Preparing for the Purchase of a Business
The decision to purchase a business requires careful consideration of the many factors involved. These factors include conducting the necessary investigations, establishing a rationale for pricing evaluation and obtaining the appropriate financing for your purchase. It is imperative that a purchaser carefully think through the motives for considering the purchase of a business and the criteria for selecting one. A purchaser should consider: its experience, both vocational and avocational; what it is good at and what it enjoys; the vendor’s motivation for selling; the desired location(s); the amount of money willing to be invested; the availability of financing for the purchase; the size of the business in terms of sales, profits and the number of employees; and the stability of the business.
Certain legal investigations should be conducted prior to the closing of the sale to ensure the business is truly the business that the vendor has described and represented it to be. A failure to perform proper due diligence could result in the spending of money and time seeking compensation from the vendor for either misrepresenting material aspects of the business the purchaser has bought or not adequately disclosing material information about the business that the vendor should have disclosed.
The type of business you are proposing to purchase will dictate, to a large degree, the type and extent of the investigations you should make. Some of the more important investigative issues to be considered are: whether the purchase should be the purchase of assets or shares; the status of the vendor including whether the vendor is a corporation, a partnership or an individual operating as a sole proprietorship; the residency of the vendor; real estate property searches (for both freehold and leasehold property); ownership of machinery, equipment, vehicles and other tangible personal property; employee related matters; and tax matters. Constraints, such as time and money, may prevent you from conducting every search you might otherwise conduct. Your lawyer can help you decide the appropriate investigations for the particular business you are planning to buy and help you cover off any remaining exposure in the legal documentation that will be used to implement the transaction.
The process of business evaluations is complex and fraught with potential for differences of opinions. For the transaction to come to conclusion, both parties must be satisfied with the price and be able to understand how it was determined. The process takes into account many variables and requires that a number of assumptions be made. Some of these factors are: recent profit history; general condition of the business; market demand; economic conditions; transferability of goodwill or other intangibles; future profit potential; special circumstances of particular vendor and purchaser; trade-off between cash and terms; and relative tax consequences. Professional advice should always be sought when attempting to value a business.
A purchaser’s source of financing depends in part on the size of the business being purchased. The vast majority of businesses are purchased with a significant portion of the purchase price financed by the vendor. The purchaser, however, must still make a down payment and be sure that adequate working capital sources are available. It is rare for a privately-held business to be acquired without leveraging the business’s assets in some manner, pledging them as collateral for a loan made either by the owner of the business or an outside lender. The vendor has a strong incentive to provide financing if it feels it is necessary to get the price it wants for the business and has confidence in the purchaser. An outside lender must be convinced that the loan’s risk of failure is minimal and represents a profitable transaction. To obtain outside financing it is important to be well prepared and have the information that a lender needs to make a decision. Finally, in most cases (and particularly for small transactions), to grant financing a lender is almost certain to require personal collateral for the loan and possibly a compendium of financial and operating data of the business to be acquired.
This article was originally published in the November 11, 2008 edition of the Ottawa Business Journal.