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Things to Consider when Buying a Business

by Mike Massey on September 3, 2012

Can you afford it?

That seems like a simple one doesn’t it. Unfortunately, many purchasers get their hearts so set on buying a business that they fail to realistically consider the financial requirements. For instance, you may decide you can obtain the financing necessary to make the purchase and carry the note but what about the cash flow needs. The cost of the business is one part of the analysis, not the end of it. How long will it take for the anticipated revenues to cover the ongoing expenses of operating. Since most deals involve asset sales rather than stock sales, you will likely not be acquiring receivables. It may take awhile for the work you do or products you sell to be realized in the form of cash. A line of credit may be required. How much? Most businesses fail because of cash flow problems. Carefully consider the cash flow needs in addition to the “value” of the assets being acquired when deciding whether you can afford it.

Will you be able to retain the customers?

If the current owner will stay on after the acquisition, you will stand a better chance of retaining the customers. If not, make sure the owner has executed a non-competition and non-solicitation agreement to protect you. The current owner may decide in a year or two that he wants back in the same business in which case you may have a competitor with close ties to “your” customers. Be sure to protect yourself. Non-compete agreements must be reasonable in time and scope to be enforceable. Carefully evaluate your strategy for quickly establishing relationships with the customer base being acquired to avoid excessive losses during the transition.

Due Diligence

Before completing an acquisition, it is critical that you perform due diligence, which means reviewing the corporate records and books. The price you are paying is largely determined by past financial results. Carefully review the financial statements for at least three years if the business has been open that long. Also review the tax returns since people are generally less inclined to overstate their income on tax returns. Look for any discrepancies in the financial statements and tax returns and ask questions. Perform a UCC search to determine what lenders have liens against the property you are acquiring. If real property is acquired, you also will need to have title work performed to verify title and encumbrances on the property. Prepare a due diligence checklist and have the seller provide the requested documentation. To facilitate the exchange of information a confidentiality agreement is typically executed to give the seller confidence in making full disclosure concerning his business.

Employment Issues

Do you intend to retain the current employees of the business? If you do, are you confident that you will retain the business after the current owner leaves? What obligations do you intend to assume relevant to accrued vacations and sick time, etc. What are your obligations with respect to health insurance or pension plans? If you need for certain key personnel to work for you to make the purchase viable, you may need to have employment agreements prepared and agreed to in principle before making the acquisition.

Undisclosed Liabilities

If you acquire the assets of the business and not the stock, you may be able to avoid liability issues that show up later. If you buy the stock, you effectively are purchasing the company lock, stock and barrell. In Mississippi, the typical statute of limitations period is three years. If someone has a claim against the company, a lawsuit may not be filed for years yet even though the cause of action really accrued due to actions or negligence by the prior owner. When buying a business, you should demand representations that there are no such pending actions looming on the horizon. Furthermore, you may want to include indemnification provisions in the contract requiring the owner to protect or indemnify you in the event any such problems manifest themselves after you acquire the company.

The Contract

After you have decided to complete the purchase, a definitive agreement spelling out the details of the purchase will be prepared. Be precise about the assets you intend to acquire, attaching an item-by-item exhibit if at all possible, and also spelling out in detail any liabilities that you will assume. You should be precise as possible to avoid later disputes over who is responsible for a given liability. Read my top ten tips on business contract negotiations.

This article is intended to give you a brief overview of the issues involved in buying a business. There are other important issues and you should seek the advice of your attorney and CPA before signing the first document. Your bargaining strength and ability to get the seller to do things to clean up the deal will never be greater than BEFORE you close the deal or sign on the dotted line. Getting a good deal involves patient and careful negotiating, doing your homework, dotting your “I’s” and crossing your “T’s”.

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