Buying A Business

Buying a business can be a big step forward – but can also turn out to be a big disaster even for large corporations. The main pitfalls to acquiring a business are the same no matter what the size of the business that is being bought.

In this section we aim to cover the aspects of approaching a target business, completion of due diligence, negotiating the purchase and settlement once the deal is complete. To visit a specific section follow the links below.

Approaching A Business With View To Acquisition

The primary aim is to convince the vendor that he really wants to sell his business to you. With this in mind the purchaser needs to establish that he is a credible purchaser.

The buyer should initially register their interest in purchasing the business. The target will usually have instructed professional advisor’s to sell the business therefore it is the advisor’s that should be approached initially not the management.

The advisor’s will require the purchaser to explain what their current business is (or the background of the purchaser if they do not currently have a business), why they are interested in that business, how they intend to purchase the business and if funds are currently available or how they will be obtained.

Integrity and future plans will often be extremely important to any vendor particularly if they have built their business up with the current workforce.

During discussions with the vendor and his advisors, the purchaser should attempt to evaluate whether the vendor needs to sell the business and if so what are the required timescales. Is money the prime motivation for selling and will the existing management and workforce remain involved in the business? These factors will have a bearing on the possible offer price.

Due Diligence

A prospective purchaser should assure himself that there are no major problems with the target business by possibly analysing annual and management accounts info over several years. (It should always be borne in mind that a Sales Memorandum will usually gloss over or avoid weak or problem areas.). The purchaser should meet with the vendor and also try and visit the business. Whenever possible, make enquiries from industry experts as to the prospective demand for the products or services of the business, whether prices(and margins) are rising or falling and what is the nature of the competition in that market place , both current and potential.

A more substantial detailed due diligence should be carried out once Heads of Agreement are signed (see later)

Professional Advisors

create10The purchaser should appoint advisors with the appropriate experience.

There may be a requirement for experts in different specialist areas such as:

  • Market research, accounting, tax and legal fields
  • Corporate finance
  • HR policies especially in the areas of contract terms and pension fund provisions
  • Negotiating the deal on your behalf

When choosing advisors it is best to draw up remits specific to each one. Put in writing exactly what is expected from each advisor possibly following consultation with each to decide what will be required. Also devise a timetable for each aspect of the work to be completed and monitor it closely.

Fee levels should be clearly agreed. If the advisor charges by the hour (which is often the case), a target number of hours should be agreed for each stage of the work and a system for being regularly informed of costs incurred. Wherever possible get advisors to charge on a fixed fee basis.

Fees may also be agreed on other factors such as a fixed fee plus an additional amount upon

The Initial Offer

Take professional advice in helping to value the target business.

Make sure that you can produce your own profit projections with any additional costs/savings or potential increases in sales or new markets to move into. Also use sensitivity analysis and produce various scenarios (Best, Worst and Most likely cases).

Consider the possible Risks

There is an inherently higher level of risk if the target business

  • Has assets which are worth less than the offer price
  • Relies on a few customers or suppliers
  • Has key employees that the business relies heavily on
  • Is currently unprofitable or has a history of losses
  • Has not invested in assets recently
  • Is borrowing heavily to finance the purchase may also increase risk especially if it was the lack of finance that was holding the business back.

Work out the initial offer and the maximum price that you are willing to offer

Take into account the following aspects:

  • The initial valuation arrived at
  • What possible competition you have for the purchase of the company
  • What the vendors objectives are eg retirement sale, sale due to ill health or the business has a lack of funding

It is common for the initial offer to be low, with the expectation that the vendor will insist on a higher price. Always leave room for negotiation!

Submit the Offer

  • Use a formal letter headed ‘Subject to contract’ so that there is no legal commitment at this point.
  • Put the emphasis on the positive points of the offer eg that you intend to ensure that all employees will be kept on in the business.
  • Make sure that all issues are clarified promptly.
  • Should the vendor endeavour to play you off against other interested parties, ask for evidence of the other buyers interest (they may not exist)

Heads Of Agreement

These will specify the main terms of the sale. The more detail that is contained and agreed within these, the lower that the likely legal costs will be.

Specify exactly what it is that you will be buying:

  • This may be the whole business, the share capital (where the business is a limited company) or just the assets of the business.
  • By only buying the assets of the business you avoid a number of potential legal liabilities such as any legal action arising ona previous contract or shortfalls in final salary pension schemes

Set out the amount and timing of the payments:

  • The amount to be paid may be contingent on x number of years profits
  • Some of the payment may be deferred which can benefit both sides i.e . they can allow the purchaser to pay for the business out of the cash generated by the business itself or they can take the form of an ‘earn-out’ where the final payments are related to the businesses future performance so if it doesn’t perform up to the expected levels the purchaser pays less for the business. The earn out could also be linked to certain events such as the winning of a large contract which may be in doubt at the time of purchase. They could also be used to reduce the vendors tax bill eg capital gains tax on the sale may be spread over more than one tax year and income tax on ‘consultancy’ payments to the owner can be similarly spread.

Agree a period of exclusivity:

This would effectively stop the vendor from negotiating with anyone else for an agreed period eg 3 months. This would mean that you should be able to confidently employ your advisors without the risk that the business could be sold before you get to agreeing a price for the company.

Make a list of any preconditions that you would want to insist on:

Examples may be the winning of a contract or the disposal of part of the business. You would only be committed to the purchase if the preconditions are met

Agree any warranties and indemnities which you require the vendor to provide:

  • A warranty is a written statement which confirms requested key information about the business e.g. All assets in the business are owned by the business and free from any financial incumberance such as title being assigned to a finance company.
  • An Indemnity is a commitment by the vendor to reimburse the buyer in a specified situation e.g. An indemnity would be sought to cover any undisclosed tax liabilities relating to transactions before the date that the business is sold

The need for warranties and indemnities is greatest where the shares of a company are being purchased and much less so where an asset sale is contemplated.

Detailed Due Diligence

After signing the heads of agreement the purchasor should carry out a detailed examination of the business.

Checks should be made on the customer base from the accounting records which should include

  • Examination of how long they have been customers
  • Any contracts that are in place
  • How quickly do they pay their debts
  • Do they also use competitors?
  • What is the expected future demands for the business products or services?
  • Are there any potential bad debtors or problems with orders fulfilled?

With regard to suppliers

  • Does the business pay its suppliers on time?
  • What is the main suppliers perception of the business?
  • Do they use several similar suppliers for the same produce?

Historical Information And Trends Should Be Thoroughly Analysed

  • Trends covering sales growth, profit margins and overhead spend should be ascertained and reasons for deviations sought.
  • In depth analysis of working capital history and future requirements (debtors, creditors and stocks ) should be carried out and potential improvements identified.
  • Are the debtors periods and the bad debt provisions realistic?
  • A comparison of the businesses projections in terms of cash flow and profitability should be compared with historical evidence and any forecasts that have been independently produced.
  • Do the sales forecasts look achievable particularly in relation to the current order book and do they reflect the outlook for the industry and the economy as a whole

The business projections should be revised if they differ from any of theses indicators.

Check On The Major Balance Sheet Items

  • Has the company had an audit within the last 6 months?
  • What are the stock levels and can the levels of slow moving and obsolete stock be verified.
  • Have stock levels increased without a requisite increase in turnover. Rising stock levels could show a potential decline in sales.
  • Are the fixed assets within the company in good condition and in working order particularly machinery in a manufacturing company or does it look as though as though maintenance has been reduced to a minimum in order to make the business more profitable?

Consider an employee audit (If you are allowed access to the business)

  • Identify the key employees and if possible ‘interview’ them to enable you to plan what structure you want to run the business in the future.%