Recently, I ventured to buy an existing business. Although the deal fell through, I compiled in detail the various steps I took and should be taken (up to the point the deal fell through). This is based on my experience and comments and additional pointers are always welcome.


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POST 1: BUILDING A LIST AND CONTACTING SELLERS

The first step in the pursuit of a business acquisition is to identify what kind of business you really want to acquire and manage. Rather than thinking along the lines of your education or current and past professions, think along the lines of what your risk tolerance is, how big of a business you can afford and what your interests and passions are. This would allow you to narrow down the field to look for.

Once you identify the industry or the field, say, hospitality, retail or education, visit sites such as http://www.businessesforsale.com" rel="nofollow">LINK or http://www.businesssellcanada.com" rel="nofollow">LINK to look for businesses posted for sale. The above two websites will allow you to contact the seller directly. You must also bear in mind that few of these postings could be a scam, few might not even respond thinking your query is a scam, and few might simply not work out. For all these and many more reasons, you should typically build up a list of 8 to 10 advertised businesses that you should contact.

Once you have a decent list of businesses that are for sale, send a brief but genuine sounding query to the seller expressing your interest in the business and asking for more information. To make your message credible to the seller, you should include your background information as an indication of your interest in this particular business, your email address and your phone number where the seller can contact you.

Typically, an equally motivated and interested seller would respond anywhere from few hours to a day or two at the most. If you do not get this level of response, you should follow up with another message indicating your previous message and your continued interest for more information. Any seller that is keenly interested but had ignored your first message as a potential scam will definitely respond to you this time. You should simply ignore any others that did not respond after your second query.

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Dimple2001

POST 2: FIRST COMMUNICATION BETWEEN YOU AND THE SELLER

When the seller responds, don’t expect a wide array of information. Bear in mind, the seller is also testing the waters to check out your interest. Consequently, the most you are likely to receive is the nature of the business, its actual location, name of the business, an email address and an invitation to contact the seller by phone.

At this point, forget emails and call the seller over the phone. If the seller did not provide a number, ask for it over email and call. If the seller is unable to speak immediately, setup a mutually convenient time for a 30 minute phone conversation. The phone conversation will allow you to introduce yourself, explain your background, explain your interest, allow the seller to explain his/her background and so on. Some of the questions you should ask at this time are, the reason for selling the business, what the seller intends to do after the sale, details of the nature of business, how long the business has been in existence, number of employees (to understand overhead), any franchise information (to understand royalties and support offered), location leased or owned, details about the city or town where the business is located (if you are not familiar), demographics of the businesses’ clients, mode of marketing, and so on.

If the business being sold is a franchise, this would also be the time to ask the seller if there are any clauses in the franchise agreement or disclosure that stipulates the maximum financing debt that the buyer can have as soon as the purchase is completed. This is an important question and will tend to be hidden until much later, but will be a deal breaker if this condition is not met by you. In other words, the debt limit will indicate how much cash you need to have in capital while you can finance the remaining.

Bear in mind, during this first phone call, the seller will not reveal any proprietary information. Therefore, you may not get information such as employees’ salaries or net profit or what the rental agreement is with the building landlord.

If, after the phone call, you feel this business is something to pursue further, request the seller for a NDA. The NDA is the Non-Disclosure Agreement. In most cases, the seller will already have one drafted and ready to provide you one for your signature if you wish to proceed. The NDA dictates that all parties maintain confidentiality about all proprietary information that would be shared as part of the next couple of meetings. Also, the NDA is the first legal agreement between you and the seller prior to you providing a conditional offer to buy the business.

Most sellers would email you the NDA which you can sign, scan and email back. However, all sellers would require you to provide them the hard copy original of the signed NDA. The hard copy can be given to the seller during the on-site visit which is described later. Always read all the legal agreements, including the NDA, from top to bottom and don’t simply rely on lawyers. Once the NDA is signed, you should independently dig up any information that you can find about the business. Usually, a website will provide the information; however, the website will obviously not reveal any negatives of this business. Also, don’t forget to get the seller sign the NDA and get yourself a copy with all signatures.

You should repeat the above steps with all the businesses that have contacted you and you wish to pursue. By this time, usually one to two weeks would have gone by. If you are satisfied with the conversation(s) with the seller(s) and still interested in pursuing the businesses, this would be the time to schedule an on-site visits to these businesses. You should by this time be able to short-list the number of businesses to, say, a manageable 3 or 4. This 3 or 4 are the ones you will be pursuing to the next step (on-site visit) and the rest will be discarded.

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Dimple2001

POST 3: PREPARING FOR ON-SITE VISIT

Your on-site visit should allow at least 4 hours at the site in order to obtain as much information you can without feeling rushed. Also, if the businesses to be visited are close to each other, you may be able to schedule two visits, although, it might make for a long day. Let the seller know that you intend to spend at least 4 hours and emphasize to the seller it is important that you do not feel rushed. After all, you are the one “interviewing” the candidate.

While you wait for the day to travel to the business site, which might be next day or a week from now, start thinking about the three “advisors” you would most likely require to advice and help guide you through the legal process of acquisition. The advisors would the Banker, Lawyer and the Accountant. Instead of simply browsing through the yellow pages, ask your network of people for referrals. For example, if you have a financial advisor, you could ask your FA for some recommendations from their client base or their business network. Look for a lawyer that specializes in business purchase and sale and try to avoid the “one-stop shop” lawyer who does everything. Pick an accountant that knows to handle corporate level finances.

Once you receive the names for each of the three advisors, call them, introduce yourself and mention you were referred to them by so and so. Describe the purpose of your call and let them know you are yet to complete an on-site visit. You could ask them if they have any suggestions for you during your on-site visit. In any case, this call to the three advisors is only meant to be an initial introduction, except for the banker. In the case of the banker, you might want to understand what it would entail to obtain the necessary financing. This information would be really helpful if, say, you have targeted a million dollar business while you might be able to get financing for only $200,000. In other words, the banker might be able to provide some sense of reality towards your acquisition pursuit. Ask for numbers such as potential monthly payments for different amounts of financing and for different terms and amortization. Ask what you would have to offer as collateral to obtain this financing. This preliminary information will be useful at a little later stage.

Going back to the on-site visit, ensure you dress professionally. Do not for a moment assume a nonchalant attitude just because you are the buyer. Any negative attitude or appearance will put off a serious seller. For example, for men, a dress shirt and pants with a jacket would be a good start. I myself do not prefer a tie as I prefer not to start looking like a used car salesman. Also, in my experience, nobody gives a hoot about what your race, origin, etc is, but almost always, all will care about your professional tone, appearance, attitude and conduct.
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Dimple2001

POST 4: ON-SITE VISIT

After you arrive on-site at the business location, ensure you and the seller have signed off the hard copy of the NDA and each retains a copy. Utilize the next few hours covering the following topics/questions. Take as detailed of notes as you can as you will be surprised how easy it is to forget or confuse one over the other. The list is not in any particular order as coverage of each item will be driven by the course of conversation:

1. Complete tour of the business site (facility tour).
2. Review and question the business website (intranet) to understand its purpose and functionality.
3. Process flow of how the business creates a client or a customer.
4. Who is the primary employee that creates the client?
5. Demographics of clients.
6. Geographic coverage from where the business gets clients.
7. How many clients are there right now? How many are projected to become clients? How many did they lose and why?
8. How did the seller arrive at the asking price?
9. What is included in the sale and what is not included in the sale? Breakdown of the asking price by what is included.
10. Number of employees, contractors and sub contractors.
11. Wages and benefits of the employees, contractors and sub-contractors.
12. Discuss most recent financial statements plus prior 2 or 3 statements. Either get a copy or write down the numbers.
13. At this time, the key details to note on the financial statements are the earned revenue, itemized breakdown of the operating expenses, operating profit, tax and net profit. Therefore, the income statement should be adequate for now although the financial statements would include the balance sheet and the cash flow statement. Also, bear in mind that the numbers you are looking for must be a documented historical figures (by means of a well accepted legal statement), and not projections, possibilities or would be/could be/should be scenarios.
14. How do they advertise and market their product or service?
15. Ask to see samples of their advertising literature, flyers, etc.
16. Does the business track which mode of advertising brought the customers?
17. Typical work schedule and business operations’ schedule.
18. What is the businesses structure? Sole Proprietorship, Corporation, Partnership, etc.
19. What kind of insurances does the business carry? Discuss both mandatory and optional insurance.
20. In general, discuss all the operating expense items at a high level to understand the reason behind the amount reported. For example, if repairs are listed at $30,000 on a $700,000 business, ask them what those repairs were and if they are recurring.
21. Are there any other businesses run by the same owner on this premises? If so, are any of the expenses being subsidized by either of the businesses? This is a red flag since the books of the company being sold can be made to look favorable by reporting it on the other business.
22. Details of bad debt, collections and any negatives.
23. Why is the owner selling and what will the owner be doing next?
24. How much training will the owner offer after the sale?
25. Any Government fee or bond that need to be maintained and how much would that be?
26. Is the seller looking for asset sale or share sale?

Here is a brief note on asset sale and share sale. Research the web to get detailed theory on the asset and share sale. However, in short, in an asset sale, the asset of the company moves under a new corporation (assuming a corporation structure) under you and the existing corporation is dissolved. In a share sale, the existing corporation is transferred to the new buyer (you).

While there are exceptions to every rule, in general, an asset sale will allow the buyer to liquidate all contracts and devise entirely new ones including employee contracts. So, for example, if your intent is not to keep the employees and hire your family, then asset sale would be a better approach. In the share sale, you’ll inherit all the existing contracts and liabilities although you could insert a clause stating otherwise.

For example, in a share sale, if you want the bank account, cash account, etc to transfer, you’d most likely have to inherit the liabilities as well or you will get those accounts after all the liabilities are paid off. A share sale is much simpler than an asset sale since all you are doing is transferring the existing business as is to your name.

Back to the on-site visit, due to logistics and scheduling, by the time you complete your on-site visit, usually, another 2 weeks would have gone by, marking almost one month since you initiated the first contact with the seller.

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Dimple2001

POST 5: DECIDING WHICH ONE TO PURSUE TO THE NEXT STEP

After completing the on-site visits to all the businesses, review all the information you have noted down. Specifically, make an excel spreadsheet and put down the revenue and expenses numbers in itemized detail. In addition to the numbers, include another column that shows the expense as a percentage of the revenue. These details will allow you to make an “apple to apple” comparison. You can this sheet as the “current state”. Then make another spreadsheet, call it the “future state” and see if you can identify means to improve revenue or decrease expenses in order to improve profitability. Don’t blindly project numbers; instead, use your on-site discussion as a basis.

For example, if the current owner has car lease included in the vehicle expense and you don’t have a lease to worry about, you could cut down potentially few thousands off that item, thereby identifying an opportunity to reduce cost. Another example might be a business owner who has hired her dearest friend as the “assistant director” to make copies and fax things for you. Unless you need such an assistant director, you can pretty much exclude that individual as an employee, thereby improving the bottom-line.

Take about a day or two to review your spreadsheet and other details and make a final decision as to which business you will be pursuing from this point forward. Once you make that decision, call and email the owners and notify them of your decision. At this point, the seller will expect you to make a conditional offer, formally known as the Letter of Intent (LOI).

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Dimple2001

POST 6: PREPARING THE LETTER OF INTENT (LOI)

There are two trains of thought on the LOI. Some feel that the LOI is a 1 to 2 page document that very briefly states what you are intending to offer as the purchase price and what you would be buying. Others feel that the LOI could be as detailed as 8 to 30 page document with every conceivable detail.

The difference is if the LOI is short, then your purchase agreement will have to be created in detail from scratch. If the LOI is detailed, then the purchase agreement will be for the most part a copy and paste from the LOI plus few other details. If the seller discloses most of what you are looking for, you may go for the short LOI, if not go for the long LOI so as to protect yourself from the unknown. Regardless, your lawyer will definitely make money off of you.

At this point, call your lawyer, discuss the outcome and the decision, fix up an appointment for some face time and go visit the lawyer. Before walking into the law firm, make sure you have organized all your notes, emails, etc into a three ring binder since most likely your lawyer would like to make a photocopy of the entire binder. During your visit at the lawyer’s office, you should discuss the business and ask and answer any questions in a candid manner so as to ensure all the information is accurate.

My lawyer charged me at $250 an hour. Depending on how busy the lawyer is, he/she would be able to send you the LOI in about a week. My lawyer recommended the LOI in the APA format (Asset Purchase Agreement) for an asset sale and structured a LOI in that manner. However, the seller insisted on a share sale since an asset sale would trigger capital gains for him and therefore the price would go up. I did not see any pressing disadvantages on the share sale and so I agreed. The lawyer then had to reformat the LOI to SPA (Share Purchase Agreement) and that took another 2 days. I will not discuss the contents of the SPA in details since any lawyer well versed in this would draft a good LOI from a well established legal template. However, as matter of diligence, read all the agreements and all the paperwork entirely before relying on lawyer/accountant or banker’s advice.

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Dimple2001

POST 7: NEGOTIATING AND SIGNING THE LOI

At this time, the LOI will be communicated back and forth via email. Therefore, you should email the LOI to the seller for the seller’s review. Usually, the seller would come back with questions, objections and request for revisions. This is where you negotiate with the seller on his comments using your lawyer as your advisor. Although you could have your lawyer do the discussions directly with the seller or seller’s lawyer, you need to be mindful of how much you want to spend on legal fee. Therefore, be prepared to handle all communications yourself and use the lawyer only to get legal drafts of the LOI.

In regards to the negotiation, let me give you an example. The seller in my case wanted $10k as good faith deposit with the LOI plus $50k when conditions were waived and the balance upon closing the deal. My lawyer refused outright stating $5k for good faith was enough and there would be no interim payment and the balance would be paid only upon closing the deal. The lawyer’s argument was based on the fact that no one will provide the financing for the $50k several days before the closing; therefore, it is an unnecessary burden. Of course, if you have cash on hand, you could agree if you wanted, but you need not.

It wouldn’t be unusual to run through 3 or 4 iterations before both you and seller would be able to agree upon the terms of the LOI. Now if you offered the short LOI, this process would go much faster since there are not too many points to argue over. But then, you’ll spend more time later on to argue and negotiate these points during the drafting of the purchase agreement. During the negotiation, you might find it easier if you could share your computer screen with the seller while reviewing the finer points of the LOI. You could use http://join.me website for this purpose and it is free.

The LOI will include conditions that need to be removed before you will be able to close the deal. Similar to buying a home, one of the conditions would be to obtain satisfactory financing among other things. But the most important aspect is the satisfactory completion of the due diligence by you. Due diligence is the process of digging up all the information about the business and reviewing them yourself and having it reviewed by your lawyer. Make sure you get at least 30 days for the due diligence. Some businesses might insist on 15 days and some may suggest 21 days, but do not compromise on anything fewer than 30 days. It is important you are completely satisfied by everything about the business and not feel pressured for later regrets.

Once both the seller and you have agreed on the terms, you should print out the hard copy of the LOI, initial all the pages with date, sign the agreement and ship it off with the good faith deposit. Make sure you make the good faith deposit payable to the seller’s lawyer who can hold it in a trust. Do not make the check payable to the seller or his corporation. This is just one more step to protect you.

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Dimple2001