Should you buy it? The price is worth it? The reasons for conducting due diligence are to ensure that you are receiving the business you are purchasing in the condition that the Seller presented it to you, also to discover any surprises that may arise later or to discover any unexplained liabilities. It is your responsibility to do the due diligence process.
It’s okay to get outside help, like your accountant or lawyer. Ultimately it will be your judgment when the process is finished and that is the way it should be. After all, you will be the new captain and it should feel comfortable for you. The due diligence process is talked about a lot and is an important part of the buying process, but in reality, the due diligence process should start with the first look at the business. All you ask before the letter of intent will be questions that lead you and the seller through the due diligence process.
That’s why you should take good notes during meetings with the Seller or broker. If they give numbers or make statements about the business, you can look in their notes to make sure you get the numbers you discussed at the beginning. During the process, you must have full access to all financial books and records. You are trying to discover hidden skeletons.
1. Possible loss of important accounts. A family member or friend can be an important account.
2. Increased rent for the building, or insufficient rent.
3. Entry of new competition (large chain stores).
4. Difficulty obtaining inventory or services.
5. Zoning changes, such as a new bypass or limited expansion.
6. Franchise fees change or transfer fees are too high.
7. Image and reputation in the commercial area damaged by bad reports.
8. Drop in turnover in the last half of the year.
9. Credit problems with suppliers and vendors.
10. Trials and links against the company.
11. Violations of state and federal laws. Unpaid taxes. License suspension.
12. Inventory and old or dead equipment, significant replacement cost.
13. Partner or spouse who does not want to sell.
14. Violations of environmental and safety requirements.
15. Key employee replacement issue, union issues.
16. Potential increase in product-related liability insurance.
17. Agreements or contractual relationships.
Remember that you do not have cash to deposit. What do you do for a living?
Send as low a security deposit as you think will work. You may have to bring it up a bit later, but if the seller is eager to sell, they may not pay much attention. Remember, with the exit clauses you’ve included, you won’t have to go through with the deal anyway. You just don’t want a seller or broker tying up your cash. This is how he arranges to put money down in escrow with the seller or his broker.
Do not include a check with your contract with the Seller. The Contract Agreement will state that the security money has been deposited with your attorney as escrow agent. Write a post-dated check for the agreed amount and the agreed closing date, payable to the Seller. Do not date the check as the date you write it, use the closing date instead. give the check to your lawyer. Tell him not to deposit it but to retain it. The seller or broker does not know that the check is post-dated. However, there is no way that the Seller can retain the security money due to the external clauses of the contract. The most important thing to remember is never to give the earnest money to the seller, broker or his title company.
In most cases, you should prefer to purchase the business through asset transfer. There will be cases where you may want to take over a corporation. For example, your personal credit might not be up to scratch and if you can acquire an ongoing business with a stock option and assume the assets and liabilities, this could be to your advantage. You may not have to provide financial information to the owner and vendors when you make a stock option. Make sure the business owner has not mixed other business activities with the business you are buying. Have the Seller sign a strong indemnity clause.
Of course, this clause is only as good as the Seller’s bank account. If a prior problem arose due to a prior act of Seller, you, as the new owner of the corporation, would be responsible for any amounts Seller is unable to pay. This is the reason why most buyers will not buy the shares of the corporation when buying a business. If Seller fails to pay or correct the situation, it is important that Buyer have a right of set clause against Buyer’s Note to Seller for any claims arising from past actions of Seller and shareholders of the corporation.
If Seller refuses to correct the problem, Buyer may pay the claim and deduct the amount from their payment note to Seller. I strongly recommend that you involve both your attorney and your accountant in the purchase of corporate stock in a company. Get them involved early on in the process. It is better to be proactive than reactive. One more word, it costs less to get it right the first time than to go back and fix it.
When you decide to acquire the business through an asset sale, instruct your attorney to set up the transfer so that the corporation will sell the assets to you. This means that you do not buy the shares. You buy the business. I recommend that the sale be set up as an asset sale rather than buying the shares. The next step is to identify the assets and agreements that will make up the sale of the business.
The goal now is to allocate portions of the purchase price to the assets and agreements that will be transferred as part of the sale of the business. As a Buyer, you want to contribute the majority of the purchase price of the business to items that can be charged to expenses, rather than to depreciable assets. This will provide you with short-term amortization of those portions of the purchase price. Get your accountant involved in these assignments. Now that the structure of the commercial sale has been determined, the next thing you want to identify are the agreements that the Buyer and Seller will need to execute.
Commit not to compete. It would be a disaster if you bought a business and the seller or a shareholder opened a competing business across the street next month. That’s why you make sellers sign a no-compete pact. This agreement must indicate the geographic area and a period of time in which the Seller will not conduct business doing a type of business similar to the one he is selling. It shouldn’t make any difference to you if the Seller is 90 years old and retires or moves. Get the no-compete pact signed.
Consulting Agreement You should be aware of the importance of the Seller remaining for a period of time after the close of the sale as a paid consultant. He should get the first thirty days free of charge. That might be enough time for you to understand the business and be able to find the bathroom. If it’s a business you’re not familiar with, draw up a consulting contract. Of course, the terms and conditions are open to negotiation. As the Buyer, you want the Seller to stay in business as long as possible with low compensation. You have to make this call depending on your comfort level.