5 Essential Steps to a Successful Business Purchase
The trail of business sales gone bad is littered with examples of buyer missteps
Once a buyer identifies a business to purchase, the real work begins to critically evaluate the target to make sure it’s the right business, beyond the purchase price. Buying a business has significant legal, tax and accounting risks that must be managed. Everything from contracts, understanding what’s being sold, the reputation of the business, income streams, transition and financing is fraught with pitfalls to avoid.
The trail of business sales gone bad is littered with examples of buyer missteps. Some examples include:
- Supply chain debts. A buyer of a business discovered after closing that the seller owed an indispensable supplier a significant amount of money. Even though the transaction was structured as an asset sale and the buyer was legally not obligated to pay this debt, the supplier refused to sell product to the buyer until the seller's account was paid off.
- Seasonality, one-time or infrequent sales spikes. A buyer of a roofing company was surprised and dismayed when revenues after closing were 50% off from the seller's financial statements. The buyer discovered too late that there had been a wide-spread and damaging hailstorm in the previous summer that had spiked financial results.
- Sales promotions in lead up to transaction. A buyer of a restaurant was shocked when revenues plummeted compared to the revenues reported by the seller, even though there were no changes in chefs, staff or menu after closing. The buyer later discovered that the seller had performed a massive coupon promotion prior to the sale, which drove up revenues and inflated the purchase price.
Sales misrepresentations can often be avoided by taking the tried and true path to a successful purchase. This includes five steps that can help mitigate risk in business transactions. For owners that have spent a lifetime building a business, following the trail of success can help the buyer navigate this complex process to a smooth purchase.
1. Reduce risk
Reducing risk through comprehensive due diligence on both the seller and the business is the most important task a buyer undertakes. Examining the target business from all angles, inside and out, can sometimes reveal that the financial and operational status of the business is materially and adversely different from what is represented. There are numerous matters buyers should examine, including:
- Background checks, such as UCC searches, credit reports and criminal record searches.
- A detailed and skeptical review of financial statements and revenue numbers.
- Confirm any loan and account balances with banks and other lenders.
- Check the status with important suppliers: Is the seller in good standing with these suppliers? Is the seller current on payments owed to primary suppliers?
- Confirm employee relations. Much can be determined about the financial health and goodwill of a business by assessing the seller's relationship with its employees.
- Discuss all lawsuits in which the seller has been involved, past and present, and determine if any material threats are being alleged against the seller.
2. Provide for Transition and Continuity
Often during negotiations, relationships between the parties can become strained and buyers may want to make a clean break with the seller after closing. But it can be difficult to take over a business without some type of transition assistance from the seller and key employees.
During purchase negotiations, lock in the efforts of individuals who are critical to transition success and business continuity. When an owner who is key to attracting business, or holds the required knowledge or skill set to operate the business, or is the namesake of the business, departs too abruptly, the credibility and customer base of the business could suffer.
Prior to closing, the buyer and seller should define the scope and terms of any transition help. This includes the number of hours the seller will devote during the term, the length of the term, and whether such services are part of the purchase price of the business or additional compensation will be paid to the seller for these services.
Similarly, a key employee that customers are used to dealing with should know his or her job is not in jeopardy with the sale of the business. Consider signing an employment or consulting agreement with key employees and make this agreement a condition to closing the transaction.
3. Protect the Business
A buyer can and should require the seller (and its owners if the business is operated through an entity) to directly and indirectly agree to non-compete and non-solicitation provisions. Non-solicitation provisions generally bar sellers and their affiliates for a specified number of months after closing from soliciting the employees of the business being bought.
4. Assess Legal, Tax and Accounting Impact
Sales of private businesses are typically structured as either asset sales or stock sales. Most private businesses are owned and operated through some type of entity, such as a corporation or limited liability company.
Buyers generally favor asset purchases to avoid winding up with liabilities of the entity which may or may not have been known to the seller. In an asset sale, the buyer of the business purchases all the assets used in the business along with the associated goodwill, but does not purchase the entity itself. The purchase agreement should specify how the purchase price is allocated among the assets being purchased to avoid serious income tax consequences for both the buyer and seller.
5. Don’t Go it Alone
Don't let your emotional enthusiasm for a target business override savvy and objective financial decision-making. Buying a business typically entails a material investment in time and money to determine whether the purchase is financially feasible and advisable.
Few buyers have the bandwidth and experience to handle the full spectrum of legal, tax and accounting complexities in buying a business. By assembling an experienced go-to transaction team, a buyer can see that their best interests are protected as they pursue and complete the purchase of a business.
This is part two of a two-part series on mitigating the risks associated with business transactions. For part one, click here.
David A. Thayer, Esq., is a corporate and transaction attorney, and former CPA, that focuses on being a deal maker, not a deal breaker, as he helps clients achieve their business dreams. He can be reached at firstname.lastname@example.org.
This information is not intended as legal advice. Seek specific legal advice before acting.