Planning a Business Venture
At the start of a business venture, the entrepreneur first needs a compelling business idea, a business plan, and a well-thought-out financing strategy. When it comes to implementation, the key question is whether to start a completely new company or, instead, acquire an existing one and continue it with your own ideas. The pros and cons must be carefully weighed.
Starting a New Business
In theory, starting a new business offers the advantage of building a completely new company from the ground up, tailored to one’s own vision and business goals. There are no third-party influences, such as those of a previous owner, at this stage. The corporate culture can be developed freely and according to one’s own vision. Lean structures and the initial absence of existing ties guarantee greater freedom of action; the issue of inheriting legacy burdens or undesirable lines of business does not arise. The startup itself typically requires less capital investment initially than the purchase of an existing company, so the risk of loss is correspondingly manageable.
On the other hand, revenue and profits tend to be low at the outset, so sufficient capital must be available for the initial investments and operating costs—which are often underestimated in total. The higher the investment requirements—particularly for premises, equipment, employees, inventory, and other upfront costs—the more pressing the financing issue becomes right from the start. Whether the business will succeed is often uncertain from the outset and fraught with risks, especially since the company is completely unknown in the market at the start and must face existing competition. The search for suitable employees is fraught with risks, and effective marketing, sales, a customer base, and supplier relationships do not yet exist. Business premises must be found, the necessary equipment procured, and the required permits obtained. Setting up the company therefore requires a significant time investment. The advantages of greater freedom to shape the business when starting from scratch and the often lower initial capital investment (compared to acquiring an existing company) are consequently offset by the risk of operating a business that has not yet been developed or proven.
Purchase of an Existing Business
The organizational and creative freedom offered by starting a new business naturally does not exist in a succession scenario. Both the company’s culture and its business operations are already in place, so it is necessary to carefully assess whether the company aligns with the successor’s philosophical and business vision and strategic goals, and whether it allows sufficient potential and flexibility—both in terms of operations and personnel—for desired changes and new visions. Finally, the successor should take into account that, given the company’s history, gaining the acceptance of employees and business partners in a short period of time may present an unexpected hurdle.
If the preliminary questions can be answered positively, the acquisition of a carefully managed company can offer a wide range of advantages and opportunities. The business is established in the market and offers predictable earnings prospects, an existing workforce, a well-developed organizational structure, proven business processes, the necessary business equipment, and established relationships with customers and suppliers. Ideally, it also offers potential for further development and modernization by the successor. The potential valuation of the existing company based on current financial figures can also simplify the credit assessment by the financing banks and thus facilitate the process of securing a loan. Last but not least, as part of a succession plan, it may be advisable to retain the seller in the company for a certain period of time—for example, as a managing director or consultant—in order to draw on their experience and facilitate a seamless transition to the successor. The company’s existing legal structure should generally not pose an obstacle to an acquisition and could be modified, if necessary, through a conversion.
As promising as the acquisition of an existing company may be, it is essential to thoroughly examine it in advance through a careful “due diligence” process—from business, legal, and tax perspectives—to reduce risks associated with the acquisition. The seller’s cooperation—by providing the corporate information necessary for a proper review—is essential in this process. To protect the buyer, the seller must typically guarantee the accuracy and completeness of this information in the purchase agreement.
Financing the Start-up or Acquisition
Financing the startup or the purchase price typically poses a particular challenge for both founders and successors. Often, the founder’s or successor’s equity is insufficient to establish or acquire the business. Whether establishing a new business or acquiring an existing one, entrepreneurs and business successors can turn to government funding programs—which have varying objectives and eligibility requirements—for financial assistance, particularly those offered by KfW (e.g., the “ERP Start-up Loan – StartGeld,” “ERP Capital for Start-ups,” “ERP SME Grant Loan,” and the “KfW Grant Loan for Large Medium-Sized Enterprises”) as well as those offered by the federal states (e.g., the “Hamburg Loan for Start-ups and Succession,” the “NRW. Bank. Start-up Loan,” or the “Lower Saxony Start-up Loan”). Other financing options include equity investments or traditional bank loans.
In the context of a business acquisition, there are additional options available to reduce the financial burden on the successor. One option, for example, is for the seller to grant the successor a so-called seller’s loan for part of the purchase price by deferring payment of that portion of the purchase price with interest. As a positive side effect, such a seller’s loan can also provide additional incentive for the seller to support a smooth and successful transition of the business in order to secure their prospects for repayment of the seller’s loan. In relation to concurrent bank financing, a seller’s loan often raises follow-up questions that require clarification, such as which source of financing should be prioritized in the event of a cash crunch. Another option for structuring the purchase price may be to agree on a lower base purchase price, but with obligations to make additional payments in the event of positive business performance during subsequent periods to be determined (“earn-out”). This can reduce the successor’s initial risk of paying an excessively high purchase price. If the company subsequently fails to achieve the agreed-upon results, the transaction remains at the base purchase price.
Conclusion
Consequently, there is no one-size-fits-all answer as to whether purchasing an existing business is preferable to starting a new one. In any case, however, the M&A market offers promising opportunities to acquire a suitable and established company—provided financing is available—in order to begin full-scale business operations immediately and without a lengthy start-up phase. To ensure the success of such an acquisition, a thorough preliminary review of the business—from conceptual, business, legal, and tax perspectives—is essential in order to address any potential obstacles early on.
