Buying a business is one of the biggest commitments you can make in your life. Business ownership involves an incredible contribution of time, sweat and money, and you constantly need to balance various demands and risks to ensure growth. Are you familiar with the legal steps to buying a business?
A key component in any successful business is making sure you follow the right process before getting started. Below are the five key steps you should take when you are about to buy a business:
1. Do Your Research
The first step is to properly research each prospective business to get a very clear sense of the business’ strengths and weaknesses and what it is exactly you will be buying. In other words, kick the tires and see what is under the hood.
For example, you should request the company’s:
- Financial statements
- Lists of customers and suppliers
- List of employees, including a breakdown of salaries and years of service
- Details of any major contracts necessary for the operation of the business, including the lease of any premises;
- List of all equipment and assets of the business
- Any related debts, licenses and liabilities.
Before sharing this sort of detailed information with you, the seller may insist that you sign a non disclosure agreement to prevent you from using it for any purpose other than buying the business. Any documents you are asked to sign at this early stage should be shown to a lawyer to ensure you are not making any unwise legal commitments.
When reviewing the content, use the available government databases to verify any information the information provided is correct. These searches will show, for example, whether there are any liens on the business assets; whether there are unpaid taxes; whether there are ongoing lawsuits or human rights complaints; and whether certain buildings or motor vehicles are in fact owned by the seller.
2. Decide on a Structure for the Purchase
The structure of the purchase means the most basic aspects of the deal: who will be buying and selling; whether shares or assets will be bought; what price will be paid; and when and how that amount will be given to the seller.
A. Who Will be Buying and Selling, and will it be Shares or Assets?
Most businesses are operated by private companies. This means that, in most cases, all the important items associated with any business – like the inventory, the trademark, and so on –will be owned by a company. As a result, when you buy a business you will first need to decide:
- who will be buying the business – will it be you personally or you through your own company; and
- what will be bought – will your buy the shares of the company that owns the business or the business assets directly.
In nearly every case, it makes sense for a buyer to make the purchase through a company. There are tax benefits to operating a business through a company. It also limits the business risks to whatever else is owned by the company while putting your personal assets out of reach of creditors of the business.
Assets Vs Shares
One of the main advantages of buying the assets of a business is that it gives you a better sense of the specific assets and liabilities you will have when you have completed the transaction; instead of getting a company that may or may not have unknown or undisclosed liabilities. It also gives you more flexibility and control in what you are buying; for example, you can decide that only certain employees or business assets will be transferred to you. The downsides of buying the assets include that certain one-time transaction costs connected to the purchase might be more expensive.
Additionally, buying the assets means you will be in a contract with the company that owns the business, while buying the shares means you will be in a contract with the person or people who own the company, which requires a high level of trust on information given by the seller. There is also a risk that if the business goes sideways, the seller, as a private company, may have no other assets. You will therefore need to be compensated. One way to deal with this risk is to insist on ongoing commitments or responsibilities – commonly called “indemnities” – from the person or people who own the company.
B. What Price will be Paid, and When and How will that Amount be Given to the Seller?
Arriving on a dollar amount for the value of a business is only one element of the price, and it is rarely as simple as deciding on a price and paying that to the seller in a particular sale date.
The business will probably be active around the sale date, which means inventory, accounts receivable and other items will be in flux. Also, a cautious buyer may insist that a portion of the price be held back for a certain period to ensure that information given by the seller is in fact correct or that profit expectations are met. Finally, you may be unable to pay the price in a lump-sum and will need to pay in monthly or annual instalments.
3. Negotiate the Other Terms
Contract terms are not just about the structure of the purchase, sale date and whether there will be a personal indemnity if the seller is a company. However the number and type of other terms to be negotiated can vary depending on the risks associated with the business.
For example, in an asset sale of a business with many employees, the seller may insist that you take on all of the employees, while you may want only a handful of them. The seller may also refuse to fire the employees on the eve of the purchase. Even if you intend to re hire the employees after you have purchased the business, this is an important process to go through as it can influence the amount of severance you might have to pay an employee should things do not work out after the change in ownership
To prevent the seller, or the owner of the seller (if the seller is a company), from creating a competitor business after the sale, you should insist that he or she sign a “Non-Competition Agreement”.
4. Have the Legal Documents Prepared
The buyer is generally responsible for preparing the legal documents, which are often complex and lengthy and are sent to the seller’s lawyer for review before being finalized. The first legal document, though, is short and simple; it is commonly called a “Letter of Intent” (or a “Term Sheet”) and is used to record the basic aspects of the deal early on. This helps to prevent misunderstandings and avoids having to renegotiate any key terms very close to the sale date.
The main legal document is called a “Purchase Agreement”. This covers everything connected to the purchase. It builds on the content of the Letter of Intent and includes, as efficiently as possible, the significant details of what the buyer and seller are actually agreeing to, and anticipates the situations where things may not go as planned. One of the most important parts of this agreement for you will be the seller’s “representations and warranties”. This effectively puts the seller on the hook for the information given to you about the business and aims to ensure that you are getting what you are paying for. The description of the business assets and liabilities related to the business that you will assume are another important part of this document. They are usually included in “schedules” attached to the main agreement.
Many purchases will also involve a document showing the consent of the landlord or franchisor, each of which might be necessary for the deal to move forward. Depending on the type of sale and individual situation of the business, there may also be other documents which your lawyer will need to prepare including the above mentioned Non- Competition Agreement.
5. Final Tips to Keep in Mind
Buying a business is a very complicated event. Here are some final tips to keep in mind that will reduce the likelihood of an exciting opportunity turning into a nightmare:
- Know what to focus on when. Keep perspective by taking one thing at a time. Before committing to the purchase make sure you have done the proper research. Once that stage is complete and you understand the risks involved, come to an agreement with the seller on the basic terms and then spend the time on the details. Write a list of your priorities and concerns and refer back to them or revise them as the sale date nears. Do not let the seller control the process or keep you in the dark or uncertain about any issue that is important to you.
- Get the right advisors, and rely on them. Nobody can do everything on their own, and there are experts in an area for a reason. Good advice can be worth far more than it costs, and it would be foolish to make an enormous commitment without spending a relatively small amount to ensure the right pair of eyes are involved in helping to direct you toward success.
- Know when to walk away. The process of buying a business costs money and time. But if the information from the seller does not add up, or the risks involved are simply too great, it may be more advantageous to walk away rather than pay a considerable amount of money for a business riddled with problems that will cost you even more.
Ask an Expert Series: Ask a Lawyer
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