Buying a business vs starting one — an honest comparison

If you want to work for yourself, the first big decision is whether to build a business from scratch or buy one that is already trading. Both can work. Both can fail. They fail in different ways, and they ask different things of you, so it pays to compare them honestly before you commit money.

The short version

Starting a business usually costs less up front but carries a higher risk that the business never becomes profitable. Buying a business costs more up front, often with borrowed money, but you are paying for something that has already shown it can make money. The question is which set of risks you would rather manage.

Cost and capital

Starting. The initial outlay can be modest: registering an ABN, setting up a structure, equipment, a website, perhaps a fit-out or stock. The hidden cost is time. Many founders earn little or nothing for months or years, and the money they live on during that period is part of the real cost.

Buying. You pay for the business's assets and its goodwill on day one. For a small business, that can mean hundreds of thousands of dollars or more, usually funded by a mix of your own equity, a bank loan and sometimes vendor finance. You also pay for advisers: an accountant for due diligence, a lawyer for the sale agreement and lease, and possibly a valuation.

As an illustration, imagine a business earning $300,000 a year in seller's discretionary earnings, sold at a 2.5x multiple. The price would be $750,000. A buyer might put in $250,000 of their own money, borrow $400,000 from a bank, and agree to pay the seller $100,000 over time. These numbers are examples only. Multiples vary widely by industry, size and risk, and the funding mix depends on the buyer and the lender. For how earnings are measured, see SDE vs EBITDA.

Risk

Starting. The central risk is that nobody buys what you are selling, or not at a price that covers your costs. You are testing a product, a market, a price and your own ability to sell, all at once.

Buying. The business has customers and a history. The risks are different:

• you overpay, so the debt is too heavy for the profit
• the profit was overstated, or depended on the seller personally
• key customers, staff or suppliers leave after the sale
• there are problems you did not find in due diligence, such as tax issues, lease terms or unpaid employee entitlements

The good news is that most of these risks can be investigated before you sign. A startup's market risk cannot really be tested until you are in it. A purchase's risks can be examined line by line. Our financial due diligence checklist sets out what to look at.

Cash flow

This is where the two paths differ most.

A new business usually burns cash before it earns it. You need enough runway to survive the gap.

A well-bought business should produce cash from the first month. That cash has to cover your salary, the business's costs and repayments on any acquisition debt. If the numbers have been done properly, there should be a margin left over. If they have not, debt repayments can squeeze the business hard, especially in a slow season.

Lifestyle and workload

Neither path is a quiet life at the start.

Founders often do everything themselves: selling, delivering, bookkeeping, marketing. The workload is broad, and the hours are long, but you shape every part of the business.

Buyers step into an existing operation with staff, customers and routines. The work is less about inventing and more about leading, learning quickly and making careful changes. You inherit the culture the previous owner built, for better or worse. Our article on the first 100 days after buying covers how to approach that period.

Skills each path rewards

Starting a business rewards:

• product and market instinct
• selling with no track record behind you
• comfort with uncertainty and slow early progress

Buying a business rewards:

• financial literacy, including reading accounts and understanding debt
• negotiation and deal judgement
• people leadership, especially with staff who did not choose you
• operational discipline and steady improvement

Be honest about which list describes you. Neither is better. They are different jobs.

Control and identity

A startup is entirely yours. The name, the product, the culture and the customers all come from you. Some people value that deeply.

A purchased business has its own history. Customers may still ask for the previous owner. Staff may compare you to them. Change has to be paced so you do not lose what made the business work. Some buyers find this frustrating; others find it reassuring to have a foundation to build on.

Exit

Over time, both paths can build something you can sell. A purchased business starts with a value from day one, and your job is to increase it by growing profit, reducing reliance on you and strengthening systems. A startup has to reach profitability before most buyers will pay much for it.

A simple way to decide

Ask yourself these questions:

1. Do I have, or can I raise, meaningful equity and support borrowing?
2. Do I have a product or service idea that I believe in and can test cheaply?
3. Am I more energised by creating something new, or by improving something that already works?
4. How long could I go without a salary?
5. Am I comfortable leading a team I did not hire?

If you have capital, management experience, and limited tolerance for months without income, buying may suit you. If you have a strong idea, can test it cheaply, and can live without a salary for a while, starting may suit you.

Starting a business is a bet that you can create demand. Buying a business is a bet that you can keep and grow demand that already exists, at a price that leaves room for you.

Do not skip the structure question

Whichever path you take, decide early how you will hold the business. A company, a trust or a combination each has different tax, liability and succession consequences. Changing structure later can trigger tax and stamp duty costs, so it is easier to get right at the start.

How we can help

Kainos Consultants helps Australians weigh up buying against starting, and then supports them through whichever path they choose. For buyers, we look at the numbers, the structure and the deal; for founders, we set up the accounting and structure properly from day one. See our business sales and purchases service or contact us to talk it through.

This article is general information only and does not take into account your circumstances. Speak to a qualified adviser before acting on it.