14 Aug What should I be thinking about when buying a business?
Common question: I’m thinking of buying a business. What should I be thinking about and how do I prepare to do this?
Buying a business
At the risk of over-simplifying (e.g. ignoring the huge step of financing the transaction, which is a major hurdle and often not simple at all), it might be helpful to think of a business transaction as having 2 major steps:
- valuing the thing that is being purchased (assets or stock/ownership units); and
- crafting and negotiating an agreement that guarantees that that thing is what the seller says it is, and ensures that what everyone thinks is going to happen, happens.
[I take the buyer’s perspective here but sellers have no shortage of need to heed the topics discussed herein. Another important note here is that while they share many overlapping qualities, there are important differences between (a) buying a business and (b) buying into a business.]
If you’re buying a business, the first question is whether you’re buying the stock (or ownership units) of a company, or some or all of the assets of the underlying business. That’s an important foundational question, and one I should probably write about for you. #notetoself
For the sake of this one, however, we’ll assume an asset sale.
Most clients are initially laser-focused on the money. How much am I paying? Luckily, to properly value the assets you need to dive in the other legally relevant aspects of the transaction [whew!]. (But be thankful, valuing assets is much easier to do with certainty than assessing the value of the stock of a going-concern (a revenue-generating business).)
Most businesses have a mix of hard and soft assets. In valuation, hard assets and soft assets are different animals; the former are fairly simple to value while the latter can leave you guessing.
Hard assets (e.g. equipment, tools, and vehicles) can be valued by subject matter professionals, or even by online market places like eBay and Craigslist. In some cases though, even hard assets are difficult to assess, particularly for one-of-a-kind or custom machinery. In those cases, cost of production, assessment of wear and tear, and perceived value to the buyer play a large role.
Valuing soft assets, on the other hand, can be a bear, as the value thereof is often determined through negotiation. It’s often the soft assets, like trademarks, copyrights, customer lists, vendor contracts, custom software, and the famous catch-all “goodwill”, whose values might be heavily inflated at the outset to allow for “wiggle room”. In general, the more protected or protectable a soft asset is, the more valuable it is (e.g. are the claimed trademarks registered with the USPTO?). Whether the protection is by registration, statute, or contract, it’s the lawyer’s job to help buyers safely purchase assets and protect them by the available means.
Do your due diligence on the assets! The best thing you can do to prepare for the purchase of a business is to investigate the business and its assets. Understand as fully as you can what it is you are buying, and that you are totally comfortable with the amount you’re paying.
Pro tip: Always consult a tax professional on the tax consequences of buying or selling a business (or its assets) and on the allocation of the purchase price.
The Purchase and Sale Agreement
One of your major goals while negotiating the purchase and sale agreement for this asset transaction is to maximize your confidence that nothing in an asset’s history will bite you later. No liens, no potential claims, no funny business. Essentially, you get guarantees that the assets are what the seller says they are, and that you’re not getting any liabilities that you didn’t bargain for. It is through this agreement that you specifically exclude liabilities you know to exist, as well as to ensure that the seller indemnifies you in the event that things go wrong down the road.
Another essential purpose of the legal docs needed to acquire a business is ensuring that title properly passes from one owner to the next. In each transaction, always think about the day you might sell the business to a new buyer. When I sell these assets, will the buyer have everything they need to show this sale was totally legit?
How you can prepare: Make sure that you collect any and all documentation you have discovered or received with respect to the assets. Some of it may be relevant, or even critical, and some may not be as important, which is ok … your work was not in vain.
Your purchase and sale agreement may have a good number of “Schedules” or “Exhibits” to support the claims of the seller (e.g. a comprehensive asset list clearly identifying each asset, its date and source of acquisition, its approximate value, and any associated depreciation schedules). The sooner this stuff is collected and organized the more efficient the transaction will be.
Pro tip: Early on, ask your lawyer for a Closing Agenda and a Settlement Statement. They may also come from the other side’s lawyer. These documents – or some variation thereof – lay out the basics of what documents are needed for the transaction, who is responsible for which docs, and how much money is going to be paid to whom at the closing. You want to read those docs closely and make sure you can provide what is required of you.
Remember, we have the internet. Your closing doesn’t need to be in person, and it doesn’t need to consume a forest’s worth of trees. Consider an e-signature service. I like HelloSign.
Also, understand what kind of transaction your lawyer recommends. Some transactions are structured so that you sign a purchase and sale agreement that schedules the closing for a later date, so you have the time to do the diligence you need to ensure all is well with the assets. This is similar to a real estate transaction. Alternatively, you may be planning to sign all docs at the closing or on the closing date. Each situation has its day in the sun, but know which kind of transaction you are involved in.
In the end, help yourself by understanding the transaction, ask the critical questions of the seller, and track down as much written support for the seller’s claims as possible. Your lawyer will guide you the rest of the way. If your business broker says you don’t need a lawyer, find another business broker. Buying a business is not to be taken lightly, and while it doesn’t need to cost a fortune, it should not be done without competent legal and tax counsel.
Be safe out there, and keep it between the ditches.