Buying a Business
You may decide to buy an existing business, rather than starting a business from scratch. Buying an ongoing business provides you with the advantage of knowing what you are getting (a business that is either profitable or losing money). However, buying an ongoing, successful business might mean paying a higher price, because you are also paying the seller for the business’ customer base and the goodwill the business has developed, not just the business concept and brand.
In determining whether or not to buy an ongoing business you should go through all of the following steps.
Valuation of the Business
The first step is to determine the value of the business so that you do not overpay for it. There are a variety of methods for evaluating businesses. For example, you could figure out what each asset of the business (e.g. equipment, building, inventory, etc.) is worth. Or, you could calculate its cash flow (how much money is coming into the business every month/year reduced by the monthly/yearly expenses). You should also determine the actual, taxable “profits” or “losses” for the business.
Ask the seller to provide you with at least three years of tax returns and financial statements and review this information with your accountant. One of the best methods to use in evaluating a business is to utilize “comparables” or the prices at which other similar businesses have been sold. This will tell you what other buyers are willing to pay for businesses that are similar to the one that you are interested in purchasing.
Negotiating the Deal
Negotiations in connection with the purchase of the business may take place over a period of time and while you are carrying out the necessary steps, but typically this occurs after you have estimated the value of the business. Keep in mind that the more you know about the business – the better you understand the value of the business and have checked out every aspect of the business –the more confident you will be in negotiating or understanding the details of the final Purchase Agreement.
Some people feel comfortable negotiating for themselves, while others consult with a lawyer first and develop a negotiation strategy, and then handle the negotiations themselves. Some people prefer to have a lawyer represent them throughout the negotiation process. You should pick whichever option feels most comfortable for you.
Frequently a “deal memo” or “letter of intent” is prepared that spells out the proposed purchase price, the terms of the purchase, the key business points and the conditions for the sale of the business. The deal memo or letter of intent will form the basis for the Purchase Agreement, which will incorporate these points into a formal contract. The initial agreements made in the deal memo or letter of intent are not binding on the parties, and may change during negotiations.
The next step is the Purchase Agreement, which sets forth, in a binding contract, the terms and conditions for purchasing the business. The Purchase Agreement includes details about what parts of the business you are purchasing, such as equipment, inventory, customer lists, intellectual property and goodwill.
If you have followed the steps above and have not yet hired a lawyer to help you, you should now hire a lawyer to review the Purchase Agreement (which is typically prepared by the seller’s lawyer). A lawyer can help make sure that you have not missed anything in the process listed above, and can make sure that the details of the deal you negotiated are worded correctly so that the deal stated on the paper you sign matches the deal you thought you agreed to when you shook hands with the seller or signed the letter of intent. To protect against misunderstandings and misrepresentations, a lawyer may draft into the Purchase Agreement clauses containing representations upon which the parties rely, and a “basket” dollar amount above which one party or the other is responsible when a deviation from a representation occurs or is discovered.
A Purchase Agreement will likely call for a down payment (frequently between 5% and 10% of the purchase price) to be paid upon signing, with the cash balance to be paid at the closing. If part of the purchase price is to be “paid out”, a promissory note and perhaps a security agreement will be signed by the purchaser at the closing, as well.
Due Diligence is a process where you check everything out about the company you want to purchase, “top to bottom.” For example, you will want to make sure the business is legal and operating within the law. You must confirm that the business entity is properly formed, and in good standing with all government agencies. You should make sure the business has all the necessary licenses and permits.
During the Due Diligence, process, you should also find out if the business is violating any zoning requirements or has received any citations, been sued, paid any fines/penalties, or had any judgments against it. Also, depending on the type of business, you will see if there are no environmental rules or regulations that affect your business – and if there are, you must make sure that the business is operating without violating any of them. You will also review and analyze the business’ personal information, including all contracts, leases and employment arrangements.
Due diligence can be carried out at any time, either before serious negotiations begin, after the letter of Intent has been agreed to, or after the Purchase Agreement has been signed. After all of this work has been undertaken and accomplished, you are ready for your closing.
The closing is generally attended by the buyer, the seller and their attorneys. Sometimes, other parties will attend the closing. For instance, if there is a lease on the business property, the landlord may attend the closing to make sure the lease is properly assigned to the buyer. Also, the seller’s lender may attend if the seller has a loan that is being paid off at the closing. The buyer’s lender may attend the closing if the buyer is financing part of the purchase price.
At the closing, all applicable transfer documents, such as share certificates, bills of sale, lease assignments, etc. are signed, financing documents are signed, and the money due at closing is paid. After all of the documents are exchanged and you shake hands with the seller and your attorney, you will walk out of the closing as the new owner of your own business.
Legal Editor: Dan Brecher, November 2014 (updated November 2018)
Changes may occur in this area of law. The information provided is brought to you as a public service with the help and assistance of volunteer legal editors, and is intended to help you better understand the law in general. It is not intended to be legal advice regarding your particular problem or to substitute for the advice of a lawyer.