Buying a Business? Here Are the 5 Steps to a Successful Business Purchase
Buying a business is one of the primary ways to take control of your own destiny, and it is one of the most satisfying things a person can do. If you are buying an existing business or a franchise, it’s important to know what the steps are to a successful business purchase. This post explains what those steps are.
When you are purchasing an existing business, you might be doing so on your own, or you might be doing it through a business broker. Either way, you’re doing the same thing – looking at potential businesses to see if you can envision yourself running them one day.
You should consider things like the hours and location, and you should look into competitors. You should examine the industry by looking at trade journals and news stories to get a sense of what common issues are. Even Google reviews of the business you’re considering buying are important. Someone’s anonymous complaints on the Internet are not necessarily the gospel truth, but you can look for trends.
And of course, you’ll need to make sure you have financing. You may be using your savings, getting an SBA business loan, or you may have investors who are assisting you with the purchase price (and whom you will need to pay back out of the business’s earnings).
Once you’ve done the preliminary investigation into your business and you are ready to make an offer to buy the business, it is important to take this process step by step. Your attorney will guide you through each step so that your legal rights are protected. The ultimate goal is for you to be a business owner – but you want to ensure that you start fresh, and that you do not take on additional risks or liabilities of the prior owner.
Here are the 5 steps to successfully purchasing an existing business:
Step 1: Confidentiality Agreement
Step 1 of a successful business purchase is a Confidentiality Agreement. This is generally done to protect the seller, who does not want anyone to have their proprietary business and financial information without permission.
A Confidentiality Agreement (also called a Non-Disclosure Agreement, or NDA) will be signed by you, the buyer, and will give you permission to look at the business’s operations, tax returns, financial statements, payroll, and other vital information. You are required to keep it all confidential, but of course you can show this information to your attorney, accountant, or other trusted advisors.
Step 2: Preliminary Financial Disclosures
After the Confidentiality Agreement is signed, the business seller will usually provide you with some high-level financial disclosures. Normally this is a financial statement or perhaps tax information. These are the threshold data points you will use to decide whether to take the next step and move forward with the business purchase.
On the one hand, the financial disclosures may show a healthy profit. On the other hand, if the disclosures show repeated losses or eyebrow-raising account entries, you may want to abort the process then and there. What usually happens, though, is that if the financials look sound you can move on to the next step and sign a Letter of Intent.
Step 3: Letter of Intent
If you have decided to move forward based on the preliminary financial information from the business seller, you will then sign a Letter of Intent. A Letter of Intent provides the outline for the business purchase. It is a shorter agreement that sets out the basic terms, the rest of which will be filled in later by the Asset Purchase Agreement.
The most important term in the Letter of Intent is the price, of course. There will also be provisions stating that the buyer shall be permitted to make requests for other financial information, contracts the seller has with third parties, corporate bylaws or operating agreements, inspections, and other details of the business.
A Letter of Intent usually says that the seller will not accept any other offers for a certain period of time. Otherwise, the seller could play two buyers against each other and attempt to inflate the business price.
One other common provision in a Letter of Intent is that the parties will agree that there is no formal agreement to purchase yet. Though there is an agreed price, the buyer and the seller understand that that price may change based on what the buyer finds in the course of its investigations. There could, for instance, be liabilities that the seller did not mention at the outset, things like a large loan or an ongoing lawsuit, the costs of which would need to be deducted from the purchase price if the buyer is taking on those obligations.
Step 4: Due Diligence
Due diligence is one of the most time-consuming aspects of buying a business. Your attorney and accountant will make requests for various documents from the seller to ensure that there is a complete picture of every aspect of the business.
In short, we want to understand in as much detail as possible the history of the seller’s business, the details of its financial condition, the quality of its assets, the extent and nature of its existing (and potential) liabilities, and the nature of its relationships with its customers, vendors, and others. To reach this understanding, our office will present a due diligence request to the seller or their attorneys.
Our office does a number of things when we conduct due diligence. We do a background check on the business sellers to see if there are any issues we should be aware of. We search for previous lawsuits against the business in state and federal court for the same reason. There may be UCC filings (liens) with the state that have to be paid off. We review contracts with vendors, agreements with clients, leases, and mortgages. What needs to be reviewed ultimately depends on the nature of the seller’s business.
Step 5: Sign the Asset Purchase Agreement
The Asset Purchase Agreement is the final agreement between the buyer and seller pursuant to which the business is sold.
The Asset Purchase Agreement contains the price, lists the exact assets you are purchasing from the seller, and will often state which assets are not being purchased. It will contain representations and warranties of the seller stating the condition of the assets and affirming that nothing has happened during the due diligence period that would materially affect the business.
Because the business will change hands from one day to the next, there may be outstanding bills, payroll, or lease payments that will affect the final price. Thus, a few days before the closing the buyer and seller will adjust the price as necessary to account for those factors.
The former owner may stay on as a consultant for a short period of time to help with the transition. This ensures an orderly transfer and allows the buyer to ask questions about how things work. This is an important provision that the buyer and seller should consider including.
Another provision that most business sales include in the Asset Purchase Agreement is a non-compete. The buyer does not want the seller to set up a competing business across the street using the know-how they have acquired. Because of this, the seller usually signs a non-compete agreement which may be for a period of one to five years, or even longer.
An important distinction should be made about an Asset Purchase Agreement and the other types of business sales. With an Asset Purchase Agreement, you create a new legal entity (an LLC or a corporation) which buys all the assets of the selling business. You may buy its inventory, supplies, vehicles, its good name, and its goodwill. But, all those things are purchased buy your company.
This is in contrast to an agreement where you buy the corporation or LLC itself from the owner. It may seem like a distinction without a difference, but it is vitally important. When you buy someone’s company, you take on all the liabilities the company has, even those that you don’t know about. With an Asset Purchase Agreement, you are buying only the listed assets so you know exactly what you’re getting. You are getting a fresh start.
As you can see, the sale and purchase of a business contains important steps that should be followed. The above overview is just an example, and some sales are more complicated or contain additional steps depending on the nature of the business and the terms of the sale. With a competent attorney helping you through the process, though, you can let the attorney handle most of these steps and get ready to get a running start on owning your own business.
DYE CULIK PC is a Charlotte, North Carolina business law firm that represents small business owners and franchisees for everything from starting a business, to buying or selling a business, or even disputes and litigation with competitors, employees, and customers. If you have a question about what to do, contact us at 980-999-3557 to see how we can help you succeed.