Want to Buy a Business? Here Are the Steps
You have found a business that you want to buy. Now what do you do? In this article, we'll look at the steps you'll need to take to make that business your own.
1. Get Your Team Together
Before you get into the process of evaluating a potential business for sale and negotiating, you will need some help from business advisors, including:
- A certified public accountant (CPA) to help you review the books and financials. Your accountant will be your "right-hand" person during this process; seek someone who can work with the lawyer and you as a team. Accountants are conservative by nature, and some are good auditors, but not good advisors—seek one who is assertive but not aggressive.
- An attorney to help prepare and review documents for the sale.
- Unless you have the cash for the purchase, you'll need to get a lender for the purchase.
- You may also begin to talk with insurance advisors, from whom you will purchase business (property and casualty) insurance and malpractice insurance (from separate companies).
- A business broker. Some business purchases are made through a broker. As with the sale of a home, the broker will receive a commission from the seller (up to 10%) for his/her work, payable upon closing. Here are some tips for finding a good business broker.
2. Do a Preliminary Investigation, Including Due Diligence
Before you put together an initial offer for a business purchase, there are many questions you need to have answers for. There are 7 questions you need to ask yourself before proceeding with the process of buying a business.
Due diligence is performed by the buyer and his/her accountant and attorney after the intent to purchase has been signed but before the formal purchase agreement. The purpose of due diligence is to allow you to thoroughly examine the company so you can make an informed decision before purchasing. It's also a way to make your mistakes on paper first. Use your advisors, especially your accountant, to help you examine the books and records. You will want to see financial statements and tax returns for the past four to five years.
During this due diligence period, you should:
- Hang around the business for a few days; talk to staff, workers, customers.
- Look at the competition and their positions. How are they advertising themselves? How are they doing financially?
- Look at potential future repairs/modifications.
- Look at documents showing liens or judgments that must be paid the assets.
- Check OSHA and ADA requirements for the facility.
- Make sure there is enough cash flow to support you personally.
- Look at all legal contracts entered into by the current business, including lease arrangements and vendor purchase agreements.
- Analyze the bad debts of the practice, the accounts receivable aging, and the present collection policy.
Some areas to focus on during due diligence:
- Look at monthly gross income for at least three years. Check tax returns for the business for three years or more; cross-check all information against something else.
- Look at overhead (fixed expenses) against national averages (% of gross sales).
- Look at employment tax data (941 forms, etc.) and salaries/wages paid out for the past 3 years. Are employment taxes being paid on a timely basis?
- Verify profitability by subtracting overhead and debt from gross income (before expenses). Check against the owner's income from the business.
- Prepare a list of questions; if you don't get answers, ask why.
3. Sign a Letter of Intent
Often in a business purchase, the seller will require the buyer to sign a letter of intent. This is a non-binding agreement that prohibits the buyer from discussing information about the business to outsiders. The letter also serves to keep the seller from talking to or negotiating with other potential buyers during this time. The letter then allows the buyer to do a more thorough evaluation of the business and for negotiations to continue.
4. Negotiate Terms
Your negotiation meeting with the owner may be more important than a job interview. Don't forget that this person is not just selling a business; he/she is selling a life.
Remember, these common mistakes made by sellers:
- Unrealistic price
- Misunderstanding "hidden profit"
- Assuming that the buyer knows the area
- Lack of proper counsel
- Misunderstood buyer motive
- Inadequate documentation
Part of this negotiation includes analysis of the valuation of the business, performed by an appraiser. This valuation is only a starting point, though. The negotiation comes down to an agreement between both parties.
5. Close the Deal
The closing of a business deal is the time when both parties - and their attorneys - get together to sign documents and pass checks around the table. At this point, all the work has been done, and there is no more room for negotiation or changes.
At the closing, a number of documents may need to be signed:
- The bill of sale, which is evidence of the ownership of assets, and is the formal document representing ownership of the business and its assets
- Security agreement (lien) which is evidence that the assets are encumbered by the seller until the note is paid
- Purchase agreement, which may have already been signed as a letter of intent.
The purchase price may be payable in different parts:
- Earnest funds (already paid) are deducted
- Balance of down payment is also deducted
- Assumption of liability or paid by seller portion deducted
- Remaining balance in a promissory note