How to Purchase a Business
Purchasing an existing business can appear straight-forward at first glance. One party proposes an offer to purchase the business and the other party either accepts or rejects the offer. It is often less risky than starting from scratch due to established infrastructure alongside continuing cash flows. Then you start asking questions. How do I purchase this business? How do you know the business is suitable and strong? What price do you offer for the business? How do you mitigate against risks? This guide will explain the general procedure in purchasing (or ‘acquiring’) a business.
If you are buying or selling a business, to protect your personal and future business interests, it always advisable to engage a business purchase/sale lawyer.
Narrowing the Field – A Preliminary Due Diligence
As simple as it sounds, the first key step is to make sure you are choosing to purchase the right business. This involves narrowing the field of potential businesses to purchase. Brokers can assist in narrowing the search by identifying your interests, prescreening businesses, negotiations and assisting with paperwork. Whether you decide to utilise a broker or not, there are a variety of factors you should consider in narrowing your search:
- Industry – What is the industry you are looking to acquire into? What is the current market position of competition in the industry?
- Risks – What are the risks associated with the business? What is its extent? How can these risks be mitigated?
- Skills and experience – Being honest about your skills and experience, what business ventures are most suited to you?
- Size of the Business – What’s the ideal size of the business in terms of employees, customer base, sales and so on?
- Location – Where would be an ideal geographical area for your business be?
- Labor Pool and costs – What would be the availability of work and costs associated with the business
- Quantity of Investment – How much would you have to invest?
The above factors should be weighed against one another to determine whether you are interested in purchasing a business. You can thereby express your interest in purchasing a business by signing a heads of Agreement or confidentiality agreement. This will usually provide access to more detailed information.
To buy or not to buy – The Decisive Detailed Due Diligence
With the risk of over-dramatising the acquisition procedure, this step is arguably the most important and will be decisive in deciding whether to purchase a business. Therefore you will definitely want to build your ‘acquisition team’ together to assist you – you banker, accountant and attorney. This will provide invaluable support and advice in reviewing and verifying all relevant information regarding the business to ensure you make the best decision for your business needs. This assessment should be comprehensive and may include analysis of:
- Finances – Analyse the historical trends regarding various financial analytics including sales growth, profit margins, overheads and working capital. Does the financial structure look sustainably profitable?
- Business Potential – Is there scope for you to improve the business to increase return and profits? Where does your skill and experience provide value? Does future outlook of the company look positive or negative? Is an achievable forecast reflective of the company’s performance or the industry as a whole?
- Reputation and business relationships – How is the business perceived? Are its relationships with customers, suppliers and vendors sustainably positive? If not, are there contingencies available? Are suppliers reliable?
- Auditing – When was the last full audit? What is the debt situation? How large are bad debts and why did they occur?
- Employees – Who are the key employees? What is their general skill level, turnover rate and pay? How do people feel about a change in ownership?
- Legal Due diligence – Confirm legal ownership of all key assets. Are there any past, current or pending lawsuits? What contractual obligations are imposed on the business?
- Goodwill (Intangible Assets) – What is the estimated value of goodwill? How should you negotiate to reduce goodwill?
- Business Value – What is the overall value of the business? What would be a fair and equitable price for the sale of the business?
Methods of Purchasing
Following due diligence, if you believe purchasing the business is the best decision, then the final step is arranging the method of acquisition. The standard perception is that of a lump cash sum. However, there are a variety of arrangements that can be made.
Firstly, payment in cash, which encompasses both assets and goodwill, may be paid over a period of time rather than upfront. This allows cash generated by the business to pay the debt and may signal confidence by seller in the future performance of the company.
Secondly, publicly-listed businesses can utilise an Employee Stock Ownership Plan (ESOP). ESOPs sell stock in the business to employees. The sale of non-voting shares of stock will ensure that you retain control. Thirdly, you can organise for the seller to lease the business to you with an option to purchase following the lease.
LawPath can get you in touch with a highly qualified business purchase/sale lawyer. Contact a LawPath consultant on 1800 LAWPATH to learn more about customising legal documents, obtaining a fixed-fee quote from our network of 600+ expert lawyers or to get answers to your legal questions.