How to Buy a Small Business: From First Look to Closing Day

Decide what you're actually looking for

Start with the size of deal you can finance, not the kind of business you'd enjoy. Your cash, what a lender will add, and whether a seller will carry part of the price set a ceiling that rules out most listings before you look at them.

Then narrow by what you can run. A business whose profit depends on the owner's personal relationships or licenses is harder to take over than one with systems and staff that already work without the owner in the room. Location, industry and your own skills matter, but transferability matters more than any of them.

Find deals and read the first numbers

Businesses for sale come through brokers, online marketplaces, and direct approaches to owners who haven't listed. A large share of good small businesses never reach a listing, which is why some buyers write to owners in their target industry directly.

A broker will usually send a confidential information memorandum once you've signed a confidentiality agreement. It describes the business and its finances, written by the side that wants a high price. Ask for three years of financial statements and tax returns alongside it.

The number to work out first is seller discretionary earnings: profit plus the owner's salary, their personal expenses run through the business, interest, depreciation and genuine one-off costs. It's what one full-time owner-operator takes home, and small businesses are usually priced as a multiple of it. Check early whether one customer supplies a large share of revenue, since customer concentration is one of the fastest ways a good-looking business becomes a risky one.

Check that the financing actually works

Before making an offer, make sure the business can carry the debt you'd use to buy it. Take a business asking $900,000 with $300,000 of seller discretionary earnings, a multiple of three.

Say you'd put $90,000 down, the seller agrees to a $135,000 note at 6% over five years, and a bank lends the remaining $675,000 at 10% over ten. The bank payments come to about $107,000 a year and the seller note about $31,300: roughly $138,300 of debt payments in total.

Now subtract a market salary for the work the owner does, because either you'll do it or someone will have to be paid to. At $80,000, the business has $220,000 left to service $138,300 of debt, a coverage of about 1.6. That leaves around $82,000 a year before taxes and any spending on equipment. It works, with a cushion, and a buyer who can't make this arithmetic work at the asking price shouldn't make an offer at it.

The letter of intent

A letter of intent sets out the main terms: price, how it's paid (cash, bank debt, seller note, any earnout), what's included, the working capital the business must be delivered with, how long diligence will take, and a period of exclusivity during which the seller won't negotiate with anyone else.

Most of an LOI isn't binding. Exclusivity and confidentiality usually are. It's still the most important document you'll sign early, because terms left vague in the letter are hard to win back later, when the seller knows you've spent money on lawyers and accountants.

Due diligence: verify before you pay

Due diligence is where you test everything you've been told. On the financial side, match the tax returns to the bank deposits and both to the profit and loss statements. If the three tell different stories, find out why before going further.

Beyond the numbers, read every lease and major contract and check whether they can be transferred to a new owner. A great location on a lease the landlord won't assign can end the deal. Talk to key employees if the seller allows it, check the condition of equipment, count the inventory, and look at how old the receivables are.

Walking away at this stage is normal. The money spent on diligence is small compared with the money a missed problem costs after closing.

Structure, closing and the handover

Small businesses are often bought as an asset purchase, where the buyer acquires the equipment, inventory, customer lists and goodwill but not the legal entity and its history. A stock purchase buys the company itself, liabilities included. The choice affects taxes for both sides and which risks move to the buyer, so it's a conversation for your attorney and accountant.

The final purchase agreement turns the letter of intent into binding terms, with the seller's representations about the business and what happens if they turn out to be false. Most deals also include a transition period in which the seller trains the buyer and introduces them to customers and suppliers. The first months after closing are when those relationships are most likely to walk out the door, so plan that handover as carefully as the price.

Key takeaways

• Size the search to what you can finance, and favor businesses that already run without the owner in the room.
• Seller discretionary earnings is the first number to work out, and customer concentration is the first risk to check.
• Before offering, confirm the business can service the acquisition debt after paying someone to do the owner's job.
• Due diligence ties tax returns, bank deposits and financial statements together. Walking away after diligence is a normal outcome.

Frequently asked questions

How much money do I need to buy a small business?

It depends on the price and how it's financed. Buyers often combine their own cash with a bank loan and a seller note, and lenders usually want to see a meaningful cash injection from the buyer. Work out the debt payments against the business's earnings before deciding how much you can afford.

How long does it take to buy a business?

From signing a letter of intent to closing often takes a few months, mostly for due diligence, financing approval and legal documents. Finding the right business can take much longer than buying it.

Should I use a business broker?

Brokers usually represent the seller, so their job is a good price for their client. They're a useful source of deals and can keep a transaction moving. For your side, rely on your own accountant and attorney.