8 Steps to Buying a Business

Thinking about buying an existing business? Here are some things you should know before you take the plunge.

By
Updated by Amanda Hayes, Attorney (University of North Carolina School of Law)

For some people, buying an existing business is a better option than starting one from scratch. Why? Because someone else has done much of the legwork for you, such as establishing a customer base, hiring employees, and negotiating a lease. Still, you'll need to do some thorough research to make sure that what you see is what you'll get.

This article provides the eight steps you should take to buy a business and explains when you should work with a lawyer or other professional:

Step 1: Find a Business to Buy

When looking for a business to purchase, you need to know:

  • what kind of businesses to look at
  • where to find companies for sale, and
  • what factors to consider.

What Type of Business Should You Buy?

Look for a business that has some connection to types of work you've done in the past, classes you've taken, or perhaps skills you've developed through a hobby. It's almost always a mistake to buy a business you know little about, no matter how good it looks. For one thing, your lack of knowledge about the industry might cause you to overpay. And if you do buy the business, you'll have to struggle up a steep learning curve afterward.

But do try to choose a business that you're excited about. It's easier to succeed in business when you enjoy the work you're doing.

Where Should You Look for Businesses to Buy?

As you begin your hunt for the perfect company, consider starting close to home. For instance, if you're currently employed by a small business you like, find out whether the present owner would consider selling.

Or, ask business associates and friends for leads on similar businesses that could be on the market. Many of the best business opportunities surface by word of mouth and are snapped up before their owners ever list them for sale.

Other avenues to explore include:

  • newspaper or online ads
  • trade associations
  • real estate brokers, and
  • business suppliers.

Finally, there are business brokers—people who earn a commission from business owners who need help finding buyers. It can be useful to use a broker to help locate a business opportunity. But you shouldn't rely on a broker—who doesn't make a commission until a sale is made—for advice about the quality of a business or the fairness of its selling price.

What Factors Should You Consider When Buying a Business?

When looking for businesses, you want to find one that's able to make a profit and can survive the change in ownership. While you could get a good price for a struggling business, you don't want to buy one if it's not recoverable. You also don't want to buy a business that'll dry up once you take it over because customers were loyal to the prior owner and not to the business itself.

Look at the business's reputation. Does it have good reviews from customers? Where does it stand against competitors? Does it have solid relationships with its suppliers and distributors? A less-than-great reputation doesn't necessarily need to be a dealbreaker, but it should be a talking point at the negotiation table.

Get a good idea of the revenue stream you can expect to inherit from the business you're buying. Can you expect sales to continue at the current rate? How many customers will you lose in the transfer? Considering these possibilities will give you realistic expectations as you look at potential businesses to buy.

Step 2: Conduct Your Due Diligence

When you hear the term due diligence, think of an investigation. Due diligence is an examination of anything and everything about the target company that could create any liability for you once you're the new owner. This review will not only help you understand how the company ticks, but will alert you to potential problems.

Tax, environmental, litigation, regulatory, and contractual liabilities are common areas of potential exposure. For instance, you should also specifically look at whether the business is following all Occupational Safety and Health Act (OSHA) standards. If the seller is falling short of any OSHA requirements, it should be addressed and resolved before you purchase the business.

Research the Business's History and Finances

Before you seriously consider buying a particular business, find out as much as you can about it. Thoroughly review copies of the business's records, including:

  • certified financial records—such as cash flow statements, balance sheets, accounts payable and receivable
  • assets—including buildings and equipment—and inventory
  • employee files—like, benefits and any employee contracts
  • major contracts—including, sales contracts and subcontractor agreements
  • lease and purchase agreements
  • organizing documents—such as articles of incorporation and bylaws
  • intellectual property registrations and licensing agreements—for trademarks, copyrights, patents, and trade secrets, and
  • any past lawsuits and other relevant information.

Don't be shy about asking for information about the business. If the seller refuses to supply any information, or if you find any misinformation, this might be a sign that you should look elsewhere.

Limit Your Liability Before Buying the Business

The purchase agreement should include ironclad provisions that either limit or eliminate your exposure to any liabilities you identify through your due diligence. For example, you could either require the seller to remove certain liabilities as a precondition to closing, indemnify you for certain post-closing liabilities, or accept a reduced purchase price.

Note that there's always a possibility that your due diligence investigation could reveal one or more liabilities that you find to be excessively problematic, resulting in your decision to walk away from the deal altogether. Walking away could seem like an unfortunate result at first. But proper due diligence can prevent you from entering into a transaction that would have otherwise resulted in immense frustration or loss down the road.

Step 3: Choose a Deal Structure

Although there are various creative ways to buy a company, there are three basic business structures that are the most common:

  • merger (your business and another business combine into one business)
  • stock purchase (you buy a company's shares), and
  • asset purchase (you buy a company's assets only).

If you're buying a business, you're likely looking at an asset or stock purchase. With a stock acquisition, you're purchasing the company's assets and liabilities. With an asset acquisition, you're only purchasing the company's assets, and only the ones you want to purchase. Make sure that whatever you choose is allowed under the business's current rules. For example, the company could have a shareholder buyout agreement in place that could prevent your purchase.

Each of these choices has different layers of complexity and varying tax and liability consequences. You should consult with your accountant, legal counsel, or tax counsel to determine which structure would best suit your tax and liability needs.

Step 4: Determine a Purchase Price

Now that you've completed your due diligence and have a good idea of the business's position, it's time to agree on a price.

Sometimes determining the offer price for a business can be fairly easy, especially if you're already quite familiar with the business, have a great deal of industry knowledge, or have familiarity with the past sales of similar businesses. Clearly, the purchase price is critical in determining whether you end up with a good deal.

If you've found a business to purchase but have little insight as to what package of compensation to offer (frequently referred to as "consideration"), then you should recruit a professional. To settle on an appropriate offer, consider working with:

  • an appraiser
  • an accountant
  • an investment banker, or
  • other valuation specialist.

Once you've determined the value of the target company, you'll be in a better position to determine what cash amount or other consideration you'd like to offer the seller, whether at a discount, market price, or a surplus. Note that the consideration you offer can be made in a combination of cash, debt, equity, assets, and so on. Ultimately, the proposed compensation will be based on your liquidity, bargaining power, and risk tolerance.

Step 5: Sign a Letter of Intent

Once you've determined the purchase price and the transaction structure for your acquisition, the parties should enter into what's called a letter of intent (LOI). The letter of intent is usually a relatively short, nonbinding letter of agreement signed by both parties that details the basic deal points for the transaction.

The LOI should include:

  • the purchase price
  • a description of the deal structure
  • due diligence requirements
  • the parties' expectations with respect to the purchase agreement
  • the anticipated timing for the closing, and
  • any other material details agreed upon by the parties.

The LOI is nonbinding so neither party will be able to sue the other if the final transaction structure ends up not precisely mirroring what's outlined in the LOI, or if the deal fails to close altogether. The LOI is intended to serve as a good faith roadmap so that both parties can comfortably move forward with the confidence that they're on the same page.

Step 6: Negotiate the Purchase Agreement

By this point, you and the seller should've agreed on the price and deal structure, and you should have an LOI to guide discussions. The purchase agreement is the final word between the parties. If you discovered any potential liabilities or risks through your due diligence, now is the time to put any protections from those risks into writing.

You'll also need to come up with the terms of payment. Most often, businesses are purchased on an installment plan, with a sizable down payment.

Typically, the buyer is responsible for drafting the purchase agreement because they're putting up the cash and carrying the greatest risk of loss. Ideally, you should have a contract attorney draft this document for you, particularly one with experience in mergers and acquisitions.

You (and your attorney) should put together a closing checklist, which is a list of every single document, instrument, or action that must be completed, signed, or delivered in connection with the closing. This list should be regularly updated and shared with the seller throughout the process so that there's complete visibility as to expectations and outstanding action items.

Step 7: Obtain All Consents and Approvals

The closing checklist should include all consents and approvals that are required to properly close the transaction. For example, the checklist should include any required consents from:

  • the buyer's and seller's landlords
  • customers
  • suppliers
  • stockholders
  • board of directors
  • creditors, or
  • other third persons.

If conducted thoroughly and properly, your due diligence process will include a review of all of the seller's contracts, including any provisions in those contracts that would require the counterparty's consent to your transaction.

For instance, the seller could have an ongoing contract with a manufacturer that includes a "successors and assigns" clause. This clause requires the manufacturer's approval before the seller signs over their obligations under the contract to someone else, including someone buying their business.

Any consent that's not obtained prior to closing could theoretically result in the termination of the contract, the payment of a penalty, the nullification of the transaction altogether, or some other adverse consequence.

Step 8: Close the Deal

Corporate attorneys consider the closing to be the moment when consideration is exchanged and the transfer of ownership occurs. In other words, it's payday.

On this day:

  • each item on the closing checklist should've been completed
  • you should be ready, willing, and able to deliver the purchase price, and
  • the seller should be ready to deliver any required stock certificates, documents, or instruments to legally effectuate the transfer of ownership.

The closing can either be done in person or remotely, so long as all documents and instruments are completely signed and exchanged. Note that all of your documents should also include a provision clarifying that they can be signed in counterparts, just in case the parties won't be in the same room to sign the same pieces of paper together.

Once everything is signed and delivered, the parties can either shake hands, have a conference call, or exchange emails to declare to each other, "We are closed," and then celebrate the successful completion of the acquisition.

Work With an Attorney

If you have experience buying businesses and you have expertise in the relevant industry, you might be able to complete the purchasing process yourself. But in all likelihood, you'll benefit from bringing in professional help at some point. You should probably talk with a small business lawyer sooner rather than later so you don't miss key legal considerations at the start that could later stall negotiations or create buyer's remorse.

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