The process of buying a business can be narrowed down to one very simple question: Is the business you’re buying actually the business that you think you’re buying ?
Some purchases are more straightforward than others. Often, this is reflected in the type of business you are purchasing.
If you have a thorough understanding of the business you are buying, then the process will be smoother.
Businesses are continually bought and sold as a result of an opportunity being made available or because of a strategic plan.Larger corporations buy businesses to take out a competitor, increase revenues, market share or even purchasing power.
Larger corporations buy businesses to take out a competitor, increase revenues, market share or even purchasing power.
The process of buying a business – whether it’s a manufacturing company, Internet Company or accounting firm – is the same.
You’re buying an established business that’s hopefully making money and has customers and employees already in place. You also know that if you buy a good business, you have the opportunity to make it a better one.
Here are Ten steps on how to build an acquisition strategy:
Step One: Defining the business you want to buy
When larger corporations do this they call it ‘acquisition profiling’. For you, it will probably manifest itself in a series of questions such as: Which kind of business do I want to buy? How do I know which kind of business is right for me? Where do I start?
Even if you already know which business is right for you, it’s still a good idea to do some research. Read up on any future legislation that may affect the business sector.
Get as much information about the sector as you can – and don’t be afraid to change your mind. If you’re thinking of buying a company, ask yourself what makes one successful? Find an example of a very successful business. Could you replicate that?
At this stage, you’ll also be considering how much to spend on buying a business. Careful financial planning is crucial, as you don’t want to overstretch yourself in the purchase only to find you have inadequate resources to make any changes or implement new plans.
Make sure you build some slack into your budgets. Start doing the calculations now.
Step Two: Targeting the business
Once you’ve defined the parameters of the business you to want buy – the market sector, size, location, the price range, et cetera – you’ll be in a position to start targeting the right business. There are two ways of targeting a business: find one already listed for sale, or approach a business, not for sale and make an offer.
However, if the business you want to buy is not actively being marketed for sale there is nothing to stop you from approaching the owner directly and making an offer. Every business has its price.
If you go down this route then it might be advisable to employ an intermediary to represent you. There are many business and accountancy firms who will target an opportunity on your behalf.
Step Three: Preliminary due diligence
Now things are getting interesting. You’ve narrowed down the opportunities and you’ve created a shortlist of businesses that interest you. Ideally, you will have less than five targets on your list.
Before you engage lawyers and accountants and start the official due diligence process you should do your own quick version of due diligence.
What is due diligence? Well, it’s a technical term, used by accountants and lawyers to describe the process of making sure the business is what it says it is.
Spending time on checking out the business could save you heartache down the line. Once you’ve got your shortlist you should get as much information as possible about each business on your list.
This is your chance to dig around and make sure the business is as good as it seems. If you’re buying a listed business for sale then it should come with a sales memorandum giving an overview of what is being sold.
This is a crucial stage. You must find out the truth about the business being sold.
Any mistakes, flaws or irregularities could also help you to negotiate the price or make your decision to walk away much easier.
You will want to get access to financial records, including audited and management accounts. For this you will be asked to sign a confidentiality agreement. This confidentiality agreement (which won’t be more than two or three of pages) is a commitment by you not to reveal sensitive information to a third party and is designed to make the seller feel comfortable about sharing the knowledge of how his business is being run.
Remember, the business will still be operational and no owner likes it to be known by his employees, customers or competitors that his business is up for sale.
You will also want access to information about existing contracts, either with suppliers or employees. You will want to research the local area and make sure there are no legal issues that might threaten your activity.
The more certain you are about the business and the more evidence you can gather to back up your case, the easier it will be to start negotiations. From your shortlist of up to five you should be narrowing down to just one or two – the major target and a backup.
Step Four: negotiating the price
Once you are satisfied that you have done as much as possible to understand the business you’re targeting, you can start to talk about actually buying it. Inevitably this will mean a conversation with the business owner or intermediary about the price of the business.
It’s important to note that at this early stage of discussions the price remains subject to contract. This means you can make an indicative offer that can change at some future point.
Between now and when the contract is drawn up you may discover some information about the business that will affect your perceived value of it, and you may wish to negotiate further on the price.
So feel free to talk about what you are willing to pay at this stage, safe in the knowledge that it won’t be binding after further investigation. Of course, it might transpire that the business is actually undervalued and that you have scored a hit.
In this case, you may just want to pay the asking price. Also, at this stage and throughout the process, don’t allow yourself to be rushed. Don’t be pushed into a quick sale; take your time.
Once you make an indicative offer a business owner or intermediary may want to rush things through. That’s only natural. However, resist them. Remember, as a buyer, you hold most of the cards.
Take as much time as you need to get to the bottom of what it is you are buying. Don’t let them force a timetable on you that you feel uncomfortable with.
Step Five: Business Valuation
A price is the ultimate reflection of the value of the business. There are many valuation methods used to assess a business.
Many companies use a multiple of earnings as a good starting point. As a general rule, you can take a multiple of future profits to land on a price.
The majority of businesses sold are done so on a multiple of between three and ten times the profit or EBITDA. I have seen even more simple calculations of 1 X revenues.
There are companies that specialize in valuing certain types of businesses and some companies or individuals engage the services of an accountant with experience in buying and selling businesses when making an assessment.
However, in the final analysis, a business is ultimately worth what you’re willing to pay for it.
Step Six: Heads of Terms Agreement
The Heads of Terms Agreement (also known as Letter of Intent or Memoranda of Understanding) is to prevent misunderstandings between the buyer and seller when it comes to completing a deal. Think of it as a roadmap that outlines how the sale will take place. It’s not the contract of sale – that comes later.
Essentially it’s a document of terms, matters that you’ve both agreed on. For example, it will include a period of exclusivity that will prevent the vendor from talking to another prospective buyer.
And it will protect the seller by preventing you from revealing information about the business to third parties. Importantly, the document gives you the right to recover costs if the seller suddenly decides to pull out of the deal.
The heads of agreement are only partially legally binding. For example, the exclusivity period or confidentiality terms discussed above are legally binding, but the price of the business, the completion date or whether you actually have to complete the deal are not.
You can still walk away, even if you’ve signed the heads of agreement. See the heads of agreement as laying down the foundation of the deal, setting the parameters. They are designed to give comfort to both the buyer and seller.
Step Seven: Due Diligence
This is the official due diligence undertaken by professionals to ensure everything is as it should be. It may include commercial due diligence to assess the business itself, legal due diligence to look at the contracts of the business, and financial due diligence to assess the tax position.
The basic principle of due diligence remains the same: to ensure the buyer is 100% sure of the business they are buying.
Step Eight: sale and purchase agreement
This legal document will contain the terms and conditions of the acquisition and the rights and obligations of the parties involved. Apart from establishing the price and how and when the purchase will be financed, the sale and purchase agreement will also contain more detailed clauses.
For example, you may put in a restrictive covenant preventing the seller from setting up a new business that will directly compete with you.
Step Nine: paying for the business
There are many ways you can structure how you pay for a business. The simplest way is to pay on completion.
Alternatively, you can defer the consideration, the legal term for payment. This involves holding back some of the payment until a certain event or milestone is hit. Some companies will also build a “buy-out or earn-out” to motivate sellers to remain with the company and achieve predetermined goals.
The seller will wish to have some security built into an agreement giving him or her an equitable stake in the business, should you fail to meet payments or if the venture fails. This is a very common way of buying a business in the US – usually called ‘loan notes’ or ‘vendor financing’.
Step Ten: completion
All the documents are signed and the business is now yours.
It can take many months to go through this 10-step process, but it’s worth being patient and thorough – because the stakes can be incredibly high. Throughout the process, you should always be prepared to walk away, however, expensive or painful it might be to do so, the pain and expense will pale in comparison with going ahead and buying the wrong business. It could be the costliest mistake you’ll ever make.
Did I miss anything? I would welcome your comments and thoughts on this topic.
To Greater Success,
Founder & CEO
Tel: 817-372 4864