Buying A Business: Offer Phase

 

After you have completed your preliminary investigation of a business to buy and decided you would like to purchase the business, you will need to develop and submit an offer to purchase the business.  Keep in mind that your evaluation of the subject business is nowhere near complete but review of highly confidential information such as customer lists will generally not be made available to a buyer until a letter of intent or purchase offer has been accepted by the seller.  The following is a list and discussion of key deal points and considerations when developing an offer.

 

1.      Asset vs Stock Purchase.  Before structuring an offer, it is necessary to determine if the seller’s price is based on an asset purchase or stock purchase.  There are significant differences between an asset and stock purchase in terms of what assets and liabilities are being acquired, tax implications and assumed liabilities.  For small and medium size businesses, the vast majority of acquisitions are asset purchases.  The predominance of asset purchases is probably because when an asset purchase is properly structured, the seller should not assume any unknown liabilities resulting from past actions of the seller. 

 

The primary financial difference between asset and stock purchase is that in an asset sale, the buyer is buying only assets and not the liabilities unless specifically negotiated otherwise.  Also, in an asset purchase, cash and in some cases, accounts receivables are typically excluded from the purchase price.  Therefore, it is very important to verify if the sale price includes or excludes accounts receivables because if they are excluded, a buyer will need to determine the amount of working capital necessary to operate the business and add that amount to the buyer’s total acquisition cost.  In either case, the offer should clearly state exactly what assets and/or liabilities are included in the purchase and which are excluded.

 

2.      Price vs Terms.  All too often buyers rely strictly on discounting price as a means to mitigate their risk in the purchase of a business.  Many of the most successful purchases are achieved when the buyer negotiates on the terms on the deal more than the price.  Sometimes it is necessary to discount the price if it hasn’t been priced based on a fair market value but it is usually more effective to develop financing terms that make a portion of the acquisition price subject to incentive based criteria that create a win-win for buyer and seller.  Typical options include seller financing in the form of a conventional note or alternatively an earn-out note.  An earn-out note is an effective means to share both risk/benefit with the seller and is an effective means for a buyer to reduce risk of overpaying.  An earn-out is a form of a seller note that is usually based on the seller receiving a percentage of future sales, future gross income or future net income.  By being creative, there really isn’t any risk associated with a business purchase that can’t be largely mitigated through terms developed to equitably allocate risk between the buyer and seller.

 

3.      Value of Equipment & Inventory Included in Purchase Price.  Prior to making an offer, the value of equipment and inventory included in the asking price should be estimated by the seller.  Any assets not included or liabilities to be assumed in the purchase should be carefully discussed prior to making an offer.  The final purchase offer should include a detailed schedule of all the fixed assets, inventory, work-in-process and finished goods to be transferred to the buyer.

 

4.      New vs Assumed Lease.  The offer should address whether the business property will be purchased or if the lease for the building premises will be assumed by the buyer or a new lease established.

 

5.      Contingencies for Financing.  If the purchase of the business is contingent on obtaining financing from SBA or some other source, the offer should clearly identify that the purchase is subject to the buyer securing and obtaining financing and funding.  The contingency should also specify the timeframe necessary to obtain finance approval and funding.

 

6.      Exclusivity Period.  The offer should include a time period during which the seller will not entertain other offers and deal exclusively with the buyer until the acquisition is completed or terminated.

 

7.      Seller Employment/Consulting Agreement.  Both parties should discuss and, if applicable, include a separate employment/consulting agreement for the seller to remain with the business for a specified period of time to transition the business to the new owner.

 

8.      Non-Compete Agreement.  The purchase agreement should identify the basic terms of the non-compete agreement such as duration and future limitations.  A separate non-compete agreement should be executed.

 

There are many other detailed legal considerations that are case specific and will need to go into a purchase agreement.  You will want to consult your business attorney when preparing and negotiating a formal business purchase agreement.

 

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