7 Clear Steps to Buying a Small Business
You’re ready to take the leap into the world of entrepreneurship, and you’ve decided to focus on digital assets.
It’s an exciting thought.
The digital asset boom that started during the COVID-19 pandemic is really just getting underway. With more forward-thinking entrepreneurs realizing that they can go into business for themselves while achieving both financial and personal freedom, it’s a great time to invest in a cash-flowing digital small business.
Unlike offline businesses, which could tie you to leases, or franchises, which can tie you to both a physical location and a strict corporate contract, online businesses give you the freedom to live and travel wherever you want while holding a profitable asset that could appreciate drastically in value.
In fact, we’ve seen buyers come through and scoop up high-potential assets on our marketplace and sell them months or years later for impressive ROIs.
But while the world of online business is exciting, fast-paced, and profitable, it can also be fraught with risks for buyers who jump in without looking first.
It’s easy to get caught up in the euphoria of the idea of owning your own business, which could end with you acquiring declining assets, losing capital from bad actors, or even investing in decent businesses that require more startup costs and time than you were willing to put in.
As a buyer, how can you protect yourself before investing?
Let’s take a look at what you need to know to buy a small business online and what you should be focusing on for a successful transaction.
Steps to Buying an Online Business Like a Pro
You wouldn’t invest your money in the stock market without carefully researching your options and performing due diligence, and the same holds true for investing in an existing online business.
The goal is to find what’s known as a turnkey business–one that is already off the ground and running and just needs you to take over the management to keep it going.
To make it easier to find your match, we’ve come up with the seven steps to follow:
- Find the perfect business
- Assess the value
- Do surface-level checks
- Consider deal structures
- Check your funding options
- Close the deal
- Conduct due diligence
Let’s break down each of these important steps to give you a springboard to investing in digital assets like a pro.
1. Find the right business
There’s no shortage of places you can look to find online businesses. They run the gamut from unregulated free-for-alls to white-glove service providers.
This might be the first step for someone new to the online business world. You can reach out to your personal and professional contacts and ask them if they have any leads, especially if they’re plugged into the digital entrepreneurship space.
Keep in mind that your contacts might not know these sellers personally, and the connection could lead to a false sense of trust and security. It’s vital to take an emotionally disengaged approach. Just because a contact sends you someone’s details doesn’t mean they’re personally recommending the seller or the business.
Falling into the trap of looking at it as a recommendation could end in fallouts and hard feelings if the deal goes wrong.
Public and private social media groups
These are often the go-tos for people who are new to the scene of selling or investing in digital assets. Part of the reason for this is that there is a low barrier to entry for these groups, and they’re usually free and easy to use.
But there are serious risks involved for both buyers and sellers with these transactions due to the ease of advertising businesses this way.
As a buyer, you can’t be sure that the seller is who they say they are or whether the business is legitimate (or legitimately owned by the seller).
The benefit of free groups like this, though, is that they can give you a general feel for what you might be able to invest in when you find the right business.
These are the equivalent of online for sale by owner (FSBO) classified ads. Any business owner can put a business up for sale on one of these sites.
Some of these marketplaces charge a fee to list a site, while others rely on advertising revenue or commissions from sales.
The drawback for buyers is that no one is verifying that the information provided by sellers is accurate. This puts a heavier due diligence burden on the buyer after negotiating a deal.
Semi-regulated marketplaces tend to give a little more information on listings than completely unregulated marketplaces, but they’re not beacons of transparency.
For example, there might be a small amount of built-in analytics attached to the listing that can’t be altered by business owners, but there’s very little aside from that to guide buyers to solid businesses or to help them post-sale.
A brokerage offers more assistance and typically higher-quality businesses than most marketplaces.
Every brokerage is different as far as the range of services they offer. Some might research sellers before agreeing to list their businesses, some offer buyers guidance during negotiations, and some offer advice and recommendations for post-sale services.
Although the types of services may vary among brokerages, their ultimate goal is to facilitate transactions for both buyers and sellers.
You might have heard this phrase before, but what does it mean?
A curated marketplace is a step up from both traditional marketplaces and typical brokerages. Along with advocating for both buyers and sellers, a curated marketplace also puts checks in place to make sure that businesses are up to standard and perform the way sellers say they are before they agree to list the site.
They also have a verified customer base to make sure all clients are who they say they are and can actually put up the necessary funds to buy the businesses they’re interested in.
Premium curated marketplaces handle business transactions from beginning to end, providing assistance across nearly every aspect of the deal.
2. Assess the Value
When you’re looking at the listing price of a business, whether it’s an accurate figure depends on a lot of factors.
If you’re shopping for an investment in private groups or on social media, there’s no way to tell from the get-go whether the business valuation is accurate. Seller emotions can drive them to expect more for an underperforming asset, because they feel a strong connection to the business that has helped them achieve important financial and personal goals.
Inexperienced sellers may also use comparison prices to list their businesses. This is a slippery slope for a lot of sellers, because comparison prices don’t account for various factors that could separate their businesses from those of other owners.
Business valuations are more of an art than a science, and it takes a certain finesse to get them right straight away.
The initial valuation formula that we use is straightforward. We use the average monthly net profit × multiple.
It looks easy enough, because the average monthly net profit is relatively simple to calculate. However, the final figure depends on the addbacks, or various one-off costs, that a seller might include to reach a higher average net profit.
Justifying addbacks can lead to a lot of tension during the negotiations and due diligence phases. Sometimes it’s easier for an unbiased third party to examine the business’ financials to see whether certain addbacks are justified.
Coming up with a multiple is a little more involved. There are numerous things that can affect the multiple of a business. The exact factors depend on the monetization method of the business, but they broadly include the age of the business, its defensibility, its brand recognition, its additional assets, and its revenue diversification.
If you’ve never valued a business before, it’s smart to get an expert involved. You might be looking at an additional cost, but it could save you from paying more than a business is worth or from losing out on a business you really want because of a lowball offer.
We have loads of resources on valuing different types of business models:
3. Do surface-level checks
You won’t want to contact the seller of every potentially interesting business you come across. Put some surface-level checks in place that can help you eliminate some listings and push others through to more comprehensive checks later.
So, what should you look for?
Although it might not be a deal breaker for you, having some knowledge of the industry or niche can make things a lot easier as you try to scale the business.
That’s not to say you need years of experience in the field behind you, but you should have more than a passing interest in it. Afterwards, you can leverage your existing know-how and passion to scale the company faster.
Set a realistic budget before you start window shopping. Remember that unlike other forms of investment, investing in a business, whether online or offline, will come with immediate expenses.
So, if you’ve got $100K to invest, set realistic limits on what you’re willing to spend upfront so you have enough capital to fuel growth in the beginning.
Beware of relying on external financing as you’re setting your budget. If you can secure it, great! But unless you already have financing in the bag, basing your budget on financing that can fall through at the last minute could set you up for failure almost immediately.
Ideally, you want a successful business that already has a positive cash flow and shows stability. There are certain business models that rely more heavily on projected performance (such as SaaS businesses), but the rule of thumb is that you want to see evidence that the business has a history of producing a profit.
The one exception to this might be if you’re looking for a fire sale. These are usually companies that show a lot of promise but are being sold at a heavy discount due to downward treads brought on by easily fixable elements (poor management, inefficient logistics, etc.).
What is the growth potential of the business? For example, you might find a killer site in a trendy niche with excellent financials. But what happens if that trend goes bust in the next year?
It’s great to have a popular product line. Just make sure there’s plenty of room to scale the business in the future.
One of the biggest advantages of digital assets from a buyer’s perspective is that you’re not taking on real estate liabilities or leases from the current owner. But that doesn’t mean online businesses always come with zero liability.
Some small business owners take out loans from a variety of sources. For example, an Amazon FBA seller might have a line of credit from Amazon that is tied directly to their Seller Central account.
Others might have third-party inventory loans. If money is owned and tied to the business account, or if there is a lien on any physical assets, such as inventory, you need to be aware.
Certain types of online businesses, such as affiliate sites, may come with promotional offers that can’t be transferred.
If the current owner has premium relationships or accounts with affiliates, suppliers, contractors, or anyone else associated with the business, you need to find out if those can be transferred. If they can’t, you’ll have to consider how much it will affect your bottom line as the new owner if you get rid of them.
When glancing over high-level data, look for revenue consistency and diversity. For example, in ecommerce businesses, having what are known as hero products is normal, but you don’t want to see a single hero product bringing in 90% of revenue. That essentially puts you at the mercy of the stability, popularity, and availability of a single product.
The same holds true for content sites that have a single affiliate. Although the commissions could be great, it still comes with a higher degree of risk that could severely affect your profits in the future.
If you use marketplaces with verified data graphs, watch out for a common scam. You’ll see sellers with relatively new sites that have extreme spikes in revenue in the month or two immediately prior to the sale.
It’s the ecommerce equivalent of a pump-and-dump scheme. Sellers invest just enough in inventory to get the business off the ground and show extreme sales in the first few months. Buyers think they’re coming in on the ground floor of a gold mine.
What they’re not seeing is there’s no more inventory, and the products could have been purchased by the seller or associates of the seller and then charged back. The buyer is left with a worthless business that looked great on paper.
Once you’ve found a potential small business that passes your surface-level checks, it’s essential that you talk to the current owner. Ask why they’re selling, what sort of business plan they currently have in place, what they see as growth opportunities, and how much support they’re willing to offer a new owner.
It’s tempting to think you could do business with anyone and that your “business is business” approach can see you through even the most challenging transactions. But remember that you’ll have to work with the previous owner for a period of time until you’re up and running.
You don’t want to end up working with someone who makes you uncomfortable or who raises red flags.
4. Look into Deal Structures
We’ve talked a little bit about how important it is to set a realistic budget, and before you find your ideal business, you need a plan in place to pay for it.
Most people focus on purchase price, but payment is an essential part of negotiating that price. If you play your hand right, you can use a deal structure as leverage to entice a seller to accept your offer. This is especially true if you find yourself in competition for a high-quality site with buyers clamoring to make attractive offers.
So what are the types of deal structures you can typically expect to see with an online business acquisition?
An earnout is essentially profit sharing for a period of time. You can offer the seller X amount upfront, combined with a percentage-based earnout tied to performance. If business profits grow by a specified amount over a specified period of time, a percentage of those profits goes to the seller.
There is often more expected seller involvement post-sale with earnouts, as the seller has some skin in the game.
Stability payments are payments made after a specified period of time, as long as the business continues to perform at current or expected levels.
For example, if you find a great business listed at $200K, you might offer $150K upfront and two stability payments of $10K each–one after 6 months and one after 12 months, contingent upon the stability of the business.
Seller financing is where the seller acts as a lender. After agreeing to a total purchase price, you might be required to pay around 75% of the purchase price upfront, with the remaining payments due as either one lump-sum payment or a series of recurring payments.
It’s a great way for buyers to get low-cost or zero-percent financing, but remember that seller financing is not dependent on the stability or growth of the business. If the business declines while you have it, you are still legally obligated to pay the remaining balance.
5. Check Your Funding Options
If you can’t or don’t want to negotiate a deal structure, there are other financing options available to you.
If you own real estate, you always have the option to use a home equity line of credit (HELOC) or other physical collateral to secure a personal loan.
You might even be able to tap into your retirement account using programs such as Rollover for Business Startups.
Getting more traditional types of business financing without putting up significant and risky collateral used to be nearly impossible. A big reason for this is that established businesses online often deal with intangible assets.
We’ve seen firsthand that financing through the Small Business Administration (SBA) rarely works for online small businesses, which is why we decided to discontinue SBA loans as part of our buyer funds verification process.
Seeing a serious gap in the marketplace inspired some players to enter and start easing the burden for buyers. Now there is an increasing number of companies willing to work with buyers who specifically want to invest in digital assets.
They can help with very specific types of small business loans, such as inventory purchases. Some are even willing to help fund the entire purchase.
The process is slightly different than going through a traditional lender, which can eliminate some of the red tape and time spent waiting for a decision.
6. Close the Deal
Once you’ve found the perfect business, it’s time to close the deal.
Negotiations can be complicated with online businesses for a number of reasons. Just as an example, if you’re approaching a seller with an offer that includes a deal structure or external financing, they might be hesitant to accept the offer for fear that the deal will fall through or that they won’t see their money in the future.
While negotiations are always best approached with a clear, logical head, it helps to understand where sellers are coming from. In their eyes, they’ve spent a lot of time and effort building this profitable business, and they might have significant emotional attachment to it.
This can make negotiations tricky, because while a buyer might feel like they’re offering a fair price for a business based on their own research and understanding, a seller might feel insulted by anything less than full price, whether that’s realistic or not.
Even slight misunderstandings can cause what otherwise would have been a great deal to break down irreparably.
Approach negotiations with both logic and compassion for the highest chances of success. For example, giving the current owner a concrete business plan showing your ideas for the kind of business you’re hoping to grow can instill greater confidence and allay fears about future payouts.
7. Conduct Due Diligence
Once you have a sales agreement in place, you can submit a letter of intent (LOI). This will give you access to the business’ financial statements so you can start verifying the information and conducting due diligence.
Although an LOI isn’t legally binding, it will normally be necessary in order to access private details about the business, especially if you’re buying assets on public platforms. Sellers will understandably want to protect their assets and will normally require some sort of confidentiality agreement or an LOI before handing over their financial information.
This is the point when you really start digging into the specifics of the business to make sure everything is in order. You’ll want to ask for at least three years’ worth of business tax returns or certified balance sheets. If the business is younger than that, ask for everything available since it was started.
If you haven’t had a chance to talk to the seller in depth, you’ll want to do that now. Get to know them, ask why they’re selling the business, and find out whether anything has happened while they’ve been running the business that you need to be aware of, such as negative impacts from algorithm updates or penalties received on ecommerce platforms.
This is the period of time when you’re examining all of the warts a business might have up close and deciding whether it’s the right one for you.
During this time, it’s helpful to have outside counsel look over legal documents and a trusted certified public accountant (CPA) check all the cash flow statements.
An Easier Way to Buy an Online Business
Investing in a cash-flowing business is one of the biggest financial decisions you’ll make. There’s a lot that goes into the process, from finding high-quality prospects to making sure the business checks out to handing over assets and funds at the end.
It’s entirely possible to do this privately, but with so much capital on the line, why would you leave yourself open to greater risk?
As a buyer, you have everything to gain by accessing a curated marketplace run by experienced business brokers who can work with you to find the perfect business for your needs.
Instead of spending countless hours hunting down potential businesses, imagine how much simpler it would be to schedule a call with one of our business advisors. They can work with you to figure out your budget, your goals, and your niche interests.
Our unlock system makes it so you don’t have to sign an LOI with each seller before being able to conduct due diligence, which means you’re in a better position to negotiate a fair offer.
Taking that first exciting step toward entrepreneurship and financial freedom has never been easier!