You have decided to buy a business. You have been talking to the seller and have agreed in principal to the sale. The seller wants you to sign a letter of intent or letter of agreement to show that you are committed. Resist the temptation. Once you have signed something, your options and ability to negotiate the terms of the sale will have decreased dramatically. Instead of a letter of intent, why not have comprehensive purchase agreement which includes all of the terms and conditions that govern the purchase of the business. The purchase agreement is key. Here are some matters to consider when purchasing business:
Know what you are buying. Make sure that you are aware of exactly what you are purchasing. Are there some equipment, customer lists, key agreements with suppliers, a building or lease, a website, phone numbers, inventory, business fixtures and any other personal property that come with the business? Is there goodwill of the business? The allocation of the purchase price among the various parts and components should be listed. What and how you deduct depreciation or other expenses included in the sale purchase price are determined by the purchase price allocation.
Have appropriate contingencies. Your purchase agreement should include contingencies so that you can conduct your due diligence before you decide to close on the deal. There should be contingencies for important matters, such as:
- Inspection of the stuff, and building, if any, that you are purchasing in order that you do not purchase something that you did not anticipate.
- Review of the books and records of the business, including financial statements and tax returns.
- Review of all key supplier and other agreements.
If anything is discovered in these contingencies that is unsatisfactory, you can walk away from the deal and get your deposit back. Or you could use the results to re-negotiate the purchase price.
Know what you are getting into. If you do not have experience with the business you are contemplating on purchasing, research it. You may want to start out small or hire experienced individuals to manage the business, at least initially.
Know your purchasing costs. Your purchase agreement should state who is paying which closing costs. Try to negotiate that you are paying as few of the closing costs as possible. If you are financing the purchase, review your lender’s costs. If the sale is seller financed, what closing and other costs will the seller require you to pay?
Know your ongoing costs. What are your monthly fixed costs of the business? What margin do you anticipate on the sale of the goods or services? Do pro-forma financials of what you expect. Review historical costs. If financed, what is your monthly principal and interest payment going to be? Make sure that you are aware of all ongoing costs before you obligate yourself to purchase the business. Prepare a cash flow projection. Will the business pay for itself or do you have to feed it every month. If you have to continually fund it, do you have adequate capital?
Include closing documents with purchase agreement. It is a good idea to include all of the documents needed to close the sale as attachments to the purchase agreement. What are the provisions of the bill of sale, promissory note, security agreement, land contract, non-competition agreement or consulting agreement? If you do not include all the closing documents at the outset, then you could be renegotiating the deal at time of closing.
Seller representations should survive closing. If you are relying upon the accuracy of the business records or anything that the seller has told you, have those representations survive the closing. After closing, if you discover that any of the representations turn out to be untrue, you may then have recourse against the seller.
Have an exit strategy. Whenever you get into business, make a plan to get out of the business. What would happen to the business when you can no longer manage it? This could be in the near future, such as with an unexpected disability or death, or could be many, many years down the road at retirement. If you have family members who can manage it, your exit strategy may be to leave it to them. If not, your plan may include professional management of the business until it can be sold or shut down.
So if you are going to invest in a business, make sure that you do your homework and you are properly capitalized and properly educated. Happy investing.
By Matthew M. Wallace, CPA, JD
Published edited June 1, 2018 in Savvy magazine, Port Huron, Michigan as: Buying a business? Don’t sign anything yet