There are plenty of similarities and differences between buying a business and buying real estate. Since both of these typically involve huge investments, both types of purchases need specific evaluation of several items including current market conditions, valuation factors and legal formalities.
When purchasing a business, many first time buyers attempt to relate the purchase of the business back to their memories of when they purchased their home. This can be severely detrimental because for many, the business purchase is undoubtedly the biggest investment of their lives and small mistakes can result in substantial losses.
Here are three items which have vastly differing processes and considerations between buying a business and buying real estate.
- Determining The Right Value
- Knowing what You are Buying
- Making a Sound Decision
Determining the Business Value
The value of any property is largely determined by doing comparative market analysis and finding out the value at which similar properties in the area were sold recently. A property appraisal can also be done by a licensed appraiser who does a physical inspection to determine a value of the property.
Unlike property, a similar business in the area could have an entirely different value because the value of a business is largely based on its financial health and well-being. There are many methods and approaches used to determine the value of a business, some of which are: Capitalized Excess Earning method, Asset Accumulation Method, Comparative Transaction Method, etc. As a general rule most small businesses tend to be valued using the Multiple of Discretionary Earnings Method.
Knowing What You're Buying
When buying a house or other real estate, most buyers want to check out the neighborhood, proximity to schools, hospitals or other amenities, and investigate safety factors and criminal activity in the area. Additionally, it is standard practice to have at least one general inspection. There may be other specific inspections such as chimney, sewer, mold, HVAC systems, etc.
Determining what you are buying when you are buying a business is a far more complex challenge. There are a myriad of documents that should be reviewed so you understand what you will be getting when you buy the business. In business purchases you need to check financial statements, tax returns, business licenses, employment agreements, documents related to vendor and customer contracts, property and equipment leases, and other documents as well. A detailed due diligence list will be a necessary tool to help you know what you're buying.
Making a Sound Decision:
When buying real estate, your decision will primarily depend on your use or purpose for buying the property. Different factors will come into play depending on whether you are buying a home, rental property, or commercial building.
When buying a business, one of the primary considerations is whether the business will be owner-operated or absentee. If you are buying an owner-operator business, it is important to find a business which interests you because you will be spending an enormous amount of time in the business every week. It should also be something for which you already have the required skills and experience to be successful.
In summary, while businesses and real estate are similar in that they are both substantial investments, the purchasing process is very different between the two. If you are thinking about buying a business, approach it strictly as a business purchase and don't try to relate it to when you purchased your home. The processes are not the same and you could end up making some costly errors.