Business Purchase Roadmap
There are two common ways to buy a business: a stock purchase or an asset purchase:
In a stock purchase, you buy the company (whether a corporation or limited liability company) that owns and operates the business. Owners sell you their stock (or membership interests as the case may be). Once you own the stock, you own the company and the business that it operates along with all the assets owned by the company. You also take the company with its debts and potential liabilities, including tax obligations.
In an asset purchase, instead of purchasing the company, the buyer purchases only the assets used or associated with the business. This typically includes real estate, equipment, inventory, intangible assets (websites, trademarks, customer lists) and the company’s rights to its existing contracts. The primary benefit of an asset purchase vs. a stock purchase is that since assets only are being transferred, the debts and liabilities say with the selling company and do not pass to the buyer.
When purchasing a business, there are ten steps in the typical transaction:
1. Select a Business
Buying an existing business is a great way to leapfrog past all the costs and risks of starting a new business from scratch. Ideally, you’ll select a business that matches your passions and skill set. By identifying clear criteria and focusing on essential fundamentals from the outset, buyers can efficiently narrow down their search to businesses that align with their objectives. This targeted approach not only saves time but also minimizes frustration by eliminating unsuitable options early in the process.
2. Sign a Non-Disclosure Agreement
You may be required to sign an NDA before receiving information regarding a company that is for sale. This is common for companies being offered for sale by business brokers. Confidentiality is often essential to the sale of a business. The process requires owners to reveal sensitive information about the business such as tax returns, profit & loss reports and employee information. Maintaining the confidentiality of any part of the proposed transaction is essential to avoiding disruptions in the business.
3. Arrange Financing
Most business purchases will involve a funding source of some kind – rarely are buyers able to finance the entire purchase with their own resources. We strongly recommend interviewing lenders before you begin the search process to preliminarily assess your creditworthiness. You may want to ask whether the lender can originate Small Business Administration loans. The lender can also tell you what to expect during the loan approval process. Understanding the likely timeline from loan application to approval is very important. The lender can also be a valuable partner in your assessment of the target company’s financial data and prospects for profitability.
4. Submit a Letter of Intent
A Letter of Intent (LOI) or a term sheet should be used to memorialize the initial negotiations, which significantly and efficiently helps move the transaction along. The core terms of the transaction, such as the purchase price, financing terms, and time deadlines, are included in the LOI. The LOI, however, is typically non-binding, which means that either party retains the right to walk away from the transaction. The LOI can also provide a period during which the seller cannot accept competing offers. While non-binding, the LOI is still very useful because it requires the parties to come to terms on the important aspects of the transaction. The more that is laid out and agreed to in the LOI, the quicker the next stage of the transaction will go.
5. Sign a Purchase Agreement
Once the core terms of the proposed transaction are agreed upon in the LOI, then it is time to move on to the purchase agreement. The purchase agreement is a binding contract that will be significantly more extensive than the LOI since it contains all the terms of the purchase. After the LOI is signed, there is usually a period between ten to thirty days during which the parties negotiate and agree upon a purchase agreement.
In addition to the core terms covered in the LOI, matters such as due diligence items and procedures, warrants and representations, indemnification, closing procedures, conditions required for closing, dispute resolution, and confidentiality. Most importantly, the agreement will set forth a timeline from the date the agreement is signed to the proposed closing date. There will be many important mile markers along the timeline relating to certain aspects of the transaction process. A typical timeline is 60 to 180 days. Deals involving real estate or approvals of non-parties (such as landlord with assumed leases and franchisors with franchise assignments) will usually be on the longer side of that timeline. Since the purchase agreement is binding on the parties once executed, a party would be in breach of contract should the party attempt to walk away from the transaction. In that case, the non-breaching party may be entitled to monetary damages, as well as the right to force the other party to proceed with the transaction.
6. Form Acquiring Business Entity
Buyers usually want to form a business entity of their own to purchase the assets or stock. We usually recommend waiting until the purchase agreement is signed to incur the expense of forming this purchasing entity. The formation process varies by state and time of the year but usually takes ten days to two weeks. If the buyer has multiple investors, this process can take a little longer for the terms of the operating agreement to be worked out among multiple people.
7. Conduct Due Diligence
Once the purchase agreement is executed the due diligence period will begin. Due diligence gives the buyer the opportunity to verify information about the business being acquired by reviewing the business’ financial records, contracts, assets, physical locations, employment records and any other information that is important to the buyer. The seller will be required to deliver certain documents and information to the buyer. The buyer will review those documents and inspect the physical location of the business. If a lender is involved, an appraisal of the business assets or real estate will likely be required and this takes every bit of a month or more. During the due diligence, the buyer typically has the opportunity to walk away from the deal without any penalty and for any reason. During the due diligence period it is also prudent to begin working on any third-party approvals that are necessary for the transaction, such as minority owners, landlords, mortgagors, local governmental permits needed to operate the business (especially for restaurants) secured creditors, or franchisors. The period reserved for due diligence is usually between 30 to 60 days and sometimes the parties negotiate extensions of that time period.
8. Revise Purchase Agreement Terms
Sometimes information discovered during due diligence causes the buyer to reevaluate the proposed transaction terms. Defects in the real estate, undisclosed liabilities (such as unpaid taxes) and misstated financial reports are among many factors that can lead to an adjustment in terms of the deal. This does not always happen but it is not unusual.
9. Close the Transaction
The closing finishes the transaction and officially transfers ownership of the business (or assets) from the seller to the buyer. The buyer will pay the purchase price, and the seller will execute any documents necessary to effectuate the transfer. In the case of an equity purchase, the seller will assign the shares or membership interests; and in the case of an asset purchase, the seller will execute assignments for intangible property, bills of sale for tangible property, and deeds for real property. Also, key personnel of the seller may also be required to execute post-closing restrictive covenants, such as a non-compete or confidentiality agreement.
In deals involving a lender, the closing is typically triggered by final lender approval. In the week prior to the closing, deal documents will be finalized and costs or expenses to be prorated will be calculated. A settlement statement will be circulated and once everything is finalized, the documents will be signed. Very frequently, closings happen online or remotely. In person closings are becoming less frequent with the advent of electronic signatures.
10. Manage Ownership Transition
Sometimes sellers agree to assist with transition of the business to the buyer. The post-closing transition process is crucial to success of the business for the buyer and should carefully be considered. A seller can introduce the new owner to valued customers and vendors; can smooth the transition for existing employees. There are always unexpected hiccups for buyers unfamiliar with the business the negative impact of which can be mitigated by a seller who agrees to assist for a period of time.
Purchasing a business is a complex process with many critical steps. Whether you are considering a stock purchase or an asset purchase, our experienced business attorneys are here to guide you through every stage, from initial selection to managing ownership transition. Contact us today to schedule a consultation and ensure your business acquisition is smooth, efficient, and legally sound.