What to look out for when buying a business

Thu 18 Sep 2008

Buying a business is a good way either to start out on a new venture or grow your existing enterprise.  The key to a successful acquisition is to understand what’s on offer and be clear on what you will buy.  Will that be shares in a company or trade and assets?  The answer will affect your process.

The purchase process: paperwork

You may be asked to sign a confidentiality agreement to protect the seller’s trading information – that’s OK but check its terms.  You should ask the seller to sign an exclusivity agreement, requiring the seller not to negotiate with anyone else while you make your investigations, so you don’t waste time and money on investigations while the seller is negotiating with a third party.

Next, write an offer letter and make sure it is subject to written contract.  Set out your offer price and any conditions to the deal.  Satisfactory due diligence will be one of your conditions.

Due diligence involves investigating the company to find out whether the claims the seller has made about the business are true; to see for yourself if there are skeletons in the cupboard.  It may prove better to walk away from the deal than buy a load of problems.

Once due diligence is complete and the key terms of the deal are agreed, you’ll need to agree the terms in writing to make provision for the transfer of ownership of the business, collection of debts and payment of creditors, treatment of employees, title to land, tax liabilities and so on.

What is the difference between buying a company and a business?

Buying a company is riskier than buying trade and assets because responsibility for its liabilities does not change – so, you need to know exactly what those are before you buy the company.

When you buy a business, you may be able to cherry pick from what the seller has to offer.  You will aim to buy the assets and leave behind all the liabilities.  Hence, your ongoing trading should not be prejudiced by anything that happened before you took over – unless that has damaged the name and reputation of the business.

Key issues to look out for

Understand the opportunity: you must investigate the claims of the seller in detail.  What are the reasons for the sale; what contracts are there; are they profitable; are any due to end; has the seller tried to expand the operation and what was the outcome; if not successful, why not?

Understand the risks: does the business have unusual levels of debt; who are its creditors; what is the value owed by its trade debtors and who will collect that debt after your purchase; are key customers also slow payers; are the assets secured in favour of a third party; will that security be released on sale?  If you are buying a company, it is essential to understand its tax and banking affairs.

Structure the price: if you can, spread out your payments according to the profitability of the business and hold back money for an agreed period as security for breaches of the transfer agreement.

Taking the plunge

Buyers must be thorough when investigating purchase opportunities, says Neil Morgan, a corporate partner at Winckworth Sherwood solicitors.  Sellers are often looking to sell because of a fall in sales in a difficult trading environment.  It’s vital to get check out their claims before plunging in and making an offer of purchase that could be legally binding.  Many buyers will need to borrow from a bank to fund their purchase and the bank will take security over their house and the business – getting things wrong from the outset is not an option.  As long as you know what you are buying, there’s every chance you will be successful because your business plan will take account of the risks as well as the opportunities.

Author: Neil Morgan, Commercial Partner.

Appeared in New Business published 18 September 2008