BUYING A BUSINESS
Buying a business can be a key strategy for growth. Expanding your product lines, increasing your market share, boosting your financial position, providing stability for a more seasonal business or gaining important personnel talents are all strong reasons for buying.
Buying a business is not an easy task. You need to be aware of your options — and potential pitfalls. A financial advisor can help you gain a better understanding of both and will also help by working with your attorney and accountant.
If you're planning to buy a business, there are several things to consider.
How the buying Process works
Motivation is a critical factor when determining the type of business to buy and when to buy it. Consider your motives before contemplating a purchase.
- Consider industries related to your own business experience or those that offer strong growth potential using available expertise.
- Know your market. Numerous sources can aid your research, including your business associates, a financial advisor, an accountant, attorney or financial lender. Other traditional resources include industry journals, business brokers and newspapers.
- Develop standards to help you evaluate prospective companies. Consider your financial status, risk tolerance, prior business experience and management skills. Then examine each company's marketing, production, management, leadership style and, most importantly, financial health.
Once you've found a business to buy, a series of meetings and negotiations will structure the deal, determine financing arrangements, make the purchase agreement and complete the transaction. You'll need to coordinate the services of an attorney, accountant and other professionals. In the meantime, we offer this general outline of the buying process.
- First meeting
- Letter of intent
- Due diligence
- Purchase agreement
- Closing the agreement
As the buyer, discover the seller's reasons for (and commitment to) selling the company. Ask detailed questions about the business's profitability, operations, market share, staff and any challenges or liens. Likewise, the seller will want to discover your commitment to buying and if you have the financial resources to do so. It's also not too early to discuss price, but avoid the specific — concentrate on determining whether an agreement is possible.
Open communication is critical throughout the acquisition. Remain flexible. Successful negotiation is a mutual understanding of each party's objectives and needs, strengths and weaknesses. The goal is for both sides to feel that they have accomplished their objectives and met their needs.
Letter of intent
The basic terms of the agreement are outlined in a letter of intent. This written confirmation between the buyer and seller signifies the intent to continue negotiations in good faith. Typically, the letter contains an escape clause that allows both parties the option to withdraw at any point.
A letter of intent often contains:
- A description of what is being purchased (list of assets, liabilities and operations).
- The purchase price.
- The structure of the agreement.
- Financial considerations.
- Escrow for contingencies. The buyer may want to set up an escrow account to cover unrecorded liabilities that appear later, such as an uncollected account.
- Other terms, such as contingent payments that identify certain buyer's rights and conditions; no compete clauses, whereby the seller agrees not to start or work for a competitive company for a given period of time to allow the buyer time to solidify the workings of the business being purchased; and existing contracts.
- Required agreements, such as leases and long-term purchases.
- A purchasing agreement including the expected timing and who will draft the agreement.
- Due diligence, which is the amount of time allowed for the buyer to analyze the company to ensure everything is being represented properly.
- Professional fees (defining who is responsible for the fees from attorneys, appraisers, accountants, bankers, etc.).
- Exclusivity agreement, defining the period of time that the seller will negotiate exclusively with the buyer.
- Bust-up fees, a provision for the buyer in the event that the company is sold to another bidder after the buyer has added value to the company by conducting business valuations and negotiations. The bust-up fee dictates that the buyer would receive a portion of the increased price as compensation for the value added. Sellers, naturally, try to avoid this fee.
- Interim operations provisions that specify how the business will operate during the negotiating period. Some activities, such as capital expenditures and hiring, may be temporarily halted.
- Closing conditions.
- Expected time of closing.
- Any applicable laws, especially if the transaction crosses state lines (some state laws may govern the agreement).
- Adjusted purchase price, allowing for any income or losses that occur up to the actual closing date.
Keep in mind that the letter of intent is not legally binding, but it can include language that:
- Requests the seller to stop marketing the company for the benefit of the buyer.
- Grants the seller some legal assurances in the event that the transaction falls through.
During due diligence, the buyer conducts an in-depth analysis of the seller's company. This procedure is always unique, but typically focuses on: identifying and evaluating key operational areas, legal and contractual agreements, financial statements, and potential risks.
Due diligence is time-consuming and usually best conducted by a team of professionals — an attorney, accountant, appraiser, engineer and operating and marketing experts. The seller may allow only these experts to conduct the study to block the buyer from talking with employees, vendors or customers before the transaction is completed.
Using the letter of intent as an outline, an attorney will draft the purchase agreement. Typically, the agreement is a working document while due diligence evaluations and negotiations are being conducted. Due diligence usually brings up negotiable issues. Likewise, the representations and warranties and the indemnification provisions of both parties are drafted along the way.
Representations and warranties
This is a reference to the related documents which make up the business such as patents, pending litigation or outstanding obligations. This area demands the most negotiation, since the buyer wants maximum disclosure about the seller. The seller views this as time-consuming and prefers minimizing the number of representations, partly to avoid making any guarantee.
Indemnification provisions specify the damages and rights of the buyer and seller in making claims against each other if the representations and warranties are not true. Typically, an agreement includes a "basket provision" that rules no compensations are payable until the misrepresentation exceeds an agreed amount. The seller may request a ceiling on the basket provision and a credit equal to any tax savings the buyer receives.
Closing the agreement
Once all the issues are resolved and the financing is set, the deal can be closed. This means all documents are signed, all stock and assets are transferred and the buyer is now the new owner.
Pending tax rulings or title transfers could delay the final closing. However, the buyer and seller can agree to a deferred closing by signing the purchase agreement and handing over the business, with the actual title transferring later. The actual title transfer ompletes the transaction.