By Andrew Comer
Not everyone who dreams of owning a business is interested in starting their own company from scratch. That’s why buying an existing business is the best way for some people to begin their entrepreneurship journey. But if you’ve never done it before, you likely have a lot of questions! How do I find a business to buy, how do I finance it, and what pitfalls do I need to watch out for?
In part one of my blog series on M&A FAQs, I addressed the most frequently asked questions about how to sell a business. Now, I’ll share answers to the top questions I get about how to buy a business.
Where can I find a business to buy?
The most popular site for purchasing a business is BizBuySell, and I recommend starting there to begin the journey of finding a company that’s available to buy in an area you’re interested in. You’ll get a sense of valuations, what types of local businesses are for sale, and who some of the popular brokers in the area are. Other good sites for buying a business can be found through a simple Google search. Scoping out businesses through these resources can actually be fun. If poring through a website doesn’t sound fun to you, there are business brokers and investment bankers who specialize in selling businesses as well, and I’m happy to provide contact information for people I’ve worked with before and trust.
How Can I Finance an Acquisition?
There are three main options. The top choice for many buyers is a Small Business Association Section 7(a) loan. This is the SBA’s primary business loan program, with a maximum loan amount of $5 million. It’s a popular choice but has some limitations – SBA loans require personal guarantees, and the terms can sometimes be worse than conventional loans. Still, a lender is often more likely to lend under the 7(a) loan program in circumstances where conventional lenders won’t because under the 7(a) loan program, a lender receives a 75% guarantee from the SBA.
The second option is a traditional bank loan, often the best option if you have good collateral and excellent personal credit and the business you are buying has good collateral.
Third, sellers will sometimes finance all or part of the transaction by taking a portion of the purchase price as a loan and agreeing to be paid back by the buyer over time.
What’s the purchase process?
The purchase process begins with initial discussions with the seller to ensure their business is something you’re interested in, that you understand the general parameters of the sale, and that you’re generally aligned on the purchase price and other terms. The Seller will likely ask you to sign a nondisclosure agreement as you explore whether the business is in good order and has the potential you hope it does.
From there, the next step is crafting a letter of intent, also known as an LOI. This is the point at which you’ll want to engage a lawyer. Often, people think LOIs are non-binding, but in actuality, they set the stage for the entire deal, and trying to negotiate away from what’s in the LOI can later kill the deal altogether. An experienced attorney will help you think through the appropriate deal structure, tax implications, and any other unique aspects of the purchase that you should consider. First-time buyers, in particular, are often unaware of nuances and potential pitfalls during this stage.
After the LOI is signed, you will enter the 30-60-day due diligence period when you can likely obtain more access to the company’s financials, corporate records, intellectual property, audits, payroll, contracts, taxes and much more. It is your opportunity to closely examine all aspects of the business and uncover any issues that might prevent the sale from going forward.
Once you’re comfortable with what you see and feel secure in your intent to purchase, your attorney will put together the necessary agreements – a purchase agreement, bill of sale for any assets being sold, non-compete documents, consulting agreements (if you would like the seller will stay on and consult in some capacity), and more. Those agreements are all negotiated between both parties with lawyers’ help.
Your attorney can also work with the bank’s team and the buyer to help ensure the financing party is prepared to close and that all financial details are properly coordinated.
How can I mitigate risk, and what are some of the biggest red flags for a buyer?
No business is risk-free, but an experienced M&A lawyer will assist with de-risking your purchase during the due diligence process by helping negotiate key provisions specific to the company you are acquiring in the purchase documents.
Most red flags are uncovered during the due diligence process. It is also the time when you’ll get to know fine details about the business you’re buying and have the opportunity to determine if its owners are people you want to enter into a deal with. The most common red flags I see that can cause a sale to fall apart are:
- Pending litigation or a sudden reveal of the threat of litigation just before close.
- The seller dragging their feet in providing documentation or springing last-minute information about the business that surprises the buyer.
- Poor accounting or bookkeeping that can’t be easily resolved. Many small businesses don’t have the best accounting, but issues that can’t be readily addressed or clarified make things like valuation, post-closing payment structures, and buyer comfort with the business’s performance a challenge.
- Key employees that don’t support the deal or won’t agree to stay on after closing.
- Misclassification of employees. If a business has employees receiving 1099s who should be getting W-2s, that can have a lot of legal, tax, and employment implications that many buyers don’t want to inherit.
How do I structure my deal in the most tax-efficient way?
By and large, this entails having a good LOI and working closely with your accountants and lawyers from the outset to ensure that the deal terms account for your personal financial situation. Will this be the first business you own or your sixth business? Are you planning on retiring with the business proceeds, or is this a side project? Your accountant and attorney can help you identify and employ various tax and trust strategies to lower your tax burden, but you must begin working with them early in the process to avoid getting saddled with excessive taxes later.
How do I ensure I get the full value of the business I’m buying?
I always ask my buyers what they care the most about in the business. For some, it’s the current operator, owners or employees; for others, it’s the location, the customer base, the software, the company name, logo, branding or intellectual property. Whatever is most important to you must be accounted for in the deal, and you should work with your attorney to identify and address what matters most. There’s nothing worse than closing a sale only to realize that you didn’t specify something important to you.
How do I ensure a seamless transition post-acquisition?
Buyers should virtually always put an agreement in place where they agree to pay the seller or key leadership team members to stay on for a while to assist with the transition. The number of people and length of time will vary depending on the size and scope of the business.
For a small business, keeping the owner on retainer for two weeks post-sale might be sufficient, whereas, with a larger company, you may want to retain key leaders for up to a year. If you have no experience in your new business’s industry, then you will undoubtedly want the previous owner or manager to stay on and provide guidance for some time while you get your bearings. However, if you are a buyer who’s experienced and savvy about the industry, or the seller’s continued presence would be counterproductive, you’ll likely want the seller around for a far shorter time (or not at all).
Whether you’re a seasoned entrepreneur or just starting your journey, buying a business can be overwhelming and complex. However, with the right counsel, you can navigate the process with comfort and certainty. I hope the answers to these frequently asked questions serve as a valuable tool and help you make informed decisions during your buying process. Please contact me with any additional questions. I love to guide buyers and sellers as they tackle this new venture!