Are you considering purchasing an existing business? You’ll want to go in well-informed and well-prepared.

A business plan is normally essential to the process of purchasing a business. A good business plan always defines the business’ specific mission and objectives, new ownership, sales focus, market, strategy, management team, and financials.

This is particularly important when you are purchasing an existing business, because there is so much uncertainty involved. Here’s what to pay attention to throughout the process, and what to include in your plan going forward, should you decide to buy an existing business.

Start with existing information

Start with the information you get from previous owners. Ideally, during the purchasing process, you received a business plan from the previous owners.

One of the important functions of a plan is to define business prospects, therefore, sophisticated business sellers normally use a business plan as a selling document. It should contain information about business history, financial history, previous management, and possible prospects.

Proceed with caution

If you do have such a plan provided by the sellers, proceed with caution. Assume the seller’s plan was developed to sell the business, not to manage the business, and may be too optimistic.

Question the assumptions. At every point that you possibly can, compare the seller’s plan for the business with its past financial information, market data from objective sources, and whatever other reality checks you can find.

Make sure you have enough information on the financials

You should always have financial information. Normally you’ll have past financial statements, and copies of tax forms, at the very least—few transactions take place without some basic financial information.

Use this financial information as a basis of comparison

Question the information sources: copies of tax forms, if they are real, show what the sellers have told the government. Do they match the financial statements coming from the accounting? How reliable are the financial statements? Have they been audited by outside accountants? Is the seller willing to allow an audit?

Growth forecasts are immediately suspect

Compare projected growth to past results. If the seller shows a future much more rosy than the past, ask why? What assumptions justify the change? Why was this business for sale if projections are optimistic?

However, sometimes sellers have good reasons—needing capital, aging, divorce, for example—so don’t automatically assume that all growth projections are false. Try to understand why owners are selling a business, and how this affects their willingness to produce real numbers, and how it affects your own possibilities to make this purchased business work for you.

Don’t underestimate the importance of reality checks

Don’t rely on second-hand information. Where possible, spend time at the business in question, talk to customers, eat at the counter, use the service. For retail locations, for example, you can spend some time outside the store, count the customers, see how many go in empty-handed and how many come out with bags.

Make estimates

Count the business for some sample hours, and then calculate what total sales might be by multiplying your estimated average purchase value per hour.

For example, say a shoe store has three customers per average hour, and guess that the average sale is $50. That’s $150 per hour total, which would be $1,200 per day and $7,200 per six-day week at eight hours per day. If that’s what you estimate and the seller reports $30,000 in sales per month, you’re reassured, because the two numbers—your estimate and the sellers reports—are in the same range. $7,200 per week for 4 weeks is $28,800, so $30,000 is close. However, if the seller is reporting $100,000 per month you will need to investigate carefully to explain this discrepancy.

Plan for a new business or an existing one?

As you plan for the business you purchase, you start by making an important choice: business plans can be either for startup new businesses or for already-existing and ongoing business. When you buy a business from somebody else, either option is acceptable. This is a choice you make.

The main difference between the two options is the existence in the plan of either a startup table, or a past performance table. In a new business, a startup table establishes opening balances for starting expenses, and financial balances including initial capital, debt, and assets. For an existing business, a past performance table shows past history of profit or loss, and balances of capital, debt, and assets.

How to decide? Either way can be acceptable. Here are some suggestions:

  • Consider the status of the business. Does the previous history build your business reputation? Would a loan or a new investment be more likely based on the previous history, or less?
    • When you are purchasing a strong business with a good past, use that strength as an asset by developing a plan for an existing business. Develop a plan for an ongoing business, use the past performance table to set your balances, and include a section on company history.
    • If you’re purchasing a failed business (presumably for a good price), then start over, with a new plan, built for a new company. Set your startup table for a new business, and treat the business as a new business when you describe its history (or lack of history), ownership, and strategy.
  • The better the information available from the sellers, the more advisable that you develop the plan as a plan for an existing business. In the worst cases, when you have little information available, then you don’t really have the option of starting with past performance, because you don’t know about past performance.
  • Consider the name. If you plan to keep the business name, lean toward a plan for an existing business. If you are planning to change the business name, then you’re more likely to be better off with a new plan, not an existing plan. The naming decision is often a tip-off to the same variables that affect the plan. The factors that make you want to keep the name will make you want to use past performance and develop a plan for an ongoing business.

Ultimately, it’s your choice

Remember a business plan is always your plan; not the consultant’s plan, not the expert’s plan, but your own plan, for your business. As you look at the business you’re purchasing, decide what makes you feel best about it, and make that the choice for startup or ongoing.

Tim BerryTim Berry

Tim Berry is the founder and chairman of Palo Alto Software and Follow him on Twitter @Timberry.