If South Africa’s emerging entrepreneurial spirit has taken root in your life and you have your sights set on running your own business, you have two choices. Either start a business from scratch which comes with enormous challenges or buy an existing business or franchise.
Economic hardships and high unemployment rates are key drivers for the growing self-employment movement, underpinned by both the frustration and insecurity of working for a boss. However, if owning your own business was easy, the business ownership rate in South Africa would be higher than the low 32.5% statistics.
A Quick Overview of Everything you need to know about Buying a Business:
✔️ Pros and Cons of Buying an Existing Business
✔️ Existing Business Versus Franchise: Which One Suits You Better?
✔️ 10 Steps to Buying a Business in South Africa
What is Factoring?
Information You Need From The Seller
How To Determine if the Price is Right
How a Seller Sets the Price for a Business for Sale
How to Conduct Due Diligence on an Existing Business
How to Write a Business Plan for Your New Business
In Summary
Owning your own business comes with obvious risks but it is also very rewarding. Before you go down this route, there are a number of things to consider. We cover some of them so you can weigh up the pros and cons of buying an existing business before making such a momentous decision.
Did you know?
The established business ownership rate in South Africa is a mere 2.5 percent according to the 2016-2017 Global Entrepreneurship Monitor South Africa report.
This means that just 2.5 percent of the adult population between the ages of 18 and 64 own or manage a business that has been in operation for more than 42 months. South Africa’s business ownership rate is well below the global average of just over 50%. GEM ranks South Africa 55 out of 62 economies surveyed.
Pros and Cons of Buying an Existing Business
To start your own business or buy an existing business? That’s the big question with pros and cons to both. It makes sense that you have a higher chance of success taking over a going concern than starting from scratch but then, it’s not a guarantee.
One of the issues with buying an existing business is you inherit the legacy of the previous owner, good or bad. When looking at an existing business, you need to do some thorough sleuthing to uncover its past activities. At least with an existing business, you have access to its financial records and can fairly accurately gauge its profit to loss ratio.
Advantages of Buying an Existing Business
The hard graft of setting up a business from scratch has been done and you can step in and take over pretty much as soon as your “cheque” clears.
The infrastructure and equipment needed to run the business is there. You might need to build a lick of paint and a cleanup but you’re saved valuable time and money if everything you need to run a successful business is already in place.
It’s often easier to obtain finance for a going concern than it is for a start-up. You can produce financial records and a proven track record that banks like to see.
Most problems relating to manufacturing, distribution and day-to-day operations will have come to light if the business is well established. Finetuning and streamlining a going concern tends to be easier than entering into unknown territory.
A business and marketing plan will be in place and the current owner should be able to provide information to conduct a SWOT analysis to ascertain if the business is on track.
The business should have an established name as well as a website and social media platforms that are well optimized for Google rankings. If this is the case, you don’t need to break through the clutter with a new brand in the marketplace.
The business should have an established client or customer base as well as skilled employees and reliable suppliers. You’ll need to investigate to what extent they are loyal to the business or whether their loyalty lies purely with the current business owner.
Disadvantages of Buying an Existing Business
You may not know to what extent the books “have been cooked” or to what extent the business has been neglected. For this reason, it’s a good idea to use the services of a qualified accountant or business broker to conduct thorough due diligence.
The business may need a large capital injection to give it a boost, particularly if the current owner has lost interest and started to loosen the reigns on controls.
You’ll have to win over the loyalty and support of employees, suppliers and clients or customers. Often, a company’s strong performance is linked to the owner rather than the business. Separating the owner from the business is a true test of the company’s ability to stand on its own.
You need to budget for legal and accounting fees. If you buy a business through a broker, there’ll be costs there too.
You need at least 6-months working capital to get you through the transition period as well as to assist with cash flow.
There are existing contracts that may have to be honored despite them not being applicable to the business.
You may inherit employees that are not up to scratch, demotivated or disloyal. It takes time to work out who you want to keep and let go, and it’s not an easy process. Staff morale might be low if the business has been neglected and it’ll take time to win them over and gain their trust and loyalty.
Existing Business Versus Franchise: Which One Suits You Better?
Choosing between buying an existing business and a franchise largely comes down to personality type. In essence, owning a franchise is like working for a boss again. If you opt to buy a franchise, you trade freedom and independence off against security and guidance.
Franchise owners have a degree of independence but decision-making isn’t autonomous. You work to a “winning formula” and there’s little room to stamp one’s individual identity on your business. Putting up a poster, running your own promotion or sponsoring a school sports team is not allowed if not approved by head office.
Franchisees do enjoy more security than independent business owners because they’re following a business model that’s tried and tested. If you follow the model and put in the hard work, your business should be successful. There are no guarantees though.
Franchisees also benefit from ongoing support, guidance and training offered by the franchise group and can tap into legal and accounting expertise. Marketing is typically handled by the head office which is beneficial if that’s not your area of expertise but it does come at a price.
A franchise often requires a lower investment but the monthly obligation to meet the franchisor fees on top of your operating costs can be onerous, particularly when there is little room to make changes to the business model that could make your franchise more profitable.
10 Steps to Buying a Business in South Africa
The 10 steps involved in buying a business are universal. The only difference if you’re buying a business in South Africa is understanding the legal requirements that pertain to business laws. You’ll need help with that from a reputable attorney or business broker.
Step 1: Determine if the seller’s price is fair
This is covered further down in this article but the general principle is to understand what method the seller has used to evaluate the business and set the going price. Obtain the services of a business appraiser, accountant or valuation specialist to help you determine if the price is right.
Step: Determine how the deal will be structured
There are three basic ways to buy a business; asset purchase, stock purchase or merger.
Each option has its pros and cons and is subject to various liability and tax consequences. Again, consult your business advisor, tax accountant or attorney to decide of the best way to structure the business you want to buy.
Step 3: Draw up and sign a Letter of Intent
When the purchase price and details of how the deal will be structured have been finalized, the next step is to draw up and sign a Letter of Intent (LOI). It’s a non-binding letter of agreement, usually short and to the point with details of the basic points that satisfy both the seller and buyer.
A Letter of Intent covers the following:
- purchase price
- description of the deal structure
- due diligence requirements
- expectations of each party of the purchase agreement
- approximate timing for the conclusion of the sale
- any other material details agreed upon by both parties
Step 4: Draw up a closing checklist
A closing checklist for a business for sale is a list of everything that needs to be actioned before the sale transaction will be concluded. Both parties need to agree to it and the list should be updated regularly. Business brokers say that the closing checklist is the most important document required to proceed with the sale of the business because it protects both the seller and the buyer.
As a guideline, the following is typically covered in a closing checklist where it is applicable:
- collect revenue from outstanding accounts
- sell off inventory
- notify creditors of a change of ownership, including suppliers, lenders, service providers and utilities
- notify employees of a change of ownership; give notice and pay out retrenchments if applicable and/or pay out what is due for accrued or unused leave
- notify customers of a change of ownership and negotiate a deal on any remaining contractual obligations
- terminate the commercial lease if applicable, giving the required notice to the landlord
- settle or pay off any debt within your means, where applicable negotiate terms to pay creditors after the sale is concluded
- liquidate business assets
- submit final tax returns and payments for the business and owner’s personal tax returns; obtain a tax clearance certificate to show there are no outstanding tax obligations to the receiver of revenue
- give notice to utility companies such as Eskom and Telkom
- settle money owed and cancel all business credit and debit cards
- close the business account and any other accounts relating to the business
- dissolve a partnership, LLC or partnership; file the required forms, including a certificate of dissolution (not applicable to sole proprietors)
- Cancel subscriptions and memberships to organizations
- cancel any sales permits or business licenses
- provide a full list and contact details of employees, customers, and suppliers
- create working folders with all marketing material, intellectual property and contractual agreements etc.
Step 5: Proceed with due diligence
This is an essential step in the process of buying an existing business and is covered in more detail below. Due diligence is a thorough investigation of the company’s financial and management records as well as operations and the market to identify any potential liabilities and risks associated with buying the business.
Step 6: Obtain the finance you need for the sale and working capital
There are different financing options available to you, and often one option is used in collaboration with others. Here is a list of the most common ways to finance the purchase of an existing business:
- personal funds
- seller financing
- bank loan
- small business loan (where you don’t qualify for a bank loan)
- investors
- factoring (see ‘What is factoring’ below)
Step 7: Finalise the purchase agreement
It’s the responsibility of the buyer to draw up the purchase agreement and it should be done with the help of a business broker, accountant or contract attorney.
Step 8: Sign off the closing checklist
Check that everything on the closing checklist has been actioned. This should include all consents and approvals that are needed to close the transaction in the proper way, covering agreements with employees, landlords, customers, suppliers, creditors, shareholders, board of directors and any other third party.
Step 9: Execute the closing and transfer of ownership
Each item on the closing checklist should have been actioned, all consents and approvals finalized and all documents and certificates required to close the deal should have been presented to the contract attorney. You’re ready to take ownership of the business and for the company to be legally transferred into your name.
Step 10: Manage the transition phase
Introduce yourself to employees, suppliers and key customers who will continue with you on your new journey, and map out your vision for the company and how you plan to take the business forward.
If the previous owner has agreed to stay on for a period of time to hand over the business or in a consultancy capacity, you have time to learn everything you need to know about running the business.
Get to grips with every component of the business, from invoicing, payments and orders to marketing, accounting and operations. Be patient with yourself and lean on people who will facilitate a smooth transition and help you find your feet in your new business.
What is Factoring?
Factoring is a globally recognized way to finance options and is a well-established method in South Africa. It provides SMEs and other enterprises wishing to expand their business operations with access to working capital in a fast and scalable way. Factoring is linked to turnover rather than the value of bricks and mortar, stock and market value.
Factoring is not dependent on a business’s credit score but rather on the creditworthiness of its customers. Typically, the pay-out period is one working week or thereabouts which means a business can access working capital fast to fund its operations and meet its goals.
The way factoring works is as follows:
- a business enters into a contract with a reputable factoring company that agrees to factor its credit sales
- the business receives a purchase order from a customer, completes the work and delivers the product or service.
- the business creates an invoice and sends it to the customer and copies the factoring company, including the Proof of Delivery (POD).
- the factoring company pays up to 75% of the invoice amount which provides the business with a cash injection to continue running your business optimally.
- the factoring company handles the collection of payments. Once the payment has been received from the customer, the factor releases the balance to your business minus an administration fee.
Information You Need From The Seller
If you’ve found a business for sale that interests you, the seller needs to provide you with the following information:
- financial statements going back a minimum of 3 years
- management reports
- business and marketing plan
- full disclosure on all aspects of the business in negotiation
- full disclosure on any possible legal proceedings past and present, as well as operation and financial contractual obligations
- full disclosure of assessed loss
How To Determine if the Price is Right
There are a number of ways to determine whether a seller is asking a fair price for the business. A starting point is scrutinizing the company’s financial records but you do need to look beyond the business to the potential value of the market.
Determine the value of the assets
This is a simple ‘add and subtracts’ exercise where you add up the value of everything the business owns – including all equipment and stock – and subtract any debts or liabilities.
The health of the business’s balance sheet is a good starting point but a business is typically worth more than what net assets on the balance sheet.
Determine the price from revenue
The most basic method is to base the price on revenue. The more popular times-revenue method uses a multiple of current revenues to determine the maximum price threshold. The multiple might be one to two times the actual revenue but it depends on the industry and type of business.
Base the price on the price-to-earnings ratio
Calculate the price-to-earnings ratio where you look at an estimate of what the company will potentially earn over the next few years. For example, if a typical price-to-earnings ratio is 15 and the projected earnings are R1 million a year; the price-to-earnings value is R15 million.
Conduct a discounted cash-flow analysis
This is a complex formula that looks at the company’s annual cash flow, projects it into the future and then discounts the value of future cash flow using a net present value calculation. You can find a NPV calculator online which is easy to use.
Determine the market value
This involves looking beyond the financial records and calculating a price based on a one-dimensional formula. It’s more than likely the business has intrinsic value in its staff, suppliers and customers as well as extrinsic value in its location, market dynamics and the potential growth of the industry itself. The market value looks at the potential for growth over and above the current financial health of the business.
How a Seller Sets the Price for a Business for Sale
There are three common methods a seller will use to evaluate a business. You need to know which method has been used in order to determine if the owner is asking a fair price for the company.
Asset-based valuation
The asset-based valuation method calculates the end value by finding the difference between assets and liabilities. It’s a simple case of addition and subtraction.
Components such as machinery and infrastructure that add value are considered to be assets. Components such as bad debt that reduce value are considered liabilities. To find the value, an appraiser subtracts liabilities from assets.
The asset-based method finds the book value of your business which is the equity on the balance sheet. The book value is the lowest price you would ask for your business. If you are selling a healthy business, you would want to price higher than the book value. If you are selling a business that’s not performing well or you’re trying to sell it fast, you’ll ask a price closer to the book value.
Market-based valuation
The market-based valuation method looks at comparable sale prices for businesses sold in that industry and sets the price at a fair market value. The price determined by the valuator reflects the net worth of what the market would consider paying for the business.
It’s similar to selling a home at a fair market value. You would consider what other homes in a particular area sell for based on what the market are prepared to pay for the type of home in that location. So it’s a market-centric price rather than a business-centric price.
Income-based valuation
The income-based valuation method considers the financial history of the business and the average profit made year-on-year. For this reason, it’s important that you keep good financial records from the get-go and keep accurate records as the business grows.
The onus lies on the business owner to prove how much profit the business has made each year, depending on how far the valuator will go back. The company does not need to be debt-free but must be able to show that the business makes a profit despite its debt obligations.
It’s a simple process of looking at past profits and cash flow statements and finding the average. The valuator will then help you estimate what profit the business is likely to make in the future and its ability to sustain its current profit-to-loss ratio.
How to Conduct Due Diligence on an Existing Business
It goes without saying that conducting due diligence on a business for sale is vitally important because it’s the best way to ascertain the value of the business and uncover associated risks with buying it.
Due diligence evaluation is usually conducted after the seller and buyer have agreed in principle to the sale but before a binding contract has been drawn up and signed. It varies in scope depending on the size and value of the business but it typically covers the following:
- financial analysis of the business and its value
- evaluation of assets, including tangible and intangible assets such as intellectual property
- assessment of any immediate or future risk to the value of the business
- investigate if there is any legal impediment to the transaction, including any entity or person(s) or shareholder who would likely object to the transaction (in particular, shareholders)
- determine the formal requirements and procedures required to conclude the transaction
- assess whether the business operates in a sound and lawful manner where it complies with industry standards and legislation
How to Write a Business Plan for your New Business
The current owner should be able to provide you with a business plan but it’s a good idea to prepare your own one. Here are 5 reasons why a business plan is important.
- A business helps you understand the industry and market you will operate in and identify areas of strengths and weaknesses that need to be addressed as well as opportunities and threats that are out of your control (basic SWOT analysis).
- Financial institutions usually ask to see a business plan before considering your application for finance.
- A business plan guides decision-making and helps your management team to identify with how you plan to take the business forward.
- A business plan template covers all aspects of the business, some of which you may have overlooked.
- A business plan is like a map; it shows you where you have come from and where you want to go which allows you to make adjustments if and when things change.
Basic business plan template
You can download detailed templates from online sources. Here is what is typically included in a basic business plan for an existing business.
Business details
- name or trading name
- physical and postal address
- business contact numbers
- occupancy status: owner or tenant
- contact person and details
Executive summary: maximum 2 pages
- short summary of the most important aspects of the business, including:
- nature of activities
- financial status (current and projected)
- when it was founded
General company description: maximum 2 pages
- legal entity type
- registration number
- ownership details
- vision and mission statement
- SWOT analysis (strengths, weaknesses, opportunities and threats)
- description of the industry
- competitor analysis
- debtors details
- creditor details
- insurance cover
Business analysis: maximum 3 pages
Opportunity analysis
- where is the gap in the market?
- what has given rise to this gap?
- how was this gap identified?
- how will the gap be filled?
Market analysis
- what is the total size of the market?
- how fast is the market growing?
- what percentage share of the market will you have?
- what are the major trends in the target market?
Business strategy: maximum 2 pages
- what is the target market?
- how the business will succeed in the market?
- what is your unique selling proposition?
- How does your business compare to your competitors?
Management and organization: maximum 2 pages
Curriculum vitae for:
- owner or partners
- management team
Employee details
- names
- job description
- length of service
Marketing plan: maximum 3 pages
- the product (or service) and why it is valuable to customers
- the focused and detailed description of the target market
- the positioning of the product or service – how it should be perceived by customers
- the pricing strategy with specific price points at which the product or service will be sold
- the sales and distribution channels that will be used to get the product or service to the customer
- the promotion strategy including public relations activities, specific promotions, advertising and intended viral marketing activities
Financial plan: maximum 4 pages
- working capital & start-up cost requirement.
- 12-month profit and loss projection (month-by-month)
- three-year profit and loss projection (quarter-by-quarter) / pro-forma financials if not available
- 12-month cash-flow projection
- three-year cash-flow projection (quarter-by-quarter)
- projected balance sheet at start-up and at the end of years one to three
- a break-even calculation
- asset register
- gross profit calculation
Funding requirements
- reasons finance is needed
- ownership contributions
- monies owed to creditors
- suretyship agreements
- asset financing break-down
Appendix
- marketing and advertising materials
- industry studies
- blueprints and plans
- maps and photos of the location
- magazine or other articles
- detailed lists of equipment owned or leased
- copies of leases and contracts
- letters of support from future customers
- any other materials needed to support the assumptions in this plan
- market research studies
- list of assets available as collateral for a loan
- detailed financial calculations and projections
- 3-month bank statements
Source: BizConnect
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In Summary
Now that you’re armed with important information to work with when considering buying an existing business, you’re in a better position to decide if it’s the right option for you.
The majority of South Africans who take the leap of faith to leave secure employment to run their own business are characterized by being opportunity-driven rather than efficiency-driven. By this we mean, they are individuals who have pursued an opportunity rather than being pushed by necessity. This characteristic is a strong precursor to success.
Even though the potential return from entrepreneurship is considerably higher than safe employment, there are inherent risks to owning your own business. Before you set off on this journey in pursuit of an opportunity that will give you more independence and freedom, it’s important to carefully consider your personality type and your appetite and capacity for risk.
Entrepreneurship and small business enterprises are vital to stimulating the economic growth of South Africa and now more than ever, while we deal with the fallout from the Covid-19 pandemic, thousands of people in this country are facing the harrowing prospect of retrenchment and unemployment.
Now is the time to harness your entrepreneurial spirit and seek out opportunities to own your own business. We urge you to do it with care and caution, leaning on the expertise of business brokers and attorneys who can guide you in the right direction.
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