Due diligence is crucial when it comes to considering buying a business. Before signing anything, here are a few things to consider.
Learn Why the Business is For Sale
Is the business having issues with cash flow? Is the current owner looking for a lifestyle change? There could be a variety of reasons that a business is listed for sale, and it is in a potential buyer’s best interest to learn them. Concerns that a potential buyer should be on the lookout for include:
A poor business plan (there is no market for the product or service);
Severe business debt;
Difficulties with inventory (the product is not of good quality; the cost of making the product is too high; there is not a balance of supply and demand); and
Lawsuits or regulatory action against the company.
Conversations With the Current Owner and Others
Potential buyers should have what may be difficult conversations with the current owner addressing a wide range of concerns before buying a business. It is important to talk to the owner about difficulties they’ve encountered, how they have tried solving those problems and what the results were. A good question for a potential buyer to ask themself is, “Can I overcome the same challenges they did and have the same or better results?”
Potential buyers should speak with customers of the business. Why do they do business with the seller instead of the seller’s competitors? Are there improvements that the customers would like to see?
Current employees are a critical part of the business, so it can be useful to get their thoughts. What do they like about the business as it is currently operated and what improvements they would like to see?
Consider the Deal Structure
Potential buyers should be aware of two major mechanisms they can use to buy a company. The first is a stock sale. In a stock sale, the buyer purchases stock in the seller’s company, and thereby assumes all of the seller’s assets and liabilities. Among the benefits of a stock sale is the ability to transfer business assets efficiently. A significant drawback in a stock sale, particularly for the buyer, is that all liabilities of the company pass to the buyer. When buying the stock of a business that has had a history of tax, regulatory, environmental, or customer-based liability, potential buyers are wise to conduct a diligent review of every aspect of the seller’s business.
The second major mechanism through which a buyer can purchase a business is an asset sale. Here, the buyer creates a new legal entity, and the assets of the selling company are transferred to that new entity. Liability arising out of operations before closing typically stays with the selling entity—good news to those that plan to buy a historically risky enterprise. With an asset sale, title to assets has to be transferred to the buyer’s entity. This can be an arduous task if the target business happens to own a significant amount of machinery and equipment. Nevertheless, the protection from liability offered by an asset sale often outweighs the extra leg work required to complete the transfer of assets.
Don’t Go At It Alone
Buying a business can be a complex process that requires attention to detail and asking tough questions. Therefore, buyers must assemble a strong team of advisors early in the process. It is important to have experienced tax, accounting, and legal advisors at your side. These advisors will help you navigate the strenuous due diligence process, negotiate deal terms, and identify concerns that you may not otherwise be aware of while maintaining an objective and goal-oriented outlook.
All of these factors, and many more, are imperative for potential business owners to consider before purchasing a company. While a buyer could try and do this alone, having an experienced team of attorneys supporting you can make the process much smoother. At Chipman Mazzucco Emerson LLC, we can assist with all aspects of the business buying process. Contact one of our experienced attorneys today to get started.