A potential client contacted me one day, to find out how much I would charge to help him come up with a business plan for his dry-cleaning business that he recently purchased. After all of the papers were signed and the deal was done, he realized that he overpaid for the business. The value that was presented to him by the previous owner was not the actual value of the business.

When venturing into entrepreneurship, some people think that purchasing an existing business is better or easier than trying to start from scratch. But it can be tricky, especially if you have no idea how to value a company.

Here are five steps to take before purchasing an existing business.

1. Figure out what the company is really worth (also known as Fair Market Value).

I know that looking at financial statements is the last thing that an entrepreneur really wants to do. However, understanding what the numbers mean is a key component to running a successful business. Before you purchase an existing business, look at the previous owner’s financial statements thoroughly, even though you probably dread it. If it is proving to be confusing, then hire someone to look into them for you. You may have to spend money to correctly pinpoint issues in the beginning, which can save you large amounts of money in the end if the business is overvalued.

2. Find out if the customers are contractually obligated to the company or not.

Some small businesses have exclusive contracts with clients and can be acquired with the purchase of the business. However, in the case of the dry-cleaning business, the clients are not obligated to patron your business. The previous owner may have built up a relationship with the clients and they can decide to go somewhere else after the owner leaves. You must take that into account when purchasing an existing business and ensure that you have a marketing plan in place to continue the current client relationships while expanding the business by creating new ones. When negotiating a purchase price, be sure to factor this in.

3. Can you outsource a task from another company cheaper than buying the equipment and doing it in-house?

When purchasing an existing business, there is a possibility that the previous owners have purchase agreements in place with existing equipment suppliers. This may be transferred over to you when you purchase the firm and you may be obligated to continue the payments as that piece of equipment may be an integral part of the business. If by chance, you are not obligated, then it may be better to outsource that part of the business, instead of maintaining the pricey equipment. Outsourcing can reduce costs in a business. However, there are some drawbacks and you want to make sure that you do not outsource core business operations, as it can put your business in a vulnerable situation. Core business operations are things that your business does that cannot be easily copied and give your business that competitive advantage.

4. Consider the current market value of all equipment.

It may be a little more labour intensive, but it’s worth it to take a look at the equipment within the business and find out if the current market value is represented accurately in the financial statements. Make some calls to suppliers or do some online research and compare pricing. You want to understand how the business operates and why certain equipment is necessary to the day to day operations. It is important that the equipment is appraised and the value is represented at the market value it is today (after depreciation), not the price that the original owner paid for it.

5. What liabilities does the business have?

Did the previous owner list all existing liabilities of the business under good faith? In the case of the dry cleaning business, there were some bad faith practices done by the previous owner. The fair market value of the business was not accurately represented and the new owner did not do their due diligence and hire professionals to assess the situation because they wanted to save money. I urge you to hire professional advisors BEFORE purchasing an existing business. That means hire at least a lawyer, an accountant and a business or marketing consultant. You want to have accurate information to negotiate a fair price for the business and avoid any surprises after you sign on the dotted line.