I will outline some common issues buyers and sellers of small businesses should consider. If you need a basic straightforward template, you can try my Business Purchase Agreement Generator.
OBJECTIVES
Usually, a buyer's previous experience helps in establishing goals. Buyers rarely seek out to invest in a completely new businesses, but it might be hard for them to understand the business at its ultimate levels. For instance, a person can be familiar with a business from an operating but not from a marketing perspective and vice versa. Therefore, ome form of research is needed.
SEARCH
Generally, the sellers of businesses will either do self-advertising or ask for assistance from a business broker. As a result, seeking candidates is similar to hiring employees. Newspaper ads, the Internet, and brokers who do self-advertising are all good sources of information. With the support from digital resources, a buyer can also find businesses inside a state or zip code zone, additionally separated by sort of business and sometimes even asset- size categories. It is pretty easy to look for brokers who specialize in specific locations or across the country. Obviously, much searching is required, however, it offers a ton of information about what is available, the asking prices , the location of closest target. A broker can take over the search and phone or e-mail the buyer with proposals.
EVALUATION CHECKLIST
After making contact with an applicant, a phase of mutual discovery take places, often beginning with a visit to the applicant' business, a tour around the place, following the discussion. Both buyers and sellers have essentially the same objectives. Each wants to establish the other's capabilities, thus the buyer is willing to offer as much as he or she gets, to demonstrate his or her abilities to purchase the business. If the buyer does not have a business identity, the seller would typically request references and avoid any financial disclosures beyond those stated unless there is thorough examination about the buyer's status and net worth. Several contacts will occur in the regular course of events before the buyer acquires enough information to properly check the chosen business. It is significantly critical to evaluate a business which affects later price negotiations. This has to be handled with caution and attention to prevent legal and financial issues.
The examination of a business can be broken down into four categories: the seller's background and objectives, legal concerns that influences the administration, the business's financial circumstances, and the business's status and potential in its industry.
The buyer certainly wants to know about the business's background, how it founded, the process of growth, and the reasons why now the business is for sale. The most common reason for a small business sale is the sellers wish to retire and he/she has no heirs. Also, the seller is often willing to sell his business when it has been split off from a bigger organization since it no longer fits. The buyer then become more engaged in uncovering shortcomings of the business.
Legal issues involve pending lawsuits or regulatory concerns that the new owner may be required to address. Rental agreements as well as other long-term legal liabilities are typically assessed thoroughly, preferably with the assistance of the buyer's own lawyer.
The financial evaluation is carried out with detailed examination of the company's books—its accounting reports during at least five years, or ideally from the beginning of the business. Audited financial returns are preferable; however, if the seller refuses to pay for an audit, tax records with the IRS is an alternative to provide a different picture of finances. Due to the lack of stock in sole proprietorships and partnerships, business sales are always relied on assets; the amount of attention given to assets must then be determined by their quality and worth. Based on the situation, the buyer may decide to do his or her own asset investigation or hire an appraiser. Such extensive examinations of physical assets are not frequent, although inspections by qualified people are frequently arranged in case the buyer does not have experiences.A well-run business's should, in most cases, properly reflect asset values. If somehow the company is mismanaged, the offered price can act as a risk hedge.
A buyer who is cautious will always utilize the company's financial data to establish another method to valuate the business via discounted cash flow analysis. This type of assessment usually includes estimation of the business's operating results, which is strongly necessary to have thorough understanding of the company's products, operations, and projection for future sales and profits in a competitive marketplace which is also the last category of evaluation . The asking price is then compared to the calculated value of the firm based on this analysis. An agreement is expected unless the two values are substantially similar, however , when they are too incomparable, negotiations are required or the buyer can decide to drop the deal.
The buyer eventually must work hard to gain a complete understanding of the business so that he or she can confidently run it in the future. Internally, this entails a thorough understanding of how the company operates, suppliers' information, how the systems work, and, most importantly, the state and morale of its staff. From external perspective, the buyer must be aware of the company's distribution networks, main customer or types of customers, the market as a whole, and the forces that influence it. Contacting directly with the customers of the sold company is strongly recommended as an upfront marketing to the buyer's potential customers in the future. Some businesses operate in extremely difficult conditions. An environmental services provider, for instance, may undergo extensive government enforcement to support sales. A thorough assessment of regulatory trends—and their loosening or tightening in favorable and unfavorable economic times will identify underlying flaws in a business in such a circumstance. This vast investigation which digs deeper into elements that need careful attention is essential for future estimates.
Checklist - Evaluation to Buy a Business:
1. Why does the current owner want to sell the business?
2. What type of growth potential does this business have?
3. If the business is in decline, will you be able to make it successful?
4. What sort of financial condition is the business in?
5. Be sure to carefully examine the audited year-end financial statements for the business?
6. Be sure to review the tax returns of the business for at least the past five years.
7. Examine the current contracts of the business.
8. Has the business ever been under investigation by any government agency? If so, what was the investigation about and its outcome?
9. Is the business currently under any sort of investigation? If so, what is the investigation about?
10. Is the business involved in any lawsuits? If so, what do they concern? What are the potential losses?
11. What debts does the business have? What liens, if any, are on the properties of the business?
12. What percentage of the business’s accounts are past due?
13. What has been the business bad debt write-off for the past three years?
14. How many customers or clients does the business serve on a regular basis?
15. Who makes up the market for this business? Where are the customers or clients located? Do they come from your community, from various parts of the state, or are they spread all over the country
16. Does the amount business vary from season to season?
17. Does any single customer account for a large portion of the sales volume? If so, would the business be able to survive without this customer?
NEGOTIATIONS AND PURCHASE
If the evaluation delivered favorable results, further discussions may be required to settle any underlying problems. These can take numerous forms and can cover almost any part of the organization, from the management of specific responsibilities to employment agreements for important staff or executives. A purchase agreement will finally be drafted, often with the assistance of legal specialists, and the transaction will be completed with signatures and financial transfers.
FINANCING
When the buyer and seller eventually agree to an installment sale, a leveraged buyout, a stock exchange, or an earn-out to transfer ownership of the company , the deal cannot proceed if the buyer fails to secure appropriate financing.
The majority of small businesses are purchased by buyers who fund a significant amount of the acquisition price. Nonetheless, the buyer must ensure that he or she has sufficient funds to make a down payment and meet the capital requirements of the business. Buyers are often obliged to seek finance coming from external means. The amount will be determined by how much the buyer invests. Before settling for agreement, lenders or investors prefer to see that the buyer is fully committed.
Financial institutions such as banks and consumer financing businesses are more favorable to borrowers involved in the purchase of larger businesses, although in such cases, the institutions frequently need buyers to put up the company's inventory, machinery, real estate, and accounts receivable as collateral. In order to contact potential lenders with a thorough and well-thought-out loan proposal, prudent buyers in need of outside funding will ensure that they approach them with a comprehensive and well-considered loan proposal (including a good business plan). As a result, even when purchasing an existing business, the entrepreneur may not miss that work.
CLOSING THE DEAL
Closings are often accomplished through the use of an escrow settlement or the assistance of a settlement attorney who specialize in settlem. The money to be deposited, the bill of sale, and other related documents are held in escrow by a neutral third party known as an escrow agent until all sale conditions are met. Following that, the escrow agent distributes the kept papers and funds in accordance with the conditions of the contract.
Until then, if a lawyer handles the transaction, he or she drafts a contract and operates as an escrow agent until all of the sale's terms are met, whether on behalf of the buyer or the seller. Unlike escrow settlements, which do not require the buyer and seller to attend together to sign the final documents, attorney-performed settlements do.
To accomplish the transaction between the seller and buyer, some paperwork is, of course, required. The most essential documents are purchase and sale agreement, but additional documents commonly used in closings include the escrow agreement, bill of sale, promissory note, security agreement, settlement sheet, financing statement, and employment agreement.
ASSET SALE VS STOCK SALE
Business purchase can be structured as either an asset sale or a stock sale. Asset sale is when only the assets are being sold, not the liabilities. Buyers would normally prefer that. Sellers, on the other hand, could benefit more from a stock sale, which is when business assets and liabilities are sold to new owner.
Asset Sale
In an asset sale, you sell a collection of your company's assets to a buyer. The company's individual assets, including equipment, licenses, goodwill, client lists, and inventories. There are tangible assets, such as the building or the lease and the intangible assets are, such as your customer list and the worth of the business. There could also be liabilities, like the building's mortgage or accounts payable.
Asset sales are generally not involved with the purchase of the target's cash so the seller usually keeps the target's long-term debt obligations. It's a matter of negotiation whether you sell all of your assets and liabilities to the buyer, and this can leads to more complications.
Advantages of Asset Sale
· The buyer receives a step-up in basis of assets acquired
· The buyer usually does not have to assume the liabilities of the target company.
Disadvantages of Asset Sale
· The seller is subject to a double layer of taxation
· Transferring assets may be more complicated
· Agreements tied to certain assets may need to be renegotiated
Stock Sale:
In a stock sale, the buyer purchases the target company's stock from its shareholders. The stock sale is relatively simple hence it benefits both parties. The buyer simply buys all of the owners' shares in the business which including all of its assets and liabilities. One significant advantage of stock sales above asset sales is that it doesn't require further negotiations with customers over long-term contracts. That makes it a better deal for you as the seller because, unlike with an asset sale,everything is included at the beginning of the deal.
Advantages of Stock Sale
· Cash goes directly to the shareholders
· Transferring stock rather than assets is sometimes less complicated
Disadvantages of Stock Sale
· No step-up in the tax basis of assets acquired, with the exception of 338 (h)(10) and 336(e) elections.
· The lower depreciation expense can result in a higher future tax for the buyer, as compared to an asset sale.
· The buyers may accept more risk by purchasing the company’s stock including all contingent risks that are unknown or undisclosed.
