How to Buy a Business

Thinking about expanding your portfolio? We look at how to investigate a targeted business and negotiate a good deal for purchasing it…

How to Buy a Business

If your own business is well-established and of a certain size, you may consider buying another existing one. A good purchase can see you reaping copious financial rewards, but a bad one could utterly sink you. It’s therefore vital that you investigate your potential target fully, and negotiate a deal tailored to its current positions/situation as it relates to your own.

This guide will help you approach a target, investigate it, make and follow up on an offer, negotiate the final terms and ensure a smooth transition.

How do I approach negotiations when buying a business?

One of the first steps will involve approaching the vendor. Most businesses will have appointed professional advisers to handle the sale. Contact these first, rather than the current management.

You must then register your interest and credibility. You will usually need to outline your objectives for buying and any future plans you have for the business at hand. Vendors will be reluctant to sell to you unless you can convince them of your integrity. The next step will be to try and establish the vendor’s objectives – find out the primary motive for selling the business, and why it is being sold. Are they under pressure to sell?

Finally establish important aspects of the deal. Find out how involved the existing management will be once the business has been sold, and determine what is currently causing problems and must be changed.

How do I work out whether a business is safe or suitable to buy?

Vendors of ailing businesses will try to bury and gloss over areas of weak performance. You should exercise preliminary due diligence to establish whether the business is suitable to buy in its current state, and represents a good deal to you.

Make sure to meet the vendor and have a face-to-face meeting can allow you to ask probing questions and stress details you feel are being glossed over. Also visit the business, looking at the premises and the employees. Try to get a sense of how it operates and how those working their feel about it.

Like when you start a new firm, research the market and competition. Consult experts establish what demand there is for what the business offers, how prices are changing, and how competitors are performing.

Establish your own level of risk. Businesses carry a high level or risk if they have assets worth less than your offer price, are currently unprofitable, have a history of losses (funding these losses will become your responsibility once the purchase has been made), and are over-reliant on one or two customers, suppliers, employees or contracts.

Before you make an offer, carefully consider your own objectives and whether buying the particular business you are looking at will help fulfil them. Also make profit projections and remember that you can’t rely on the vendor’s figures. Compare theirs to your own and determine what the sources of divergence are.

Finally establish potential areas for cost-cutting and improvement; ask yourself if you reduce margins in any areas and are the businesses current customers potential customers for your other operations.

Should I bring in professional advisers?

Bringing professional advisers in is practically a must – buying a business is a huge financial commitment and one that you should not undertake unless you are fully confident that you are taking ownership of a profitable outfit.

It is likely that you will need more than one type of expert to assess the businesses performance in various areas. Find professionals with specialised experience of accounting, tax, market research, legal due diligence, employee terms and final deal negotiations.

Remember that you will then need to organise your advisers and explain your objectives to them. For instance, give them remits and explain what you want them to do. Also give them a timetable and make sure all your advisers know when they need to complete their work. Also co-ordinate them and use planning documents to make sure everyone is on the same page.

Finally negotiate a fee. Advisers usually charge by the hour, by job, or on a contingency basis (the deal they negotiate will affect the payment they receive). Negotiate with them to come to a mutually satisfactory pay level.

How do I make an offer on a business and what happens after?

The first thing to do will be to determine the initial and maximum offer. Do so by taking your initial valuation into account alongside the competition and the objectives of the vendor.

After you have figured this out, it will be time to submit the offer. Highlight the positive points and outline the financial specifics (what you are paying/preparing to pay and what you are receiving in return). Send as a formal letter titled ‘SUBJECT TO CONTRACT’ (it prevents you from committing to the offer).

Make sure to follow it up. Listen to feedback, clear up issues, and revise your terms if necessary.

After you have submitted you offer

You should set out a ‘Heads of Terms’ or a ’Heads of Agreement’. This will establish the main terms of the sale and should specify what you are buying – i.e. the business or just the assets (this will allow you to sidestep any legal liabilities the business comes with, such as litigations over outstanding contracts).

Make sure to set an exclusivity period. This will prevent the vendors talking to any other potential buyers for a set period. You might need to agree to reimburse the vendor if you pull out during this stage.

Also establish the payment structure. Payments can be complex – the amount might depend on projected profit figures on the following set of audited accounts, and portions of it can be deferred, or involve your own business shares. And outline any preconditions – such as ‘you will not buy unless X result is met’. Only if these are met are you committed to the sale.

You should also request warranties and indemnities. A warranty is a written statement confirming that the business information provided by the vendor (i.e. the accounts, orderbook, list of debtors and creditors etc) is correct. Whereas an indemnity commits the vendor to reimbursing you in a certain situation, for example if a tax indemnity makes you exempt from payment of undisclosed tax liabilities on transactions made prior to the sale of the business.

Once this has been signed, carry out secondary due diligence to investigate the business in detail and establish its suitability. Make sure to interview customers, employees and suppliers asking them their opinion on how the business is run, the services, and products and why they use/have stayed with the business.

Additionally make sure to analyse past performance: investigate profit margins, overheads, levels of capital and sales growth prior to the sale. Follow up on any inconsistencies – many businesses instigate changes to accounting policy prior to a sale to increase the book value of stock.

Alongside interviewing employees, you should consider conducting an employee audit. If you have access to the business, investigate the key employees, general skill levels, employee turnover and pay. Compare theses to averages within the industry.

Also follow up on balance sheet items. Find out when the last audit was (if it was over six months ago, do a new one), what the stock levels are (large or rising ones are a bad sign), and what outstanding debts they have.

Finally carry out legal due diligence and make sure you own all the key assets, examine contractual obligations (employee contracts, pensions, and contracts with suppliers/customers). Find out if there are any past, present, or pending law suits associated with the business.

How do I negotiate the final terms?

Use what you have discovered during due diligence checks to strengthen your negotiating positions – if you have uncovered areas of weakness and poor performance, use these to request better terms or a lower offer.

Make sure to request reasonable concessions and explain your reasons for requesting them. Be firm as vendors may become awkward and difficult at this stage, but are unlikely to pull out this close to a deal.

How to ensure a smooth transition

Once you have bought the business, the next step will be to make sure the acquisition goes as successful as possible. Announce the change of ownership and work with the vendor to ensure the news is communicated positively. Take time to meet with employees, individually if possible so you can ensure they understand what the change will entail and they remain motivated.  Also write to major customers and outline the advantages to them.

You will then need to start putting your action plan into place. You will have developed this during and based on the buying process as a whole as it should be completed and outlined before the final offer is made. Your plan should outline the strategy for improving profitability, cashflow and customer relationships.  It’s also vital that your plan involves gaining the trust of the employees and establishing confidence in the future – include a timetable and make sure the employees understand your determination to carry out the objectives.

Buying an established business can be a great way to grow your network or begin your entrepreneurial journey as the base is already there so you just need to add to and improve it. While taking over another entrepreneur’s business is never easy, the road to business does not tend to be, with careful planning and a focus on keeping the employees and customers happy, it can be a rewarding one.

For more help, check out our article on the 11 rules for buying a business here.

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