BUYING A BUSINESS
Thinking of buying a business or part of a business? If so, then congratulations! Simply by reading this article, you are exhibiting the prudence and wisdom that many of your peers lack. While buying a business can be quite romanticized, it can wind up being a great investment or major headache. The sad truth is that most acquirers of small businesses will move forward with perhaps one of the largest financial deals in their lives without taking the proper steps. Namely, without putting a proper team together, without conducting proper due diligence, and simply making a decision based on their emotions.
Before you read further in this article, please read about the high-level issues of either acquiring or selling a business, in a previous blog article we wrote entitled, The Art of Buying and Selling a Business.
STEPS TO SUCCESS
Buying a business is complicated. In any business acquisition, there are generally four (4) critical phases, and none of them should be skipped:
- Finding just the right business
- Due diligence, and
Each phase is critically important and when we see deals fall apart it’s usually because the acquirer attempts to skip one or more steps. Even if you THINK you have just the right business, either because you stumbled across a friend’s business or you’re a current employee when your employer is trying to sell the business, you STILL should seek similar businesses to compare price and to give yourself options.
FINDING THE RIGHT BUSINESS
Think of this like “Goldilocks and the Three Bears”. You want to find a business that is ‘just right’ for your abilities, strengths and weaknesses. It helps to have a clear idea of what you want before you start looking, not only in terms of industry and geography, but in terms of your budget, background and commitment. The two biggest mistakes we see when someone buys a business is (1) they think they can do the business better than the seller, and (2) becoming so emotionally invested in the ‘idea’ of a business that they ignore the red flags of ‘reality’. Owning a business is a noble goal, but make sure you are approaching it from a practical mindset. While “finding the right business” isn’t considered a legal issue, we recommend the following steps:
Don’t get sold on the idea of a business alone!
- Find and identify your professional team: A business broker, a business lawyer, a CPA and a banker (if appropriate). Choose carefully. Make sure they have experience in the particular field you are looking into.
- Find at least one other alternative acquisition option (1) in the neighborhood and (2) in the industry. If none exist, consider why.
- Pull together your funding sources.
- Seek the advice of your professional team, and other (unrelated, disinterested) parties in the same industry. You want unrelated, disinterested parties so you can get truthful, unbiased information and prevent competition for purchasing the business.
This is where your professional team — especially your business broker — can help. You need to know comparable prices for the industry and the locale. This is similar to looking for a home, you will finding comparable business sales and comparing prices. Your business broker will identify a fair price for the business, taking into account the financial status of the business and its assets and liabilities.
Steps for this phase include:
- Finalize purchase price and terms for the sale.
- Finalize conditions and other requirements for the sale.
- Do you require the seller to remain for some period of time for training or transitioning purposes?
- Is there some form of seller financing?
- What do the non-compete or non-solicitation requirements look like?
- Are there personal assets to be included in the sale?
- Identify the assets included in and excluded from the sale.
- Identify the liabilities assumed with and excluded from the sale.
- Identify and negotiate any special circumstances, such as Intellectual Property transfer or licensing, sales or revenues requirements, etc.
Due diligence is often overlooked by many a buyer of small businesses. This is where your professional team can be critical to your success. Not only do you want to verify and validate all the assets, but you want to identify problems, unknowns, risks and other ‘gotchas’ that can spell doom for your newly acquired business. This phase is also your last chance to cancel the deal, to avoid from making significant financial mistakes.
Steps for this phase include:
- Obtain all company formation and ownership documents (whether LLC or S-Corp/C-Corp); Review and validate.
- Perform UCC search (at the State level) and lien search (at the County level). Read why a UCC Search & Lien Search in a Business Acquisition is a critical step that cannot be skipped.
- Verify and validate all assets included in the sale, especially critical inventory and/or supply chain.
- Verify and validate all liabilities.
- Verify the financial statements and conduct appropriate financial audits.
- Verify and validate all “lists,” including (but not limited to) customer list and gift certificate purchases (if any).
- Obtain a list (and all copies) of important contracts, including lease, utilities, insurance, and payroll service.
- Verify all such contracts are assumable or otherwise don’t need approval for this transaction.
- For all contracts needing approval (assume the lease requires approval), negotiate as appropriate.
- Obtain any relevant information for all financial-related assets, including any business bank accounts, merchant accounts, notes, lines of credit or credit cards, and retirement or trust accounts.
- Obtain appropriate tax clearances from appropriate taxing authorities.
- Obtain appropriate licensing approvals, from appropriate governmental agencies, where or as appropriate.
- Obtain funds
- Obtain accurate closing financials:
- Purchase Price – Assumed Liabilities
- Account for pay period and assumed payroll liability
- Create new corporate entity as the acquiring entity, if appropriate
The closing is the proverbial date at which “the keys change hands,” but oftentimes it is just a mere formality setting the specific date at which the business transfers from the seller to the purchaser. At the very least, documents are signed and assets are transferred. Steps in this phase include:
- Finalize closing documents, which can include but are not limited to:
- Closing Checklist, for your particular situation and circumstances
- Purchase Agreement (for both asset purchases and share or membership interest purchases)
- Promissory Note, if applicable
- Escrow instructions, if applicable
- Bill of Sale
- Corporate resolutions, as appropriate
- Licensing or assignment documents, if applicable
- Employment Agreement, if applicable
- Finalize lease or lease assignment, if applicable
- Finalize assignments for other third-party contracts
- IRS Form 8594 relating to the assets
- IRS Form 8822-B relating to the identity of the responsible party, if buying the shares or membership interest
EACH ACQUISITION IS UNIQUE
We understand that no two business acquisitions are the same.
Please use the above-lists as a starting point for your unique situation, and be sure to utilize your professional team to help you fully flesh out your business acquisition checklist. Assign responsibilities as or where appropriate.
Finally, good luck on your business purchase!