As we begin the New Year, more people are looking to get into a business for themselves.  I think it’s very important to understand the major differences between buying an existing business or starting from scratch.  There are pro's and con's on both sides, and I want to emphasize on major differences to buyers and break down the process in hopes that buyers and sellers can make educated decisions. 

Most people who decide to buy a business, look for an existing businesses first.  The idea of an instant cash flow, existing customer base, brand, and lack of knowledge on how to start from scratch, are the biggest reasons why established businesses are so attractive to buyers, especially first time buyers. 

The most common first question the buyer asks me is "How much money can I make in this business?"  This is the wrong question to ask and in order to understand why, let's closely examine the above mentioned reasons for people wanting to buy established businesses.

1. Existing Customer Base - this is very attractive to any new buyer since an existing customer base makes it easy to get into the business.  However, there is a big catch here and that is; how many of these existing customers will continue to be customers when they find out that the business is sold?  There is always a percent of customers who will leave once they find out that there is a new owner.  Some will leave because they don't like the new owner, some will leave because of their relationship with the old owner, some might have already left and the seller is not disclosing the information and etc.  Unfortunately it is very difficult to predict what percentage of customers will leave, and this factor will reduce the CASH FLOW of the business once a new owner takes over.
2. Brand - I am not talking about the name on the door, but the reputation of the business.  If the business has a bad reputation, it is very difficult to build it back up.  Unfortunately, it is also very difficult from the buyer’s stand point to determine what the reputation is.  Perhaps something happened recently that made the reputation a bad one, and it may not be reflected in the recent numbers.  Reputation does not just mean negative things about the business, it could also mean product.  Let's say that the company you are looking to buy has a reputation of being the most expensive for the product you sell, or it could have a reputation of having sub par product.  Again, the reputation and Brand of the company and business will impact the CASH FLOW.
3. Cash Flow - Notice I left this one for last.  The reason is all of the above factors directly impact the bottom line and even thought the business is making money for the seller, it does not mean the same cash flow will transfer to the new owner.  Just because a business is showing $100K cash flow annually, it does not mean the new buyer will make that money and the decrease could be substantial.

So what should the buyer ask as the first question? "What do I NEED to do to make the money I want and need in this business?"  Here is the reason why this is an appropriate question.  In order for the new buyer to make the same money as the seller, the buyer has to virtually duplicate what the owner is currently doing in the business.  That means if the owner is up at 5am and in the office by 6am, buyer must do the same.  If the owner is attending every business networking meeting, buyer must do the same.  If the owner is out all day selling, cold calling, etc, the BUYER must do the same thing.  If the buyer does not want to continue this pattern, the chances are sales are going to suffer and cash flow will be reduced.  Very often I hear sellers say that they are selling the business, because they didn't know there was so much selling involved, or they didn't know about the hours and etc. Every buyer needs to take a close look at  what the owner does on daily basis and ask themselves, "Can I do this? , Do I want to do this?", because if the answer to any of these is NO, then this business is not for you and you will not have the same cash flow.  Here is one last factor and that is employees:  It is very common for key employees to leave a company when ownership changes hands and that could be a big blow to the bottom line at least until that employee is replaced.  Most existing businesses are priced based on their cash flow or goodwill.  Imagine paying a price for a business based on say $100K and because of the factors above the business does $70K, you just lost equity.

Let's analyze start ups. 

1. Customer Base - Customer Base will take time to build, however once they become customers, they become YOUR customers and YOUR relationships.  Depending on the business and the owner, a customer base could be build quickly. 
2. Brand/Reputation-is build from scratch, so again it becomes YOUR brand and YOUR reputation.  We as people are very curious and like new things, so NO reputation is better than BAD reputation.
3. Cash Flow - Cash Flow in the start up is of course going to be minimal in the beginning, and that is why a person opening a business from scratch has to make sure they are well funded.  That means having at least 3 months of operating expenses for the business and 6 months of personal living expenses.  Depending on the business and the owner, a start up could be in the black after a month from opening their door, but as long as you are well funded, you can concentrate on running your business and not worry about paying bills.  Also keep in mind that you are building your equity from scratch.  
4. Unknown of starting a business - Look into buying a Franchise and they will guide you, teach you, train you and help you with all of the start up process.

So look at existing and established businesses, but ask the right questions and don't be afraid of looking at Start Ups, most of the time the real bargains are there.