By Richard Harroch
Buying an existing business can provide advantages including existing operations and customers, immediate cash flow, existing brand and goodwill, and many more. But if you are thinking of buying a small business, you will need to consider several important business, legal, and financial factors. In this article, I discuss the 12 key factors you should consider when buying a small business.
What to do before buying a business
1. Review multiple business opportunities
It’s helpful to review multiple opportunities of businesses for sale, so that you can compare and contrast the companies. Do a search on business for sale websites such as BizBuySell and BizQuest, and consider using a business broker to bring you opportunities. Business brokers in your area can be found on the same business-for-sale websites you are already searching.
2. Do due diligence
The most important thing you need to do is thorough due diligence on the business you are hoping to buy. Books have been written on due diligence, but here are some of the key areas:
- Review past financial statements and tax returns, especially monthly financials to spot trends. Have sales been going up or down recently? How profitable is the business?
- Review assets that come with the business
- Review any debt or other liabilities of the business
- Review contracts and other liabilities you want or need to assume
- Do a lien search on the business
- Review important intellectual property such as patents, copyrights, and trademarks
- Consider talking to key customers
- Do a Google or Yelp search for any reviews of the business
- Do employee interviews to ensure they are competent and will stay on with the business after the acquisition
- Review any key leases—will they continue? Are there burdensome terms? Do you need to amend the term of the lease or other provisions?
- Can you physically work at the business for a period of time before committing?
- Review the status of any inventory, equipment, and physical assets
- Review customer information
- Do a legal review of organizational corporate or LLC documents
3. Expect to sign an NDA
Most sellers will expect you to sign a Non-Disclosure Agreement (NDA) before they provide you with sensitive confidential information. Most forms of NDA are standard, but occasionally unreasonable terms are thrown in. Have your attorney bless the form before you sign it.
4. Find the right business attorney
Acquisitions are heavily legal intensive and you need a good business attorney who has handled many acquisitions of small businesses in the past. See Finding the Right Business Lawyer.
5. Set up an LLC or corporation as the buyer
You will likely want to set up or use an LLC or a corporation as the buyer of the company, to help protect you from personal liability in your individual capacity.
6. Decide on a type of business to buy
Determine what type of business is ideal for your situation. A brick-and-mortar business or an online business? A franchise? What personal time commitment can you make to run the business—full-time or part-time? Ideally, you will want to buy a company with a business you know something about to avoid the problem of “you don’t know what you don’t know.”
7. Decide on the type of acquisition
Ideally, you will want the acquisition as a purchase of all of the assets of the business and assumption of only specific liabilities and contracts, to avoid taking on unknown liabilities. However, some sellers may insist on the deal structured as a purchase of stock or a merger for tax reasons.
8. Prepare a good term sheet or letter of intent
Before you get into the complexities and costs of preparing a definitive purchase agreement, you will want to prepare and get the seller to sign a letter of intent or term sheet that spells out the key terms of the deal to make sure everyone is on the same page. A letter of intent shows that you are serious about doing a deal. Here are key terms to include in such a document:
- Purchase price: all cash? Part cash and the rest payable in installments? Seller financing through a promissory note? Adjustments to price based on account receivables collected or working capital at closing? Escrow of some of the cash in case of breach of representations and warranties by the seller? Understand that the price and terms are almost always negotiable.
- Structure of deal: asset or stock purchase?
- Exclusivity/no shop period for buyer to finish due diligence
- Key conditions to closing
- Timing of deal
- Any continued involvement or employment of selling owner to ensure a smooth transition
- Non-compete by selling owner so he or she doesn’t set up a new competing business
- Confidentiality obligation of seller
- Access to employees and books and records during exclusivity period
- How employees are to be treated
- Indemnification obligations of seller
- Key representations and warranties of seller
- How disputes will be handled and in what jurisdiction (hopefully by binding arbitration)
Most of the terms of the letter of intent or term sheet will be non-binding, but the buyer will want the exclusivity due diligence/no shop provision to be binding.
See How to Negotiate a Business Acquisition Letter of Intent for a good in-depth discussion.
9. Assess the risks of the business
Is the business heavily dependent on the owner or key employees? Are there significant potential liabilities? Is the business overly dependent on certain customers or suppliers? Are key contracts transferable or at risk of cancellation?
10. Prepare financial projections
It will be helpful for the buyer to prepare monthly projections of the business for the 1-year or 2-year period following the sale of the business, to determine what working capital may be needed and to budget accordingly. Take into account any reserves for problems that may arise.
11. Prepare a good acquisition agreement
It’s essential that your business lawyer prepares a good pro-buyer acquisition agreement. This is a complicated agreement to protect the buyer, especially dealing with representations, warranties, and indemnification. Thousands of articles are out there on this topic but here are a few good ones:
12. Check out permits and licenses
Find out if the company has all the proper licenses and permits in place, especially for regulated businesses like healthcare, childcare, and restaurants. Will you need to amend or get new permits or licenses after you buy the business? Also verify the business is in compliance with zoning laws and applicable environmental laws.
By systemically and carefully taking these factors into account, you will significantly increase your chances of closing a successful small business acquisition.
About the Author
Richard D. Harroch is a Managing Director and Global Head of M&A at VantagePoint Capital Partners, a venture capital fund in the San Francisco area. His focus is on Internet, digital media, and software companies, and he was the founder of several Internet companies. His articles have appeared online in Forbes, Fortune, MSN, Yahoo, FoxBusiness, and AllBusiness.com. Richard is the author of several books on startups and entrepreneurship as well as the co-author of Poker for Dummies and a Wall Street Journal-bestselling book on small business. He is the co-author of a 1,500-page book by Bloomberg, Mergers and Acquisitions of Privately Held Companies: Analysis, Forms and Agreements. He was also a corporate and M&A partner at the law firm of Orrick, Herrington & Sutcliffe, with experience in startups, mergers and acquisitions, and venture capital. He has been involved in over 200 M&A transactions and 250 startup financings. He can be reached through LinkedIn.
Copyright by Richard D. Harroch. All rights reserved.