So you have found a business that you are interested in buying. Before you enter into the sale and purchase agreement you should complete an initial appraisal of the business. You should try to identify the business’ major strengths and weaknesses so that you can address any concerns in the sale and purchase agreement and in setting the purchase price.
Before entering an agreement you should consider the following:
1. Who will be the purchaser?
You will need to decide on an ownership structure to suit your needs. You could own and operate the business as a sole trader, in partnership with one or many other owners, or through a company or trust. Alternatively, you could divide the ownership and operation of the business and use one entity to own the assets of the business and another entity to operate the business.
2. What will you purchase?
Most business purchases involve purchasing the business assets (including intellectual property), stock and contract rights (such as leases). However, if the business is owned by a company it is possible to purchase the shares in that company, rather than the business itself. More issues do arise with this option so you should seek legal advice. You will take on the company’s trading history including its liabilities, existing agreements, any tax due and holiday pay liabilities.
3. What is your offer?
Involve your accountant in this process as there are many ways of valuing a business. You may only be able to get limited financial information prior to making your offer so your offer should be subject to an investigation of the business (generally called a “due diligence condition”). This will give you an opportunity to adjust your valuation if your offer turns out to be too high after you receive more information.
Once the agreement is signed the due diligence process will enable you to verify the financial information provided by the vendor and the purchase price. However, your first offer will create an expectation for the vendor and it may be hard to renegotiate the purchase price after the agreement is signed so you still need to take your first offer seriously.
You will need to consider how the purchase price should be allocated between fixed assets, trading stock and goodwill.
You should also consider different options for payment of the purchase price. A fixed price payable on settlement date is easier and cleaner but you could put in place a buy out or partnership plan with the vendor. Under these arrangements, you may pay the vendor additional amounts after settlement if the business performs well.
4. What is a due diligence condition?
A due diligence condition gives you an opportunity to complete a more thorough review of the business before you are committed to the purchase. It gives you time to collect information to verify the business’ performance. You should involve your lawyer, accountant and other advisers in this due diligence process.
During the due diligence period, take the time to look beyond the financials and obtain other information regarding the business’ reputation. Research the market to determine whether demand for the product or service is increasing or decreasing. Research the competition: are they growing? Ask whether it is a business that is easy to replicate and whether there is any point of difference for the business. Talk with as many people as you can within the industry including the business’ clients and suppliers, other professionals within the industry and even the competition. This will give you a good idea of the regard in which the business is held.
You may decide that you do not want to purchase the business after you have completed your investigation. A good due diligence clause will allow you to cancel your purchase if that occurs or to renegotiate the terms (including the purchase price) if required.
5. What warranties should you include in the agreement?
Warranties are promises that the vendor makes to you about the performance and quality of their business. You can sue the vendor after settlement if the warranties turn out to be incorrect. Warranties therefore reduce some of the risks you face when purchasing a business. However, they are only as good as the financial backing of the vendor after the sale. If the vendor company liquidates after the sale you will find it difficult to enforce warranties.
A standard business purchase agreement contains the following warranties from the vendor:
- There are no outstanding government (including local) requirements not disclosed;
- Assets are unencumbered and there are no charges on electrical and other installations;
- Plant, fitting and fixtures are in good operational order;
- All debts and liabilities are paid;
- A statement at settlement will account for adjustments of accounts and receivables as at the possession date;
- There are no outstanding requisitions at settlement;
- Business will be carried on as usual until possession is given;
- The turnover figures provided are correct;
- The vendor will do all that is necessary to transfer the full benefit of the business (e.g assign licences or contracts);
- The telephone connection will be transferred;
- The vendor will assist when required during the period specified for giving assistance;
- Any building works have consents and permits where required.
You should consider whether you need to add any other warranties that are specific to the business you are buying and that could address risk areas you are aware of or concerned about. Warranties may be difficult to enforce after a sale so do not rely on them too much. Although warranties are useful you should make sure you are happy to purchase the business without the warranties. To make the warranties more useful, you should ensure that the agreement for sale and purchase is personally guaranteed by the directors of the vendor company.
6. Are there any key staff?
It is important to identify staffing requirements and key employees for the business as quickly as possible. Employees are often an essential and very valuable asset of the business. If you are purchasing a business (rather than shares in a company which operates a business) your purchase agreement will need to address the responsibilities of the vendor to the staff at settlement and ensure that any existing staff entitlements rights are met by the vendor to commence a fresh contract on your terms with the staff members. If any staff are particularly important, you may want to make it clear that you will only purchase the business if those key staff accept your employment terms.
7. Is there any intellectual property?
Business trade marks, trade secrets, processes, information and product names are very important and can be significant assets for many businesses. You need to ensure these items are identified and included in your purchase agreement.
8. Is there a lease?
Many businesses operate from leased premises. You need to ensure there is a lease in place if required and review the lease terms. You need to be comfortable with the length of the remaining lease term and the obligations you will take on under the lease as the new business owner and tenant. You may want to negotiate new terms with the Landlord directly to make the lease a more useful asset however, this may not be an option.
9. What stock is included in the purchase?
Are there supply agreements in place and what conditions need to be met to transfer those agreements to you?. If the business is a franchise, the ongoing purchase of stock may be tied up with the franchise arrangements
Also consider what trading stock is actually included in the purchase and make sure the estimated value of that stock is specified in the agreement. Under a standard agreement for sale and purchase the final value of trading stock is determined by way of a joint stock take. You will need to purchase stock up to the estimated stock value as specified in the agreement plus a maximum percentage adjustment. You need to make provision for potential stock adjustments in your finance arrangements. Should the final stock exceed the maximum allowance then you can elect what stock to take and the vendor can be required to take the excess stock.
Your agreement should ensure that you are not purchasing any redundant stock that is unsaleable.
Purchasing a Franchise requires a thorough review of the Franchise agreement by you and your lawyer before entering into the purchase agreement. You need to be fully aware of your potential liabilities and responsibilities under the agreement. You will probably be required to pay a Franchise fee and you need to know what support and advantage that fee will give you.
For an existing business the Franchise agreement will need to be assigned to you and you will therefore need to satisfy the head franchisor’s requirements and work with them in order to take over the business.
11. Can you really afford this business?
A close analysis of the financial information you obtain for the business during the due diligence period is very important. You need to plan beyond payment of the purchase price and consider your financial ability to meet the business’ ongoing financial commitments such as its working capital and cashflow requirements.
12. What is the state of the assets?
The vendor should provide you with a thorough list of all business assets. You need to review the condition of those assets and consider:
- Is maintenance up to date?
- Are the statutory requirements being met as to licensing and inspections?
- What is the remaining useful life of the major assets?
- What is the cost of repairing or replacing?
- Does the business need to invest in new technology to keep it competitive?
- Does the vendor lease any assets?
- Is everything on the list actually in the business?
The values attributed to the assets in the agreement can have a significant effect on your ongoing balance sheet and depreciation entitlement so you should check these figures with your accountant.
13. Does this business fit you?
Is the business in an industry that you know anything about or will you be starting from scratch? What is your level of responsibility and ongoing role going to be in this business and are you capable in regards to time, skill and experience to give the business everything that it needs?
14. Can this business exist without the vendor?
Review the vendor’s role in the business to ensure that the business can continue without them. Some businesses are so tied up with the vendor’s reputation and skill that without the vendor there is effectively no business. Alternatively, some business owners operate in a very relaxed fashion, keeping all information in their head and managing their business relationships based on trust with no processes or written agreements. Will you be able to access and use this information if you purchase the business?
When buying a business it is easy to focus on its future. However, you can only analyse the business’ past and that creates risks for you when you purchase an existing business. Before you sign any business purchase agreement you should consider the issues raised in this article and discuss your plans with your lawyer and accountant. They can help you to manage the risks involved. Keep in mind it is unusual for a financially viable and strong business to be going at a cheap price. The aim of the purchase process is to identify the risks involved so that you can make a smart decision about buying the business, manage the risks and successfully push the business into the future.
Published: 13 October 2011