Buying a Small Business: 12 Key Factors and Due Diligence

Acquiring an existing business presents a compelling opportunity for entrepreneurs, offering established operations, a customer base, and immediate cash flow. But the decision to buy a small business requires careful consideration of various factors. This article delves into 12 key aspects, placing a strong emphasis on due diligence, to guide potential buyers through the process.

What to Do Before Buying a Business

Before embarking on the journey of buying a business, it’s crucial to lay a solid foundation.

• Explore Multiple Business Opportunities: Begin by exploring various businesses for sale. Websites like BizBuySell and BizQuest provide a platform for connecting with sellers. Consider engaging a business broker to expand your network and gain access to exclusive opportunities.
• Thorough Due Diligence: Due diligence is paramount in any business acquisition. It involves a comprehensive investigation to evaluate the business's financial health, operations, and legal standing.

Due Diligence: Uncovering the Business's True Value

Due diligence is an essential component of any business acquisition. It’s a process of uncovering the business’s true value, identifying potential risks, and ensuring a sound investment decision.

• Financial Statements and Tax Returns: Analyze the company's financial history through past financial statements and tax returns, particularly monthly data to detect trends in sales and profitability.
• Assets and Liabilities: Review the assets included in the acquisition, such as inventory, equipment, and intellectual property. Also, assess the company's debts and other liabilities.
• Contracts and Liabilities: Scrutinize contracts and liabilities that you intend to assume. Determine their terms and potential risks.
• Lien Search: Conduct a lien search to ensure the company has no outstanding claims or encumbrances.
• Intellectual Property Review: Evaluate the company's intellectual property holdings, such as patents, copyrights, and trademarks, to assess their value and potential risks.
• Customer Feedback: Speak to key customers to gauge their satisfaction and likelihood of continued patronage under your ownership.
• Reputation Research: Conduct a Google or Yelp search for customer reviews to understand the company's reputation in the market.
• Employee Interviews: Interview key employees to evaluate their competency and willingness to stay on after the acquisition. This helps ensure a smooth transition and continuity of operations.
• Lease Review: Examine the lease terms for the company’s premises. Ensure the lease is transferable, and there are no burdensome conditions. Consider negotiating the lease terms or obtaining an amendment.
• On-site Experience: If possible, work at the business for a period before committing to the purchase. This provides firsthand insight into operations and challenges.
• Physical Asset Inspection: Conduct a thorough inspection of inventory, equipment, and physical assets to confirm their condition and functionality.
• Customer Information: Review customer information to understand the customer base, demographics, and purchasing patterns.
• Legal Review: Engage a business attorney to review the company's legal documents, such as the Articles of Incorporation or LLC Agreement.

Legal and Financial Preparation

Beyond due diligence, there are crucial legal and financial steps to take before proceeding with the acquisition.

• Non-Disclosure Agreement (NDA): Most sellers require potential buyers to sign an NDA before providing confidential information. Review the NDA carefully with your business attorney to ensure the terms are reasonable.
• Business Attorney: Acquiring a business is a legally intensive process. Seek a reputable business attorney experienced in small business acquisitions to provide expert legal counsel.
• Buyer Entity: Set up an LLC or corporation as the buyer entity to shield your personal assets from liability.
• Type of Business and Acquisition: Decide on the ideal type of business to buy, such as a brick-and-mortar or online business, or a franchise. Determine your time commitment for running the business. It’s advantageous to buy a company in an industry you understand.

Negotiating the Acquisition Agreement

Once due diligence is completed, the focus shifts to negotiating the acquisition agreement.

• Letter of Intent (LOI): Before drafting a comprehensive purchase agreement, prepare and have the seller sign an LOI or term sheet outlining key terms of the deal. This establishes a common understanding and demonstrates your seriousness.
• Key LOI Terms: The LOI should include:
• Purchase price: Determine the method of payment, whether cash, installments, or seller financing. Consider adjustments based on factors like working capital or receivables.
• Deal structure: Decide whether the acquisition will be an asset or stock purchase.
• Exclusivity and No Shop Period: Ensure a period of exclusivity for due diligence, prohibiting the seller from engaging with other potential buyers.
• Closing conditions: Define the conditions that must be met before closing the transaction.
• Timeline: Establish a clear timeline for the acquisition process.
• Seller involvement: Specify the level of involvement or continued employment of the selling owner to ensure a smooth transition.
• Non-compete clause: Include a non-compete agreement preventing the seller from establishing a competing business.
• Confidentiality: Outline the seller's confidentiality obligations.
• Access to information: Secure access to employees, books, and records during the exclusivity period.
• Employee treatment: Determine the treatment of employees after the acquisition.
• Indemnification: Establish the seller's indemnification obligations for any undisclosed liabilities or breaches of representations.
• Representations and warranties: Include representations and warranties from the seller regarding the business's condition and performance.
• Dispute resolution: Specify the mechanism for handling disputes, ideally through binding arbitration.
• Assess Business Risks: Evaluate potential risks, such as dependence on key employees, significant liabilities, or reliance on specific customers or suppliers. Assess the transferability of key contracts.
• Financial Projections: Prepare monthly financial projections for the year following the acquisition to estimate working capital needs and budget accordingly. Include reserves for potential problems.
• Acquisition Agreement: Work with your business attorney to draft a comprehensive and pro-buyer acquisition agreement that protects your interests. This agreement should address representations, warranties, and indemnification.
• Permits and Licenses: Verify that the business has the necessary permits and licenses, especially for regulated industries. Determine whether amendments or new permits are required after the acquisition. Ensure compliance with zoning and environmental laws.

Additional Resources

For in-depth discussions and additional insights on key aspects of buying a business, refer to the following resources:

• A Comprehensive Guide to Due Diligence Issues in Mergers and Acquisitions
• Due Diligence Checklist—What to Verify Before Buying a Business
• Finding the Right Business Lawyer
• How to Negotiate a Business Acquisition Letter of Intent
• 21 Key Issues in Negotiating Merger and Acquisition Agreements for Technology Companies
• 25 Key Lessons Learned From Merger and Acquisition Transactions
• What You Need to Know About Mergers and Acquisitions: 12 Key Considerations When Selling Your Company

By meticulously considering these 12 key factors and conducting thorough due diligence, you can significantly increase your chances of successfully acquiring a small business.