Buying a Business, Part One: Before Closing

September 07, 2017

buying_a_business_part_one.jpg

Purchasing a business is a complex process and every transaction is different.  The Buyer should thoroughly review the business, anticipate potential post-closing problems and include provisions in the closing documents which will resolve these problems if they arise.

This is Part 1 of a 2-part series on what to expect when buying a business.  Part 1 focuses on the activities prior to the sale and Part 2 focuses on closing the transaction.

Letter of Intent (LOI).

 In most cases, the first step is for the Buyer to submit a Letter of Intent to the Seller.  While an LOI is not a binding contract to purchase the business, it describes the basic terms of the transaction, sets a timeline and identifies any conditions which must be met prior to consummating the transaction.  The LOI also includes provisions which protect both parties, such as an exclusivity clause prohibiting the Seller from selling the business to a third party while the Buyer is evaluating the business and a confidentiality clause protecting the business’s confidential information.  

Due Diligence.   

The due diligence process allows the Buyer to thoroughly review the company, evaluate any problems and work out solutions before making a significant investment in the business. The Buyer will almost always find some information that he or she was not expecting.  These issues may influence how much the Buyer is willing to pay for the business or the Buyer may need to include specific terms in the transaction documents to address these concerns.

Keep in mind that every business is different.  While it is impossible to identify every item a Buyer should look at in a particular transaction, here are 3 areas that are commonly reviewed: 

  1. Financial Review. The purpose of the financial review is to ensure that the Buyer has a full understanding of the business’s financial position.  Often this review is handled by an accountant.  Generally, the Buyer will review business’s tax returns from previous years, accounts receivable and payable, the company’s payroll, bank account transactions, and any outstanding loans.  Some examples of issues a Buyer would want to uncover include accounts on the books that don’t really exist, missing money, improper tax payments, or a due in full clause upon a change in ownership.
  2. Contract Review. The purpose of the contract review is to evaluate the business’s ongoing and future obligations and benefits and to identify any upcoming obligations that might affect the Buyer’s valuation of the business.  The Buyer will want to review the pertinent terms of supplier contracts, customer contracts, service contracts, leases, etc.  Examples of issues a Buyer would want to know include whether the landlord will consent to a lease assignment, when contracts with current customers expire, and any obligations that aren’t apparent in the company’s operations.
  3. Litigation Review. The litigation review is an opportunity to evaluate potential legal liabilities of the company, including ongoing litigation, potential litigation and regulatory issues.  The Buyer will evaluate the impact of current or potential litigation when determining a proper valuation for the business.  Additionally, the Buyer wants to assess potential exposure to any regulatory investigations or law suits based upon prior activities of the current owner.  The Buyer might want to include terms in the transaction such as guarantees, warranties, and/or an indemnity clause to address these issues.

Asset Purchase or Stock Purchase.

 There are two basic ways to structure the purchase of a company, either purchasing the assets of the business (an “Asset Purchase”) or purchasing the ownership interests of the company (a “Stock Purchase”).  

In most cases, the Buyer will be better off structuring the transaction as an Asset Purchase. The Buyer can pick the assets he or she wants to purchase, exclude existing liabilities and may be able to deduct or depreciate the purchase price paid for certain items such as furniture, fixtures and equipment

There are times, however, when it makes sense to structure the transaction as a Stock Purchase.  For example, the company has existing contracts, licenses or permits that are not transferrable and the cost for the Buyer to enter into new contracts, licenses or permits is too expensive or difficult.  

Legal Tips for Business in Texas

 

Topics: Legal

Kathy Tremmel

Tremmel Law

Kathy Tremmel has significant experience both as a business attorney and corporate executive. Her career spans both legal practice and business management and she opened her own solo law practice in January 2010. In additional to running her own practice, she also is of Counsel with Selman, Munser & Lerner, which is a business transaction law firm in Austin, Texas. Ms. Tremmel has more than 10 years’ experience as a business attorney, providing transactional legal services to a diverse client base, from start-up ventures to well established companies. She helps companies with all their contracts, including customer agreements, non-compete agreements, employment agreements, buy-sell agreements, loans, and leases, helps people set up new businesses, and represents buyers and sellers of businesses. In addition, Ms. Tremmel has 10 years of management experience working with start-up companies. As VP of Operations at Tusker Group, an international litigation support company, Ms. Tremmel led international teams, managed production and quality issues, handled price negotiations, worked closely with clients to determine the scope of their projects, provided project management services, and developed, implemented and documented best practices for processing and training. Ms. Tremmel earned a Doctor of Jurisprudence from the University of Colorado School of Law and a Bachelor of Arts from Dartmouth College. She is a Texas licensed attorney and a certified Project Management Professional.
Read more articles from Kathy Tremmel

Guide to Business Borrowing

Learn what banks are looking for when they prepare to make loans. Our guide covers what business owners need to know when they prepare to borrow.

BBoT-COVER-GeneralBorrowing

Download eBook