Many entrepreneurs love the challenge of starting a new business and creating everything from scratch. Others like the idea of buying an existing business in order to eliminate the initial legwork of establishing a customer base, training employees, and securing start-up funding. Both approaches have their own challenges.
For a prospective business buyer, part of the challenge is figuring out exactly what you are buying. This requires extensive due diligence with the assistance of business, tax, and legal experts. Arriving at a fair purchase price and agreeing on a deal is only possible after you have taken a deep dive into the business you are considering purchasing. Getting to that point takes a lot of work, and even after an initial agreement is signed, there are a lot of hoops to jump through.
Buying a Business and Due Diligence
When dealing with foreign relations challenges, Ronald Reagan was quoted as saying: “trust, but verify.” Trust but verify is an excellent summation of the due diligence process that occurs after business details have been reviewed and an offer has been made, but before the deal is closed.
The conduct of due diligence is often a condition of the buyer’s offer. Normally the buyer has reviewed information about the business and is prepared to move ahead with a deal—barring any unexpected revelations during the due diligence process. Uncovering issues does not mean the deal is off, but it could require further negotiations and, in some cases, a lower purchase price. Due diligence should not be conducted by the buyer without the assistance of an accountant and an attorney who have experience with business acquisitions.
Due Diligence Checklist
When buyer and seller have agreed in principle with the terms for the transaction, before commencing due diligence a non-binding letter of intent and non-disclosure and confidentiality agreement should be signed by the parties. While your attorney and accountant will guide you through due diligence, you should be aware of the information that will be reviewed during the process and what items might need your attention.
- Financial information. This includes income and cash flow statements, profit and loss statements, accounts payable and receivable, balance sheets, tax returns from the past three years, all debts owed by the business, profits itemized by each product or service, analyses of profit margins and expenses, and an inventory of all assets (including their total value).
- Business structure and operations. How is the business structured, and how does it obtain revenue? This will require review of the business’s founding documents, investors and shareholders, place of operation, products and services, marketing strategy, industry trends, competitors, customers, and branding.
- Contracts. When you buy a business, the sale generally includes transfer of any written agreements the seller made with other companies and individuals. It is vital that you know what is in these contracts and what obligations you might owe to other companies, such as the promises found in noncompete and nondisclosure agreements, leases, purchase orders and warranties, mortgages, letters of intent, sales and subscription agreements, loans and lines of credit, stock purchase agreements, and contracts between agents and principals of the business.
- Customer information. A principal advantage of buying an existing business is the ability to obtain a preexisting customer base. Confirming the strength of the customer base will require a close examination of sales records, subscriber lists, marketing and advertising programs, customer research data, and purchase and refund policies.
- Employee information. In addition to inheriting customers, you will also inherit employees when you buy a business. That means you should learn about who the employees are, how they are organized, employee contracts and contractor agreements, employee benefit plans and tax forms, payroll data, and the company’s human resources
- Legal liabilities. Does the company have any lawsuits filed against it or missing licenses and permits, zoning laws, and environmental regulations that could lead to legal disputes down the road? If so, is the business properly insured to help absorb the potential cost of a judgment or settlement?
- Tangible and intangible assets. Obtain a complete inventory of the company’s physical assets and real estate as well as its intangible assets, such as intellectual property like trademarks, copyrights, and cryptocurrency.
After Due Diligence
Once due diligence concludes, a purchase and sale agreement can be finalized. This could mean renegotiating the purchase price and other terms based on issues identified during due diligence. Changes to the deal should be reflected in the purchase and sale agreement, which is the document that is drafted and signed after the buyer and seller mutually confirm the price and the material terms of the transaction.
This agreement could be structured as an asset purchase—in which the buyer only purchases specific assets and liabilities of the company—or an equity purchase agreement, in which the buyer purchases the entire entity including all of its assets and liabilities. The former is a more tailored approach that is more complex but can secure tax advantages and help avoid liabilities. The latter approach is much more straightforward, but the buyer could end up assuming unwanted assets and liabilities. You should discuss the pros and cons of both approaches in relation to the specific deal on the table with your attorney and tax professionals.
When the deal becomes official, your work is not yet done. You may also need to take the following steps:
- Secure capital to purchase the business.
- Transfer permits and licenses from the previous owner into your name or apply for them yourself. Permits and licenses may be needed at the federal, state, and local levels.
- Transfer contracts, assets, governing documents, vehicle documentation, real estate and equipment leases, and other paperwork into the new business owner’s name.
- Renegotiate contractual terms with employees, vendors, and other parties (this may be stipulated as part of the deal or specified in the contract itself).
- File required forms with the IRS, such as IRS Form 8594 (Asset Acquisition Statement).
- File additional paperwork to officially transfer business ownership (for example, if one member of an LLC with multiple members or owners wants to buy out the other members, ownership may need to be reapportioned, which may require specific documentation, for example, a buy-sell agreement, in accordance with the LLC operating agreement.
Do Not Buy a Business without Legal Help
Buying a business, like starting a business, can be one of the most impactful life decisions you make. Even if you have bought or sold a business before, there may be more than meets the eye to a transaction, and every deal should be approached with a fresh perspective.
If you are interested in acquiring a company, an attorney with a track record of representing buyers in small business deals is a must. An attorney can help you perform due diligence, negotiate a purchase price, safeguard against unanticipated liabilities, handle contracts, and properly structure and document the purchase. To schedule a meeting with one of our experienced business attorneys, contact Davis Law Group today and we will work with you and your accountant to assist in the purchase of a business.