buyer against any such liabilities, and a part of the purchase price might be withheld by the buyer for a period after completion – in order to provide security for that indemnity.

If you buy an existing business by purchasing a trading company (rather than just the assets of the business) then the company you purchase will continue to have all of the liabilities it had prior to your purchase. Ordinarily, the buyer will ask the seller to disclose all such liabilities, and the buyer will have a claim against the seller for any undisclosed liabilities that surface after the transaction completes. Without adequate protection, though, the buyer could, in effect, end up with responsibility for liabilities that the business incurred prior to the date the buyer purchased the business.

Premises

For a variety of reasons, there can be significant benefits in taking over existing premises rather than finding a new site for a start-up business. A solicitor can advise you as to the details.

Leases can be full of traps for the unwary. If you are taking over a leasehold or other premises occupied by the business you are purchasing, you should get detailed legal advice as to the responsibilities of the business in relation to such premises, including rent, service charges, dilapidations and other matters.

Stock

An existing business is likely to have sufficient stock to meet its near-term requirements, and as a buyer you may be able to negotiate an attractive price for the stock.

The value of stock may not be as it appears. Some stock could be old, damaged, obsolete or otherwise non-saleable. Where the stock represents a significant part of what the buyer is purchasing, a stock-take at completion is usually sensible – with an understanding that there will be a reduction in price for stock that is not likely to be useable or saleable.

Equipment / Vehicles

An existing business will likely have the equipment and/or vehicles and other capital items required for the operation of the business – although it will be important to agree on the value of such of items for purposes of the depreciation that will be available to you, as buyer. If the sale is a “transfer as a going concern” it is likely that you will not have to pay VAT on such items.

The equipment, vehicles, etc owned by the existing business may be worn out or poorly maintained. Also, it may be difficult to establish a value for each such item.

Regulatory Consents

If the business requires some form of regulatory consent in order to operate, then the consent held by the existing business might – in some cases – be assignable or transferable or might continue to be valid despite a change in control.

Regulatory consents might not be assignable, so you will have to obtain new ones. In addition, the business you are purchasing might have a poor compliance record – which you will inherit.

VAT registration

If you purchase a limited company that operates the business, you will likely take over the existing VAT number of the entity. If, however, you simply purchase the assets of the business (not the entity) then you will need to register the business for VAT.

If you purchase the entity and take over its VAT registration, you may find that there are irregularities or liabilities associated with the entity’s VAT account that the seller did not disclose to you.

Tax “assets”

If you purchase a limited company that operates the business, you will get the advantage of any built-in tax assets, such as accumulated losses, depreciation, amortisation, etc. If you simply purchase the assets of the business, you will be able to depreciate certain assets based on the price allocated to them – but you will not get the benefit of losses and similar tax “assets” that belong to the seller.

The “tax assets” of a limited company that you purchase may be of little or no value to you, and in any event if you start a new business you will get depreciation on equipment and certain other capital items that you might purchase when you start the business.

Book debts

Sometimes as the purchaser of an ongoing business, you will get the benefit of uncollected book debts – generally the terms on which you do so are negotiated as part of the transaction. The ability to collect some of the existing book debts for your own account might help you generate cash shortly after you buy the business – rather than having to wait until you generate your own invoices and collect them.

The seller’s debtor book may be full of debts that are old or otherwise difficult to collect, and therefore could end up yielding little cash.

Non-competition

Frequently, the purchaser of an existing business will get the benefit of a non-compete covenant from the seller (since the value of the goodwill the buyer is purchasing could be seriously undermined if the seller were to continue to trade in the same type of business).  Even in a crowded marketplace, the non-compete covenant will remove at least one potential competitor.

Non-compete clauses can be difficult to enforce, and must be carefully drawn if they are to be enforceable.

Source:
FindLaw
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buying a business
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