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Buying a Business

The following are extracts from 'Buying a Business' - Factors to Consider.

This booklet is a guide for people who are contemplating the opportunities offered by owning their own business and is available from the REIV bookshop telephone 03 9205 6666. Cost of this booklet is $5.50 plus P & H.

Self-Assessment Checklist

The purpose of this section is to help you assess whether you would be successful in running your own business. You may find that some of the questions are hard-hitting, but if answered honestly it will indicate your chance of success or failure.

Having the skills is only part of the answer - being able to make tough decisions that affect the lives of other people and their family is critical. Ongoing self-assessment and being able to change with the ever-changing market is another important aspect. It is also vital to be able to monitor the financial welfare of your business and make decisions, disregarding one's personal ego, which for all of us is sometimes very difficult to do.

Part I, although providing no conclusive answers, has been designed in such a way as to give you an obvious summary of how you should perform, that is, of course, providing you approach it in an honest and straightforward fashion and, if need be, ask your loved ones or close friends how they see the answers which would be applicable to you.

Whether you perform with flying colours or not, there are nowspecially designed courses to acquire the skills necessary, or to improve your current skills

Thinking of Purchasing/Starting a Business?

Business is an opportunity to increase (or lose) your capital wealth over time. It is important to recognise that few businesses are a 'licence' to print money.

Capital invested in a business needs an appropriate return similar to any investment.

Your chances of success will be greater if you understand and prepare yourself for the challenges you will encounter as a business owner. It is also important to match a business with your strengths and interests.

The following self-examination is the first and most important step towards starting a business. It can also help to eliminate potential causes of failure.

Personal Appraisal

Be honest

Be honest about why you want to go into business for yourself. It will, very likely, place greater demands, responsibilities and stresses on your lifestyle.

Be realistic

Consider the advantages and the disadvantages of being your own boss. While it may provide self-satisfaction, independence and the opportunity to earn more money, you must also consider that it may mean:

Advantages Disadvantages
  • Potential high income
  • Work hours to suit you
  • Capital growth of your business
  • Improve your lifestyle and personal relationships
  • Loss of regular income
  • Long and irregular hours
  • Competition, possible failure andloss of your resources
  • Changes in your lifestyle and relationships

Be self critical

Assess your personal strengths, weaknesses and your general suitability to run your own business.

Are you:

Have you:

Personal Characteristics - Are You Suitable?

How Do You Rate Your: Rating (Tick One)
Adequate Inadequate
Ability to handle stress    
Business/accounting/legal knowledge    
Knowledge of the industry/profession    
Drive and energy    
Organisational ability    
Level of self-confidence    
Commitment to the longer term    
Ambition    
Leadership ability (Could you dismiss someone?, Can you motivate staff?)    
Level of determination and the ability to solve problems    
Ability to set clear and attainable goals    
Ability to take moderate, calculated risks    
Perseverance (when necessary)    
Willingness to seek and take advice    
Willingness to take personal responsibility    
Negotiating skills    
Ability to cope with crisis    
Ability to communicate    
Objectivity    
Overall chances of success    

Why Do You Want to Go Into Your Own Business?

  YES NO
Frustrated in your present job?    
To earn a better living?    
To be independent?    
To be your own boss?    
To do something different?    
To have flexible hours?    
To lead a group of people?    
Out of work?    
You saw a market need you can fulfill?    
Other?    

Consider Business Ownership

Advantages Disadvantages
  • Personal satisfaction
  • Independence of decision making
  • Financial reward
  • Sense of achievement
  • Social recognition
  • Opportunity for leadership
  • Financial insecurity
  • Long/irregular hours
  • You are on your own
  • Risk of failure
  • Pressure on family life
  • Isolation/frustration

Financial Checklist

When going into business it is essential that your finances are in order. Begin by being thoroughly aware of your personal assets and liabilities.

Your Personal Worth

Liabilities Assets
Housing loan(s) $ Cash/bank deposits $
Investment loan(s) $ Shares/investments $
Personal loan(s) $ House $
Credit card(s) $ Other real estate $
Hire purchase contract(s) $ Car(s) $
Store Account(s) $ Insurance/superannuation $
Any other monies owing $ Other $
Total $ Total $
You need sufficient assets to prove equity and/or to support your loan application. The lender will expect you to bear the risk. (Less) liabilities $
Your net worth $

An interactive version can be found in the Tools section.

Your Personal Needs

This is the sum of all the expenses you have and includes all bills (monthly, quarterly and yearly), plus your regular living expenses. These expenses should be calculated on a monthly basis and will include: house, car and loan repayments, insurance premiums, phone and power, rates, taxes and any other bills peculiar to your circumstances. Your living expenses include food, clothes, entertainment, education, sport, transport, etc. By totalling all of your living expenses you have an amount that represents the net (after tax) monthly income you require.

Regular Monthly Bills Other Monthly Expenses
Housing payments $ Food $
Car payments $ Health $
Credit cards $ Clothes $
Insurance premium $ Entertainment $
Phone, electricity $ Transport $
Rates, taxes $ Education $
Other $ Other $
Total $ Total $
  Total monthly bills $
(Plus) Total monthly expenses $
(Equals) Monthly income needed $

An interactive version can be found in the Tools section.

The new business, especially during the start-up period, will make a heavy demand on your funds. As it would be unwise to expect that you could withdraw your regular income from the business for some time, you should plan for funds to provide for your personal needs.

Business Structure

There are three main types of business structure you can choose from; company, partnership and sole trader. You should decide carefully, weighing up the advantages against the disadvantages in each case and the suitability to your circumstances.

The legal form of your business has implications for your tax position and your personal liability for debts etc. The form of business you choose deserves close consideration and you should seek advice from your accountant and solicitor.

GST on the Sale or Purchase of a Business

1. Supply of a going concern (Sale of a business)

The supply of a business as a going concern is GST free if certain requirements are met.

What is a supply of a going concern?

A supply of a going concern is a supply where:

A supply of a going concern is GST free if:

If all these requirements are met, GST is not payable on the sale.

2. If you purchase a going concern (A Business)

If you purchase a going concern and all the requirements are met, the sale to you is GST free. You will not have to provide additional funds to cover GST.

Researching Your Choice of Business

Will you commence a new business or buy an established business? Will you buy a franchise? You should weigh up the pros and cons of each.

If it is a totally new type of business you will have virtually no competition. An existing business may cost more but offers the advantages of instant income that sales to existing clients provide. Also contact with banks and suppliers and the advice of the previous owner are usually available.

Commencing a new business

If you plan to start from the beginning, consider the following:

Buying an existing business

If you decide to buy an established business, some of the things you should consider are:

Franchising

As an alternative you may consider buying a franchised business.

  1. What is the franchisor offering that is more beneficial than going alone?
    • What are the full entry costs?
    • What are the ongoing royalties?
    • What is the franchisor providing for these royalties:-
    • Volume buying opportunities etc?
    • Marketing strategies?
    • Technical assistance?
    • Business assistance?
    • Is the franchise agreement continuous or is it renewable after a period of time at extra cost?
    • How restrictive is the franchise agreement on your ability to "be your own boss", are you working for someone else using your capital?
  2. How long has the franchise been in existence?
  3. How successful is the franchise chain?

The Australian Competition and Consumer Commission has produced a booklet on Franchising, titled "Franchising Code of Conduct" which places obligations and safeguards on buyers and sellers of franchise businesses. This booklet is available from Australian Competition and consumer Commission offices.

Training courses and educational material are available to help you decide the best course of action.

Background to the business

An important first step is careful research into all aspects of the business.

Leases and Rent

Most Small Businesses and retail shops are leaseholds.

The Lease is a crucial aspect of a business and can affect the STABILITY, SECURITY, VIABILITY, and RESALE value of your operation.

The lease document should be perused by a solicitor. Some of the critical aspects to be considered are:

The length of the Lease should be secure, either for the period the business is to be conducted at the premises, or to enable resale.

The level of rent that sustainably can be paid is NOT a legal matter. The judgement as to what level of rent is sustainable should be made in consultation with an Accredited Business Broker or Business Valuer.

Many businesses being offered at a so-called "bargain" price may have reduced the price because of an unsustainable rent level.

Choice Some Advantages Possible Disadvantages
Starting a Business Choose your own pace High Risk and Uncertainty
Can be less competitive No immediate income
Don't have to buy goodwill Lenders may be apprehensive
Buying a Business Higher likelihood of success May inherit existing problems
Immediate income Exit of past owner may affect business
Finance may be easier to obtain Location may be inadequate
Stock and suppliers are established Premises may be inadequate
Operational ability is a known factor Landlord may be difficult
May obtain valuable employees Need to pay goodwill
Vendor may provide experience Danger goodwill is overvalued.
Buying a Franchise Training is usually provided Franchisor may be difficult
Investment risk may be lower Franchisor takes percentage of profits
Benefit of franchisor's goodwill Flexibility in buying may be restricted.
Facilities of proven performance Territorial restrictions
Volume purchasing benefits Agreement may be weighted in favour of franchisor
"Big Brother" advice You may feel like an "employee"
Structured Advertising You will share in the franchisor's errors.

Location of the Business

For most small businesses, location and type of building is one of the critical decisions. The nature of your business will determine - nine out of ten - what characteristics you should seek in a building and in location.

Operating the Business

Knowing your customers' needs and creating in your customers the awareness that you can meet their needs requires knowledge of product range, methods of distribution, pricing and promotion. In all businesses marketing is critical and you should consider attending courses provided by your industry or commerce association or your local education institutes to obtain a thorough understanding of the subject.

Advertising

Plant and equipment

Prices

Sales on credit

Your records

Complete records are important for you, your financiers and Government agencies. Do not leave the record-keeping task completely to others. Records for businessmen are as important as maps for tourists.

Stocks

Suppliers can offer substantial assistance. They need your business and they will endeavour to assist your growth. Examine and choose your suppliers carefully.

Internal controls

Insurance

Regulatory bodies

Government regulations concerning your business can be complex. If you contravene these regulations, lack of knowledge is no defence. Consequently you should approach a solicitor or the Government Small Business Agency in your State for assistance, if necessary.

Staffing

In most industries, personnel costs represent the greatest expense on gross profits. Investment in personnel is therefore critical. You should know how to create a harmonious and productive relationship between you and your employees. You should also be aware that you may not always be able to supervise your staff. Training and delegating responsibility will give some continuity if you need to be absent. The "wageline" and other government assistance can be valuable.

Business Knowledge Summary

It is essential to get a full understanding of your business environment. Knowing why some in your industry fail while others succeed, whether your industry is growing or contracting and what the critical points are for success, will give you an edge. Time and effort acquiring this knowledge before you commit yourself is a sound investment.

What sets your business above the competition?

Energy and dedication are essential but will not always guarantee success. If you can find an advantage over your competitors, you are more likely to succeed.

The Business Plan

Ultimately, the consideration given to all the points raised within this checklist should provide the basis for you to complete a Business Plan.

Are the following elements present in the Business Plan?
1. The Business
A description of the business, reasons for being in the business.
2. An Opportunities Statement
Are trends and outlooks for the market, the business and its overall performance identified?
3. A Strategic Audit
Has the business a "mission", directions for growth, identifiable advantages over competitors?
4. Objectives
Have performance measures and targets been identified and established?
5. Business Strategies
Have these been identified for marketing, production, personnel and financial matters?
6. Action Plans
Have plans for "making it happen" been identified - the who, when, what and how of being in business?
7. The Total Plan
Has provision been made for learning from the operations and experiences?

Does your Business Plan support a loan application?

Financing Requirements

You need to determine the costs involved in starting and operating your business. Some of these can be:

Capital costs

Startup costs

Growth costs

Operating costs

Financing costs

You will need to determine an appropriate mix of equity and debt for the capital structure of your business. This will be determined by your profit margin and frequency of turnover. Your accountant or business adviser will be able to help you with this. While you must be able to meet all of your financial obligations as they become due and payable, your business needs to provide an appropriate return on total capital. If it does not, you would be financially better off investing the capital in a public company or some other investment that does.

Business equity

Owners' equity is an important consideration for borrowing money to start a business because the lender will expect you to contribute part of the total amount required.

Other considerations include:

You need to determine what the cost of servicing/repaying the required level of borrowing will be. Now look carefully at the returns you can expect from the business.

To calculate whether your business will be viable or not you need to establish an initial target figure. This helps you determine the amount of sales required to break even.

To determine the initial target figure we need to look at the relationship between capital, borrowed funds, estimate of gross profits and cost of sales.

Expected level of sales $____________________
Less cost of purchases or manufacture $____________________
Gross profit $____________________
Less operating costs (including owner income) $____________________
Net profit $____________________
Less tax $____________________
Less loan interest $____________________
* Balance remaining $____________________

The balance remaining equals the sum available for principal repayment/contingencies, i.e. The principal amount of the loan can be repaid within __________ years.

An interactive version can be found in the Tools section.

Supporting Security

You need to determine what security is available to be offered to the lender to support borrowings. You need to be aware lenders are likely to place a conservative value on assets offered as security.

Sources of Outside Help/Advice

Licence or franchise - don't be caught!!

Another court decision has "deemed" that "licence agreements" marketed by a company now in liquidation were in fact franchise agreements.

The company was a Melbourne based business that promoted, marketed and sold licences nationally to use its Intellectual Property for the purpose of operating employment and recruitment services.

The Franchising Code is an industry code of the Trade Practices Act, established in October 1998. It provides the definition of what is a "franchise".

For an agreement to be classified as a franchise agreement it must contain all four of the following elements.

There are some minor exceptions.

The essence of the Code is to regulate business relationships. If your contract is not so much about a sale of your product but establishes a continuing business connection, then as a seller, you will have responsibilities to your purchaser. So even if you are not thinking of becoming a "franchisor", if your business fits these criteria, then the code will automatically apply and you must follow its requirements.

At the time the Code was introduced, many people inexperienced in business were taking up franchises. It aims to protect the purchaser by requiring the seller to provide enough information so the purchaser can make a more considered judgment about whether it will enter the contract. This information is provided through a prescribed disclosure document. This document must be updated annually and provided to all prospective franchisees and those who are looking to renew their contracts.

The contract this particular company used to licence its products was deemed to be a "franchise agreement", but because the company didn't realise it was creating a franchise, it didn't produce the disclosure document.

The Code also requires particular protective clauses about how to terminate the contract and how to resolve disputes. The company also didn't include these procedures in the contract. That was why it was fined. The court also found that the payments made for the licences were not enforceable.

Mr Graeme Samuel said "This case reinforces that compliance is not optional but mandatory".

So even if you have a clear, mutually agreeable contract between your business and others who use or sell your products, be careful to consider whether the contract fits the criteria in the Code. If it does, you must comply with all the requirements of the code, at the time of entering the contract, through the term of the contract and particularly if there is a dispute during the term or if the contract is terminated because of a breach of the contract.

This article reproduced with the kind permission of the author Julie Cox of Townsends Business & Corporate Lawyers

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