Do Your Due Diligence
Gathering information, otherwise known as due diligence, is essential for a successful business purchase. You will want to bring in others to help with this process, such as an attorney, banker and accountant. They will help you examine the records, assets and operations of a business before you sign on the dotted line.
The period of due diligence typically starts after a deal has been drafted in principle but before a binding contract is drawn up. The length of time will vary, but you should take several weeks at a minimum to make sure nothing is overlooked.
First, look at your future personnel and any other human resources issues. Evaluate the organizational chart to understand who is responsible to whom. Learn the wage of each employee and their terms and conditions of employment. What skills and experience does the staff have? Will they stay on if the business is sold?
Examining the financial operations of the business will be extremely important during this phase. Study the company’s books and records including balance sheets, income statements and tax returns as well as its accounting and bookkeeping methods. Take a look at the cash flow of the company, both past and projected. Is there debt? Does the business have an established relationship with banks and lenders that could prove helpful in the future?
Have a professional determine the fair market price of the business. In that assessment of the business’s value, take into account its financial health, earnings history and growth potential, as well as intangible assets such as brand name and market position. How does this valuation compare to the seller’s asking price?
Do an industry comparison of the products and services the business offers. Are they in line with industry standards and competitors? Identify strategies and trends in the industry, and get to know your competitors.
Examine the assets of the business, such as property, furniture, fixtures and equipment. Are any renovations necessary? Major repairs or replacing aging equipment could add a hefty sum to your initial investment. Review leases and deeds and analyze the depreciation of property and equipment values.
Make sure the property is zoned properly. If not, it could lead to trouble down the road like it did for Catherine Crews, who owns Canine Crews, a dog boarding and daycare facility in Chicago, Illinois. “My building was not zoned to be a daycare or boarding facility even though it had already been operating as one for three years before I purchased it. Someone may not have done the due diligence on their end to make sure they are legal and when you re-apply, you’ll be the one to have to deal with it,” said Crews.
Delve into the operations of the company. Consider its location, inventories, suppliers, management, customer relations and insurance policies. Know what type of insurance coverage is in place as well as who the underwriter and local company representative is, and how much the premiums are.
In addition, be on the lookout for outstanding litigation. Review major contracts and orders, IT systems and technology, environmental issues and commercial management including customer service, research and development and marketing.
Of course, it’s impossible to uncover every last detail about a business, but it’s crucial that you learn enough during the due diligence period so that you are able to make an informed decision.
Closing the Deal
Assuming all of the information gathered during due diligence doesn’t make you change your mind about buying the business, the next step is coming to an agreement with the seller. Remember that each party is coming to the table with a different perspective. Being well prepared could provide the most leverage when entering the negotiating phase.
Here are several factors to consider:
- Know who you are negotiating with. Sellers will likely have an emotional attachment to the business which could mean they think the business is worth more than it actually is. “Sellers might also have their own debt to account for, which can have a significant impact on driving up the asking price,” said Chad Simmons, author of the Business Valuation Bluebook.
- Protect yourself from a down economy. This can be accomplished by tying part of the purchase price to future earnings. These are called performance-based deals or earn outs, which basically make the seller put their money where their mouth is. If the business is as great as they say it is, they may be willing to bend on this part of the offer, especially if you happen to be at an impasse in the negotiation.
- Build in conditions to break an impasse. This allows the buyer to reduce the price or bail out of the deal altogether.
- Don’t be greedy or anxious. Mistakes can be made when you are anxious or impatient to buy a business. Take your time.
- Build in transition time. Most sellers are willing to train new buyers to operate the business. This period of time can range from a few weeks to six months or longer. You can even work out a deal where the previous owner is available on a consultation basis. At the very least, try to maintain a positive relationship with the prior owner after closing the deal. You never know when you might have a question or even need advice.
Two of the most common reasons that business sales fall through are a lack of transparency and inflexibility on behalf of one or both of the parties. If the negotiation process goes on for too long, either or both parties may tire of the process and withdraw, a result of “negotiation fatigue.” So, be willing to come to the table and be flexible enough to actually work out a deal.
Agreeing on a price is just the first step in negotiating the sale. Even more important could be how the deal is structured. Your attorney will draft the terms of sale. This agreement defines everything that you intend to purchase including business assets, customer lists, intellectual property and goodwill.
The closing is the last step in the process of buying a business. The following should be addressed in a closing with your attorney:
- Adjusted Purchase Price: This will include prorated items such as rent, utilities and inventory up to the time of the closing.
- Corporate Resolution Approving the Sale
- Promissory Note
- Security Agreements
- Uniform Commercial Code Financing Statement which is recorded with the Secretary of State in the state you will be purchasing your business
- Lease: If you are taking over a lease, make sure you have the landlord’s approval. If you are negotiating a new lease, make sure both parties are in agreement of the terms of the new lease.
- Vehicles: If the purchase of the business includes vehicles, be prepared to complete transfer documents with the local Department of Motor Vehicles.
- Bill of Sale: This proves the sale of the business.
- Patents, Trademarks and Copyrights: If these are part of the business, paperwork will need to be completed as part of the transaction.
- Closing or Settlement Sheet: This lists all financial aspects of the transaction. Everything here should have already been negotiated.
- Covenant Not to Compete: Have the seller sign an agreement to not compete against the business.
- Consultation/Employment Agreement: If the seller agrees to remain involved in the business for a specified amount of time, this documentation is necessary for legal purposes.
- Complete IRS Form 8594 Asset Acquisition Statement: This document will indicate how the purchase was allocated and the amount of assets, which will be important for tax purposes.
- Bulk Sale Laws: Be sure to comply with bulk sale laws, which govern the sale of business inventory.
Buying an existing business equates to purchasing an established foundation, history, reputation and hopefully, future potential. But there’s no such thing as a sure thing. Every business will have its ups and downs, and it’s through this buying process that prospective business owners will learn what they can and can’t live with. Buying a business requires a lot of hard work, but hopefully it pays off in satisfaction and success.
Hopefully this 3-part guide to buying a business has gotten you excited about the prospect of moving ahead with your entrepreneurial dreams. Don’t forget to start with the important self-examination described in Part 1. Then, when you’re ready to explore various business sectors and see which businesses are for sale right now, access our advanced search and get to it!