There are a number of reasons that investors are drawn to existing businesses. Generally, there are less risks when you purchase a business that is already operating. This week, however, we are exploring the risks of buying a small business. Read on to learn some of those risk factors and how to avoid potentially problematic small businesses.

Limit The Risk

As we stated earlier, there can be much fewer risks with buying a small business that is up and running. That is – if the small business being purchased is a good business. Buying a business that is already up and running can come with certain security built in that draw-in investors.

  • Cashflow. A business that has been up and running for any length of time should have established clientele or customers to provide the business with immediate cashflow.
  • Established and trained personnel. An established business already has employees trained at their jobs. This eliminates the burden of hiring and training new employees.
  • Established processes and procedures. An existing business will also have established processes and procedures.
  • Existing Equipment and inventory. A new business must determine equipment needs, set it up and provide training on it. Buying an existing business typically includes the business’s inventory and equipment.
  • Financial History. Above all, an existing company already has a track record. Knowing historical performance of the business allows a buyer to better plan, make adjustments and limit risks.

What Are The Risks

While there are clearly quite a few upsides, there are MANY risks associated with purchasing any business.

A Business Having A Low ODI

The acronym ODI stands for owner’s discretionary income. An owner’s discretionary income is essentially the money that the owner gets to actually take home at the end of the pay period. ODI is calculated by taking the total revenue of the business and subtracting the costs of running the business. Those costs include everything from paying for a lease to employee’s paychecks. Whatever is left over after all of those costs are removed is the owner’s income.

While certain businesses have a high revenue, their costs possibly follow that trend. Ultimately, that leaves the business with little money left over for the owner. Always check to see if a businesses ODI is where it should be. Additionally, double check that you are able to live on the income. Remember that the income may dip once you purchase the business. It often takes everybody a while to adjust to a new owner, so the income dips and then slowly comes back up.

Liens

Liens are a big risk to buyers of existing businesses. Businesses can have liens against them for a number of reasons.  They are usually placed against the assets of the company. Liens can be filed with the state or the county. A UCC-1 is a lien against assets. UCC-1’s are filed with the Florida Secured Transaction Registry  Liens are usually filed to protect someone’s interest in a loan, but they are also used to protect someone’s interest in a judgment. When you buy someone’s business, it is important to do a lien search to verify that there are no liens against the business or the assets.

A Not-So-Good Reputation

In this day and age, people question how a business can hide a bad reputation. The main way to get away with that is to lack any sort of online presence whatsoever. If you are considering buying a small business and they have no reviews anywhere – ask yourself why.