Buying a business vs starting one: an honest comparison

If you want to work for yourself, there are two doors: start a company from nothing, or buy one that already exists. Both are reasonable. They just carry different risks, and it helps to see those risks side by side before you choose.

What you get when you buy

An established company comes with the things a new one spends years trying to earn:

• Customers who already pay. Revenue starts the day you take over, not after months of marketing.
• People who know the work. Technicians, office staff and a manager who can answer the phone and run a job while you learn.
• A track record you can check. Years of tax returns, bank statements and customer history. You don't have to guess whether people will buy; you can see that they have.
• The unglamorous plumbing of a business. Supplier accounts, insurance, licenses, a phone number people know, a name with a local reputation.

The biggest difference is cash flow. A healthy company you buy should be able to pay you a salary and pay back the loan from its first month. A company you start often can't pay you much for a while, and nobody can tell you how long "a while" will be.

What starting has going for it

Starting from scratch has real advantages:

• It costs less up front. You pay for equipment, a little inventory and your time, not for years of someone else's work.
• You build it your way. No old habits, no outdated software, no culture you have to change gently.
• No inherited problems. Nobody else's worn-out trucks, unhappy customers or lawsuit you didn't know about.
• You can start small. Many service businesses can begin part-time while you keep your job.

The survival question

New businesses are fragile, and there's good public data on just how fragile. The Bureau of Labor Statistics tracks new business locations (establishments, in their terms) across the private sector. Of those that opened in the year ending March 2015, about 80% were still operating a year later, about half after five years, and about 35% after ten years.

Those figures include new branches of existing companies, so they aren't a perfect measure of brand-new startups. But the shape is clear: of the locations that closed within ten years, most closed in the first five.

Buying a company that has lasted twenty years lets you skip that stretch. It doesn't make you safe. An established company can still decline, especially if the owner was the reason customers stayed. But you're starting from proof instead of hope.

Financing works differently

Lenders lend against history. When you buy a business with an SBA loan (a bank loan partly guaranteed by the U.S. Small Business Administration), the lender looks at the company's actual results, checks the seller's tax returns against IRS records, and asks whether the company can pay you and the loan with room to spare. (Our guide to SBA loans for buying a business explains how they work.)

Here's a hypothetical. Say a company has owner earnings (its profit plus what the owner pays themselves, before loan payments and taxes) of $300,000 a year, and it sells for about 3 times that, or $900,000.

• You'd bring about 10% of the price as a down payment plus about 4% for closing costs: roughly $126,000 of cash.
• You'd borrow about $810,000. Over 10 years at about 10.25% interest, every dollar borrowed costs about 16 cents a year, so the payments come to about $130,000 a year.
• If you pay yourself $100,000, the company has $200,000 left for a $130,000 payment. That's about 1.5 times the payment, comfortably above the 1.25 times SBA rules require for a purchase.

So $126,000 of cash buys you a salary from the first month, plus a cushion. Starting a company with the same $126,000 might work out better in ten years, or it might not, but you'd be living on savings while you found out.

Startups can get SBA loans too, but lenders have no history to lean on. They rely on your projections, your experience and whatever collateral you can pledge, and many are more cautious as a result.

What you give up when you buy

Buying isn't secretly the safe, easy choice. Be clear about what it costs you:

• You pay for goodwill. Much of the price is for the customer base and reputation, not the equipment. If those don't transfer to you, you've paid for something you didn't get.
• You take on debt. A 10-year loan with your personal guarantee is a serious commitment.
• You inherit everything. Old equipment, a key employee who may leave, customers who were loyal to the owner personally, prices that haven't been raised in years.
• You start as the new person. The staff know the work better than you do, and changing things too fast can break what you paid for.

Who should start instead

For some people, starting is the better choice and buying would be a mistake:

• You have a new idea or a market nobody serves well. There's nothing to buy.
• The business is cheap to start and quick to make money. If customers can find you fast and you need little equipment, paying for someone else's goodwill may not make sense.
• You can't put down a meaningful amount of cash. A loan to buy a business needs real money from you, and stretching for one leaves you with no cushion.
• You'd rather invent than inherit. If running someone else's systems and team sounds miserable, it will be.
• You want to build slowly while you keep your job. Buying a company is full-time from day one.

Who tends to do well buying

Buying suits people who have managed teams, budgets or operations and want to put that experience to work in something they own. It suits people who need income from the start, and people who'd rather improve something that works than prove something new. You don't need to have done the trade yourself, but you need to be ready to lead the people who do.

How to decide this week

A few honest answers will tell you which door to try first:

1. Write down the salary you need and how soon you need it. If the answer is "a full salary within months," buying is probably your path.
2. Add up the cash you could invest without touching your emergency fund. For an SBA-financed purchase, a useful rule of thumb is cash of about 14% of the price.
3. Ask yourself whether you'd rather manage people or build a product. Neither is better, but they're different jobs.
4. Talk to a lender. A short conversation will show what they'd need from you for a purchase and for a startup.
5. Talk to two or three owners in an industry you like. Ask how they started and what they'd do differently. Their answers will tell you more than any comparison chart.

If buying wins, the next question is where to find a company worth owning. Many of the best ones aren't for sale, which is what the rest of this series is about.