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So You Want to Buy a Business?

Written by Darryl King, PARTNER; Richard Wilson, CONSULTANT on March 1st, 2012.    

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Here are some basics

Buying an established business rather than starting a business from scratch can be a good option for many potential business owners. Established businesses have a proven track record which lessens the risks and increases the likelihood of success.  However, not all acquisitions are successful and if you are not careful, you could end up with a business that has problems you did not expect. 

There is much more to buying a business than answering an advertisement for a business sale.  Buying a business is complex and time-consuming.  You will need to investigate the business and its assets in detail, assess the market and consider your ability to take over the business and run it successfully.  Rushing into a purchase without careful consideration and the assistance of experienced advisers can spell disaster.  The best outcome involves a collaborative effort between a purchaser and its advisers.

Advantages and disadvantages of buying an established business

It is generally less risky to purchase an existing business than to start a new one from scratch.  Some of the advantages of buying an established business are:

  • a proven track record reduces risks and increases the likelihood of a successful business;

  • the vendor may provide invaluable assistance and possibly finance;

  • you are buying an established business that will generate you income; and

  • stock, customers and suppliers are already in place.

Some of the disadvantages of buying an established business could include:

  • there are issues with the business and this is why the vendor is selling it, and there is a possibility of being misled by the vendor;

  • goodwill and other assets can be hard to value and you could pay too much;

  • the customers and suppliers may be loyal to the previous owner and the operational performance may be quite different with a new owner;

  • stock may be obsolete, damaged or out of date; and

  • if the business is run-down there may be unexpected expenses required to get the business up to a satisfactory standard.

Buying assets or shares – what is the difference?

There are two principal methods for buying a business.  You can buy the shares of the company that operates the business or you can buy the assets which make up the business.

There are advantages and disadvantages with each option.  The purchase of shares is generally less complex.  If shares are purchased, all of the company’s assets and liabilities are acquired - including liabilities the purchaser does not know about.  The contracts and rights of the business are unaffected by the change in ownership of the company unless they have “change of control” provisions.
 
An asset acquisition is often more complex to transition than a share acquisition as all contracts, employees, intellectual property and other assets need to be transferred as part of the sale.  The consent of third parties may be required for the transfer of some rights and contracts.  However, purchasers will often prefer an asset acquisition for a small to medium purchase because they get to choose the assets and liabilities that they are to take over.
 
There are a number of tax, accounting and legal considerations for each option and professional advice should be obtained.

It’s a risky business

Buying, owning and operating a business all involve risks.  No matter how careful a purchaser is in assessing the business to be acquired, the purchase of a business will always involve a range of risks.  Engaging professional advisers and carefully investigating the business will help reduce – but not eliminate – those risks.  As will carefully considered documentation tailored to the transaction.

What is “due diligence” and why is it important?

Due diligence is the process of carefully investigating the business and assets you are considering acquiring.  Proper investigation of a business and its assets and liabilities will take considerable time and effort and will include operational, legal and financial investigations.  Other specialist investigations may be required depending on the nature of the business and assets being acquired.   
 
Due diligence can be a lengthy and time-consuming process.  However, it is vital to ensure that you understand what it is you are buying and how much the business is worth.  Some of the major areas to evaluate include:

  • why is the vendor selling;

  • financials, sales, expenses and profits;

  • assets and liabilities;

  • employees;

  • customers & suppliers;

  • leases and key contracts;

  • the market for the business’ goods or services and market competition;

  • issues with & opportunities for the business;

  • impact of the sale on the business and its customers, suppliers and employees;

  • SWOT analysis;

  • transition to your ownership – including your ability to finance and run the business;

  • tax and structuring the purchase and ownership of the business;

  • valuation;

  • assessing and valuing risks; and

  • other, including whether it is more economical to establish your own business.

Where there is any reason to doubt the authenticity or completeness of information you have been provided or you have any residual concerns, you should try to independently check the information you have been provided.  Not all vendors are honest or provide full and frank disclosure of all issues the business is facing. You should be very cautious if you have concerns that have not been fully satisfied.

Goodwill and valuations

To ensure that you are not overpaying for the business you should obtain a valuation of the business, its assets and goodwill from an experienced accountant. 
 
Goodwill is the value of the business over and above the value of its assets.  Goodwill can be considered as the success factor or earning power of an established business.  The value of goodwill is often contentious and the subject of negotiations between the purchaser and vendor.

The process for buying a business

The process for buying a business varies but there are a number of key steps that should be followed for any successful acquisition. Jackson Russell can guide you through the process for your acquisition and let you know what to expect.

Should I sign an agreement before my detailed review?

By completing the due diligence process before preparing and negotiating the sale and purchase agreement, the purchaser is better placed to identify and deal with risks, and to better tailor the agreement to the transaction.  However, for the acquisition of a small business, detailed investigations generally occur once you have signed a sale and purchase agreement.
 
There are a number of advantages and disadvantages with signing the agreement first.  One advantage is that the vendor and purchaser know that they have agreed on the price and other key terms subject only to a confirmatory due diligence review by the purchaser.  A disadvantage is that during due diligence the purchaser may wish to change the terms based on the information it has discovered during due diligence.  Vendors will often resist any attempt to renegotiate the terms even when the purchaser has genuinely found issues during due diligence.
 
In practice many of your key evaluation considerations should be undertaken before signing the sale and purchase agreement to ensure that you have priced the purchase correctly. Ideally you should complete a preliminary investigation to ensure that you are comfortable with the pricing and whether there are any issues with the business before you sign.
 
For larger transactions, the parties may sign up to a heads of agreement or letter of intent setting out the key terms for the transaction before due diligence is undertaken in detail. That way, the key terms are locked in before the vendor has to reveal its confidential information but the parties are able to tailor the documentation to the transaction.  The heads of agreement or letter of intent will often contain an exclusive period for the purchaser to complete its due diligence and document the transaction.

Regardless of when you sign a sale and purchase agreement, you should ensure that the agreement is tailored to the transaction and adequately protects you. You should always get detailed legal advice before you agree to sign an agreement – or you agree on the key terms of the purchase.

So you have decided to proceed

Before you enter into a contract to buy, you should ensure that:

  • you have all the information you need to fully understand the business, its operations, assets and liabilities, etc;

  • you have undertaken sufficient operational, financial and legal investigations and you have verified the vendor’s claims by the business’ records, your own enquiries and by your discussions with customers and suppliers, etc.;

  • you know exactly what business and assets are to be sold and that the vendor owns, and has the right to sell, those assets;

  • you understand the market, the business’ position in the market and you have assessed the likely future position of the business after you have bought the business;

  • you understand why the vendor wants to sell and whether the business has any material problems; 

  • you have considered how the business and employees will fit with your existing business (if you have one) and you have considered the transitional logistics of the purchase; 

  • the sale and purchase agreement includes adequate warranties and other terms to protect you, and includes guarantees from solvent and substantial guarantors;

  • you know the value of the business – and you are not overpaying; and

  • any issues that you have identified have been resolved to your satisfaction and recorded in the sale and purchase agreement where applicable.

No go decision

You should always keep sight of your goals, the risks arising from buying and operating the business, and the decisions you have made about buying this business at the price you originally offered. It is better to cancel the sale than to take on a business that is over priced – or a lemon. You might lose money on professional fees and other costs but the alternative could be far worse.

How we can help

Jackson Russell’s Business Law team has extensive experience in advising purchasers of businesses ranging from small closely-held businesses through to much larger organisations.  We add value by guiding our clients through the process to:

  • reduce risks;

  • identify opportunities;

  • manage costs and what can often be a complex and time-consuming process; and

  • provide strategic advice and help our clients to achieve their objectives.
     

Some pointers for engaging Jackson Russell:

  • discuss your requirements and your expectations;

  • be aware that purchase transactions are often complicated and involved;

  • consider Jackson Russell taking an active role, assisting with the planning and helping to manage the process as we can add more value this way; and

  • get us involved as early as possible and before you have agreed on the purchase terms or process. 

     

Disclaimer
The information contained in this publication is of a general nature and is not intended as legal advice.  It is important that you seek legal advice that is specific to your circumstances.
 
All rights reserved © Jackson Russell 2012
Key Contacts

Darryl King 167
Darryl King, PARTNER
 
Topics: All , Business
 

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