Unlike most purchases, buying a business is quite unique because it can result in significant financial, tax, legal liability, and other ramifications. For this reason, it is important to use a process that minimizes your risk following the completion of the transaction (the closing). This article assumes that you’ve identified a business that you’d like to purchase, but are unsure as to the standard way to move forward in your best interests. For advice on deciding what type of business to buy, see Buying a Business: What You Need to Know.
Sometimes determining the offer price for a business can be fairly easy, especially if you are 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 or not you end up with a good deal. In instances where you’ve already identified an acquisition target, but have little insight as to what package of compensation to offer in return (frequently referred to as consideration), then you should recruit an appraiser, accountant, investment banker, or other valuation specialist to assist you. Once you’ve determined the value of the target company, you will be in a better position to determine what cash amount or other consideration you would like to offer the seller, whether at a discount, market price, or a surplus. Note that the consideration you offer the seller 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.
Although there are various creative ways to buy a business, there are three basic structures that are the most common: merger, stock purchase, and asset purchase. Each of these choices have different layers of complexity and varying tax and liability consequences. For some discussion on this topic, see Acquisition Agreements (for Sale of Business). You should consult with your accountant, legal counsel, or tax counsel to determine which structure would best suit your tax and liability needs.
Once you’ve determined the purchase price and the transaction structure for your acquisition, the parties should enter into what is called a letter of intent (LOI). The letter of intent is (typically) a relatively short, non-binding 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 (as discussed below), 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 non-binding in that neither party will be able to sue the other if the final transaction structure ends up not precisely mirroring what is outlined in the LOI, or if the deal fails to close altogether. It 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.
As soon as possible after the LOI is signed, you should put together what is called 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 is complete visibility as to expectations and outstanding action items. It can be extremely frustrating when the parties think that they are fully prepared to close, only to realize that one or more critical items have yet to be satisfied. As such, the closing checklist is the most important document in ensuring that the transaction is consummated as smoothly as possible.
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. For example, tax, environmental, litigation, regulatory, and contractual liabilities are common areas of potential exposure. This is particularly critical from your perspective because you, as the buyer, will be responsible for these liabilities going forward. The purchase agreement should include ironclad provisions that either limit or eliminate the buyer’s exposure to such liabilities. For example, the buyer could either require that the seller remove certain liabilities as a pre-condition to closing, indemnify the buyer for certain post-closing liabilities, or accept a reduced purchase price. Note that there is 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. While this could seem like an unfortunate result at first, you should also appreciate that proper due diligence can prevent you from entering into a transaction that would have otherwise resulted in immense frustration or loss down the road.
Typically, the buyer is responsible for drafting the purchase agreement because the buyer is the one putting up the cash and has 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. For more information on the documents involved in buying a business, see The Complete Guide to Buying a Business, and for guidance regarding negotiating strategies, see Contract Negotiation: Strategies for Closing the Deal.
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 contracts to which the seller is subject, including any provisions in those contracts that would mandate the counterparty’s consent to your transaction. Any consent that is 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.
Corporate attorneys consider the closing to be the moment when consideration is exchanged and transfer of ownership occurs. In other words, it’s payday. On this day, each item on the closing checklist should have 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 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 all of this is completed, 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.