How To Buy a Business – An Introduction
If you want to buy a business, planning ahead can save you significant time and expense. It can also help you avoid unnecessary hiccups that could delay getting to a closing. Learning how to buy a business is critical. Listed below are some issues that may complicate a transaction if not planned for in advance. Questions or comments?
The list is by no means exhaustive, but should give you a sense of some of the important issues impacting how to buy a business. If you are a seller, you should check out Selling a Business.
Seek Out a Business Lawyer.
When you want to buy a business, you should sit down with your attorney to discuss your plans and objectives. Getting legal advice in advance will help you streamline the process and save you time and expense. Business law attorneys who have experience in buying and selling businesses will often spot issues before you start the process to buy a business.
A business lawyer can also work with you, your accountant, and your financial and insurance advisors to help you select the most advantageous structure for your transaction, and explain the ins and outs of how to buy a business. Where appropriate, a business lawyer can also prepare a confidentiality agreement for you to use prior to engaging in discussions with a potential seller. This is especially important where the buyer has confidential or sensitive information that it might need to disclose to the potential seller as part of the deal discussions.
In some cases, a buyer will start discussing a deal with a potential seller prior to discussing the deal with their own advisors. Some buyers will even execute a letter of intent or memorandum of understanding without first consulting a business lawyer. They often believe (sometimes incorrectly) that the document will not be binding. This can often lead to poor results as if you do not know how to buy a business before you start, your chances of getting a poor deal or a deal falling through increase.
So, if you want to buy a business, consult with a business lawyer first. The structures used to buy a business can take many forms, each of which brings its own set of issues. A structure proposed by a seller and agreed to by a buyer “in principle” during early discussions might be the wrong structure for legal, tax or other reasons.
Preliminary Identification of Potential Issues When You Want To Buy a Business
A business lawyer can help identify potentially problematic issues before a buyer begins a formal due diligence process. In some cases, a little digging before the process starts can help pinpoint some key issues that will have to discussed by the parties and addressed in a transaction. These could involve any loans or credit lines the seller has in place, its lease with its landlord and agreements with its key employees and suppliers. In many cases, third party consents may be needed to close the transaction as well as approval by the equity-holders of the seller.
There may also be a regulatory framework governing the business itself which requires the buyer and/or the seller to not only maintain certain licenses, permits or approvals to conduct the business, but to seek approval of a governmental authority (or provide a notification) prior to or contemporaneously with the closing of the business sale.
If a buyer is new to the business being acquired, it should look at the transaction as if it were starting a new business and prepare to diligence the business and its regulatory framework accordingly while working with its advisors to develop an appropriate structure to buy the business.
Due Diligence Process; Exclusive Dealing; Letter of Intent
As part of any purchase of a business, a buyer will want to conduct due diligence on the seller and, in many cases, the seller’s principals. This process is done in tandem with the buyer’s team, its business lawyer and tax, insurance and other advisors. Due diligence can include reviewing the seller’s books and records, tax returns, financial statements, contracts with customers, vendors and employees, any outstanding claims or litigation, insurance, benefit plans, tangible and intangible assets and real property and a seller’s licenses, approvals, permits and other authorizations needed to conduct its business. These are all parts of the steps involved when you buy a business.
Depending on the transaction and the level of due diligence that the buyer wants to conduct, the process can take time. In some transactions, certain due diligence is left open and the buyer will conduct it only once a purchase agreement has been executed. A seller may also insist on having a purchase agreement in place prior to disclosing certain of its sensitive information.
In appropriate cases, a buyer may request that a seller provide it with an exclusive dealing period so that the buyer knows that the seller will not be negotiating with third parties while the potential buyer is expending time and expense conducting due diligence. This can be addressed in a written agreement (or amendment to an existing confidentiality agreement), or as part of a letter of intent if the discussions of the parties have reached that stage.
In some deals, the parties skip a letter of intent and work through the due diligence process while also negotiating a purchase agreement. Depending on the deal and the parties involved, this may expedite the transaction by avoiding the expense of negotiating the letter of intent (which can take time) as well as the purchase agreement. However, a letter of intent or similar document may be appropriate for a deal to memorialize certain elements the parties believe to be key terms of the transaction, subject to continued due diligence.
If used, a letter of intent should be reviewed by all of a buyer’s advisors and should make clear what parts of it are intended to be binding upon the parties and what areas are intended to be non-binding.
Employee Issues When You Buy a Business.
Buyers often seek comfort that key employees (and sometimes owners) will remain with the business after a sale to ensure a successful transition. This must be planned in advance and addressed early in the discussions.
Often, a process is established for discussions with seller employees that occurs once a purchase agreement is signed. A purchase agreement often contains a condition to closing (i.e., a requirement that must be fulfilled or waived) that a buyer has reached terms with specified employees as to their continued employment for a fixed period of time. Some employees and the owners of the seller may be offered limited duration consulting agreements.
It is in the interest of both parties for employee issues to be handled through an agreed-upon process, as employees can understandably become concerned if they become aware that a transaction may occur that impacts their livelihood and changes their status quo.
A buyer should have its insurance advisors review the seller’s insurance policies early on in the process. Insurance often forms an important funding source for issues that might be subject to claims between the parties.
In certain instances, “tail” policies can be purchased by a seller to cover the business for pre-transaction losses that fall under claims-made policies. Tail policies can be expensive, so reviewing insurance issues early in the process is important, as a buyer may want to require the seller to obtain the tail coverage to ensure that there is some back-up for certain provisions of the purchase agreement, such as the indemnification provisions. Insurance advisors are key as they can educate a buyer in answering their questions on how to buy a business from an insurance perspective.
Financing Issues When you Buy a Business.
A buyer who is offering an “all cash” deal or a deal with cash at closing and a promissory note or contractual earn-out provision will not have to deal with a third party lender as part of the transaction, other than any seller lenders who must be paid as a condition to closing the deal.
If a buyer is going to finance the deal through a lender, it should tie down any lender requirements as early as possible in the process in a commitment letter. This way the buyer will know what conditions it must satisfy to obtain the funds necessary to close with the seller, and it will know what the funds will cost so that it can do cash-flow projections that include debt service payments.
Lender requirements can be extensive and lenders often conduct independent due diligence, at the buyer’s expense, so a buyer should make sure it is clear what its responsibilities are. A buyer should involve a business lawyer in the commitment letter process, as it may be possible to negotiate and narrow certain provisions that could be obstacles to getting to a closing.
In addition, the buyer may want to discuss opening a credit line with the lender in addition to any acquisition financing so that it has a source of funds to help smooth out any periodic cash-flow issues. When working with a lender, a buyer should recognize that it is working on two transactions simultaneously and that the financing transaction is needed to close the business transaction. Sellers will want assurances that the buyer is “on the ball” with its lender and fulfilling its requirements in a timely manner. When learning how to buy a business, understanding how financing and other hurdles affect timing, risk and the deal process.
What Agreement is Used To Buy a Business?
The type of agreement used when buying a business depends on the structure of the transaction. Many transactions are structured as an asset purchase, and the buyer’s business lawyer will prepare a draft asset purchase agreement for review by seller’s counsel.
If the transaction is structured as a stock or equity purchase, the purchase agreement will be a stock purchase agreement or equity purchase agreement depending on the type of seller’s business entity (i.e., corporation, LLC, etc.). Each agreement is mapped to the structure of the deal, its economics, and ties in any ancillary or related agreements.
There are a number of other agreements and documents that may be needed for closing such as employment agreements, consulting agreements, lender and landlord consents, and a variety of certificates, resolutions and instruments of transfer. Buyer and its counsel will work together to with seller and its counsel to agree upon the forms of these documents and get them ready for closing.
As noted above, depending on the type of business involved, government approvals may need to be obtained in connection with a transaction. If a business is licensed, it may need to seek approval from the appropriate regulatory authority.
In some cases, individuals are licensed as well. Identifying and planning for these issues in advance can help avoid delays. This is even more important when the buyer entity or its principals must obtain their own licenses to operate the business.
Depending on the specific requirements, it may take time for these licenses to be issued, especially if the licensing authority must conduct its own investigations or background checks on the buyer and its principals. These licensing and regulatory issues continue on after you buy a business, so understanding them in advance is a key part of learning how to buy a business.
Using a Business Broker/Investment Banker When You Buy a Business
If a seller used a business broker or investment banker in connection with a potential sale, the purchase agreement will need to reflect seller’s obligation to pay the broker or banker in full. This is often handled directly by the buyer on behalf of the seller at closing by deducting the payment from the purchase price and reflecting this on the closing statement.
Brokers and bankers may be able to assert claims and liens if amounts due to them are not paid, so they will need to be addressed as part of the transaction. While one party may agree to indemnify the other for claims by brokers or bankers that they engaged in the purchase agreement, it is common to have obligations to brokers and bankers satisfied at closing and for receipts to be issued confirming that amounts due them have been paid in full.
The New Jersey Bulk Sale Act.
The sale of business assets outside the ordinary course is typically subject to New Jersey’s Bulk Sale Act (N.J.S. 54:50-38). This involves a process with the New Jersey Division of Taxation. However, a buyer should take note that New Jersey’s Bulk Sale Act can also apply to stock or equity transactions.
A buyer of a business should understand the requirements of New Jersey’s Bulk Sale Act and discuss it with its business lawyer so that it can be addressed as part of the transaction. Not complying with New Jersey’s Bulk Sale Act (if applicable) will result in the buyer becoming liable for all of the seller’s State tax liabilities.
If the procedures of the New Jersey Bulk Sale Act are not going to be followed, the buyer should ensure that it is comfortable that it has whatever contractual and other protection it desires to ensure that these tax liabilities are satisfied by or on behalf of the seller.
When you buy a business it takes time, money and hard work. By preparing in advance and utilizing a New Jersey business lawyer, a buyer can set the transaction and business up for success and reap the rewards in the future. Learning how to buy a business by engaging a business attorney early in the process is often critical to closing a deal and the long-term success of the business.
Copyright 2018, 2020, Geoffrey G. Gussis, Esq.. All Rights Reserved..
Shared by Geoffrey G. Gussis, Esq., a business lawyer and technology lawyer licensed in New Jersey and New York. Learn more about me, the legal services I provide, and articles I have written. Contact: firstname.lastname@example.org or (732) 898-0549 or (646) 389-2946 for a free consultation.
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