But it needn’t be like that! Buying a business is actually a straightforward process, which can be broken down into the Seven Steps:
• Heads of agreement
• Due diligence
• Drafting the agreement
Of course, the devil is in the detail but taking the Seven Steps and obtaining proper professional advice at each stage will ensure that the risks of buying a lemon or inheriting somebody else’s problems are minimised.
OK, you have found your target business so how do you actually make it yours? Simple: put the Seven Steps into operation:
1. Value the Business
Define what you are buying - establish which assets and liabilities (debts and obligations) you will be taking over, including any contingent (i.e. hidden) liabilities, such as warranty claims, legal actions, employee disputes and so on.
Will you be buying the shares of an existing company or simply its assets? In an asset purchase the liabilities stay with the seller; in a share purchase, you take the whole company, warts and all.
2. Negotiate the Price
In the early stages, all correspondence and discussions should be stated to be “subject to contract”, which means either side can change its position if information emerges that significantly alters the structure of the deal.
Once you have decided how much the business is worth, you can make your offer. How much you are prepared to pay is very subjective: there is no simple formula and there are various methods of “valuing” a business. Increasingly, valuations for smaller businesses are based simply on what the seller and buyer agree between themselves as a fair price.
The negotiating process can be quite protracted and it’s probably worth reading a couple of books on negotiation skills before you start, or hiring an experienced consultant to do the negotiation on your behalf.
3. Financing the Sale
Once you have a good idea of how much the business is going to cost, you can decide how to finance the purchase. How much of your own cash do you want to use? It is wise to keep a good sum aside for contingencies or to finance cash flow, so you will need to find funding for the balance. Your funder is likely to want to see a detailed business plan, supported by robust cash flow and profit and loss forecasts.
Talk to your bank first: traditional bank finance tends to be the cheapest (but not always). Your bank might well say no – banks are extremely risk-averse – but there are thousands of other organisations and individuals prepared to look at deals commercially and take more of a risk, albeit at a cost. You just need to factor this into your profit forecasts.
If your bank turns you down, find yourself a finance broker, who will have access to many sources of funding, such as:
• Mainstream and other banks
• Asset finance
• Factoring and invoice discounting
• Loan and equity finance through private investors
• Government and other grants
Be prepared to offer security or a personal guarantee. If you want your lender or investor to have confidence in you and your venture, you will need to demonstrate similar confidence!
4. Heads of Agreement (aka Heads of Terms)
Once you and the seller have agreed outline terms, these are recorded in a heads of agreement (“HOA”), which is not a legally-binding document but can be used to assess the original intentions of the parties if a dispute arises later. The HOA may contain restrictions on the seller negotiating with other parties and provide for confidentiality of information shared.
Once the HOA has been signed, it is usual for the parties to engage their lawyers and other advisers, such as accountants.
5. Due Diligence
This process is usually carried out by your lawyers and accountants but you could in theory do it yourself. You or your advisers will issue questionnaires to the seller, to bring out all the information you need, so you can satisfy yourself you understand exactly what you are buying, and that there are no unpleasant surprises hidden away.
The process may include:
• commercial due diligence to assess the business itself;
• legal due diligence, to look at the contracts and other obligations of the business; and
• financial due diligence.
6. Drafting the Sale Agreement
Your solicitors will normally draft the sale agreement, which will set out all the legal details of the sale and could run to many pages. It will contain, amongst other things:
• schedules of the assets and liabilities taken over;
• any warranties given by the seller as to the correctness of the information provided to you;
• details of the purchase price and how it will be paid;
• provisions as to how any disputes arising after the sale will be dealt with; and
• the rights and responsibilities of the seller after the sale, for example, restrictive covenants on competition.
The solicitors will negotiate until the final legal terms are agreed - which may take several months and can lead to irritation and frustration on the part of the parties.
Where the newly-constituted business will have more than one owner, it is wise to draft a separate shareholder or partnership agreement, to ensure that their rights and responsibilities are all made absolutely clear.
It is also important to ensure that Companies House are full informed of changes to ownership, shareholdings and Directorships etc. to avoid future problems.
Once all the negotiations have been concluded, the sale can be completed and ownership of the business will pass to you when the documents have been signed, and any associated money paid.
Completing the Seven Steps can take time, so patience is required but they are all essential. It can also seem expensive to hire the various professionals you need however it is vital to ensure that there is as little scope as possible for disputes or nasty surprises to occur after you have bought the business; and you will need to factor the costs into the overall purchase price.
Buying a business may seem rather daunting; however taking the structured approach of the Seven Steps and obtaining proper advice at every step will ensure you get off on the right foot to enable your new business to thrive and prosper - allowing you to reap the rewards for years to come!
Finally it is worth considering two other aspects relating to the purchase:
• In many cases an established business may rely for its current success on one or two key personnel. Done properly the Due Diligence should reveal this, if it is not immediately apparent. The point is that, if such key characters are identified, then part of the negotiation may need to be to ensure that those people are placed on some sort of retainer for a minimum period of time to ensure continuity of the business.
• Funding for the purchase of a business is not always easy to raise. It is an area of commercial finance, however, that we at Business Finance Services Ltd. have considerable experience and expertise, so do not hesitate to call us if you need help in this regard. We can be contacted on 01327 349779 or by e-mail at firstname.lastname@example.org .
This Blog is provided courtesy of our Associate Alan Price who is also owner of Harpconsult Ltd.