When buying any business, the best advice is to work with experienced professionals, including an experienced business lawyer, a certified public accountant (CPA) and a valuation expert. We can do #1 and we have contacts for #2 and #3. Buyers often make certain mistakes during the purchasing process that can lead to significant challenges later on, such as partnership or shareholder disputes, unexpected liabilities, non-compete violations and conflicts over payment terms. Here’s a guide to ensure your new investment is well-protected.
1. Conduct Preliminary Research
Start by learning as much as possible about the business, including its reputation and reason for sale. Review online feedback, “ghost shop” the company several times and check public records. Investigate the business’s local compliance with permits and licenses. Knowing why the business is being sold is crucial: an owner’s retirement is a different situation from a business facing financial or regulatory issues. Thorough research before negotiating can give you leverage and save you time and resources in due diligence.
2. Conduct Thorough Due Diligence
After meeting with the seller, you’ll enter an inspection period—your chance to conduct due diligence, ideally guided by an experienced business lawyer. During this time, examine both the physical aspects of the business, such as equipment and inventory, and its financials, liabilities and compliance records including all training logs.
A comprehensive due diligence checklist typically covers:
- Legal and Ownership Documents: Articles of incorporation, operating agreements and organizational charts.
- Financial Records: Audited statements, budgets, accounts payable and receivable, and debt schedules.
- Tax and Banking Information: Any arrangements with banks and creditors.
- Regulatory Compliance: Ensure that licenses and permits are in order and look for any past or pending regulatory issues.
- Assets and Property: Leases and ownership records for real and personal property.
- Intellectual Property: Trademarks, copyrights, patents, and protection methods.
- Client and Supplier Agreements: Material contracts, key suppliers, and client lists.
- Employee Records: Compensation, benefits, and employment contracts.
- Litigation History: Any resolved or ongoing legal disputes.
The documents are often shared in a virtual data room, accessible to you and your advisors. Your attorney can review the data, verify disclosure schedules and ensure the closing documents protect your interests.
About Nondisclosure Agreements
During the purchase process, the seller may request a nondisclosure agreement (“NDA”) to protect confidential information in case the deal doesn’t close. A well-crafted NDA helps protect both parties from potential legal issues so long as it’s drafted properly (e.g., exceptions for information shared publicly).
3. Prepare Your Financing
Whether paying in cash or securing financing through a lender or investor, ensure your finances are in order. Securing pre-approval can make you a more appealing buyer and provide clarity on your budget, giving you confidence in negotiations. It’s also critical to establish a business entity for liability protection. Discuss options like LLCs, corporations or partnerships with your business lawyer to find the best fit for your situation. This would apply even for an asset purchase agreement structure.
4. Sign a Letter of Intent
A letter of intent (“LOI”) sets the groundwork for negotiations and outlines preliminary terms of the sale. Though non-binding, an LOI signals serious interest and can streamline the purchasing process by setting forth the generally agreed to terms and expectations. It’s also a good test of how the other party negotiates.
5. Draft a Purchase Agreement
The purchase agreement is the foundation of the transaction, detailing what you are buying, payment terms and conditions of the sale. Ensure all assets are listed clearly, along with exceptions, warranties and any liabilities covered by a disclosure schedule.
If buyers and sellers differ on valuation, they may include an earn-out provision, allowing the final price to be tied to the business’s future performance. Ensure that this provision is clearly defined to avoid future disputes.
Before finalizing the purchase, work with the seller to create a transfer plan for a smooth transition. Former owners often agree to stay on for a set period to help with continuity. This can help mitigate risk, increase the retention of key employees and enable a smooth transition for your new customers.
BONUS: 6. Don’t Overlook a Non-Compete Agreement
A non-compete agreement is essential to prevent the seller from immediately starting a competing business. A well-drafted non-compete agreement can protect your investment and allow you time to establish yourself as the new business owner. This should be drafted to protect from both a time (e.g, 5 years) and space (e.g., within 50 miles or online) perspective.
Following these steps and working with seasoned professionals like experienced business lawyers and business consultants can help safeguard your investment, minimize risks, and position you for a successful business acquisition.
