Guide To Buying a Business

Crafting an Offer

When you make an offer to buy a business you need to decide how to structure the offer. Often it makes sense to agree in principal on the terms of the deal before creating a formal letter of intent. However, I have seen a number of successful deals where the initial offer from the buyer came in the form of a letter of intent. If you do not have an attorney, you can buy letters of intent forms for a straightforward deal from a variety of vendors. If the deal is complex, you are better off hiring a lawyer with experience in business acquisitions to assist you in drafting the letter of intent.

There are a number of items that need to go into an offer. They are: Price - The price of the business is obviously one of the most important aspects of the deal. If you and the owner are too far apart on price, it is unlikely that you will come to any agreement. Many business owners have no idea what a realistic value is for their business. Assuming you have valued the business properly, using the methods described above and the owner begins to negotiate at a price more than 25% above the value that you've calculated you should spend no more than half an hour seeing if you can get the owner to come into a reasonable range. Assuming that you don't see major movement in price in the first half hour, politely end the negotiations and walk away.

When you end negotiations with an owner that has unrealistic pricing expectations, it is important to shake the owner's hand, let him know that you don't dislike him or the business, but that the price is out of your range. Thank the owner for the time he spent with you. Often a buyer will come back to you, with a more reasonable approach after some period of time. If the business was really attractive, you may want to call or e-mail the owner in a couple of months and ask if the situation has changed. This gives an owner a chance to resume negotiations if he was too embarrassed to call you.

Terms

The terms of a deal can be as important as the price.

Seller Provided Notes

Will the owner be taking back paper to finance part of the deal? What interest rate will you pay on the note? What collateral is required to secure the note? From your perspective as a buyer, the business itself would be a good thing to pledge as security. Should it turn out that the business had really severe problems that you somehow missed, you can give it back and lose only the down payment. A seller, on the other hand, will see things differently; he's handing you a money making business and if you mess it up he doesn't want a money losing business back, so he'll want personal guarantees from you (and your spouse if you are married) and security (such as a second mortgage on your house, securities that you own placed in escrow, or a lien against other property that you own).

Earn Out Provisions

You may be able to have the current owner accept some of the purchase price in the form of an earn out provision. In this scenario you offer a percentage of sales or profits for some period of time after the sale.

Claw-backs

These are rare, but can be useful in certain situations. Usually I've seen them used to deal with situations in which the purchase of a particular business has an extraordinary risk associated with it. Here are a couple of examples:

A purchaser is buying a business where 80% of the sales are from three large customers. The seller assures the buyer that the business has good solid relationships with these customers and that they are unlikely to leave, but the buyer is wary. Fourty percent of the purchase price is placed in an escrow account with a lawyer and paid out to the seller in 24 equal monthly payments. In the event that a major customer fires the company in the first two years the money that remains in the escrow account is paid out to the buyer.

A seller maintains that 35% of his business is done in cash and he has not reported that income to the IRS. The buyer insists on having the bulk of the purchase price remain in escrow for a year and the buyer and seller agree on a formula to distribute the escrow fund if sales are less than 95% of the amount claimed by the seller during that year.

Non-compete Agreements

You do not want to buy a business only to find that the former owner opens a competing establishment which limits the prospects of the business that you just acquired. To make sure that this does not happen, you include a covenant not to compete in the purchase and sale agreement.

A covenant not to compete can not be so broad as to make it impossible (or nearly impossible) for the former owner to make a living or a court will hold it to be unenforceable. So, you want to craft it in a way that makes it difficult for the former owner to compete without making the former owner unemployable. How you craft it depends on the nature of the business that you are buying. For example, if you were purchasing a dry cleaning business where most of the customers were local you might design a non-compete agreement that prevented the owner from working for a retail business within 250 miles of any location of the dry cleaning business that you are buying. By contrast, if you are buying a software company that makes software for colleges and universities worldwide the covenant might restrict the former owner's employment by any company that derives a substantial portion of it's revenues from providing software to educational institutions.

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