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The Business Advisor PREPARATION FOR BUYING OR SELLING A BUSINESS by Mary Hanson

Planning and preparation are key to the successful purchase or sale of a business. Many buyers and sellers of businesses enter into discussions that in effect are negotiations, without adequately preparing for the discussion. In many cases, the interested buyer or seller has not even made a list of his or her objectives in the purchase or sale.

If any part of a deal is struck early on, it can be almost impossible to dislodge the specific agreements made at that time, even if they are completely unacceptable. The buyer or seller may find it necessary to accept a bad deal or walk away. It's such a sad situation when the only reason for the early commitment on certain points was a lack of preparation for the early discussions.

If you think you are interested in buying a business, or you think you would entertain an offer to sell your business, what should you do to prepare?

The most important steps are creating the big picture of your purchase or sale, checking your assumptions and calculations with your tax advisor, and preparing yourself for negotiation.

Here are some of the common important issues to consider. For your own purposes, you need to identify the items that are deal killers. If particular requirements must be met in order for you to even entertain the purchase or sale, those items should be brought up in your earliest discussions with the other party.

     * Return on investment. If you are buying a business, your key item should be the financial return on your investment. You should be only willing to pay a purchase price that is quite certain to give you the return you've determined you need to make it worthwhile. If you will be working full time for the business, you need to know that the business to be purchased will pay you adequate compensation for services and also give you a meaningful return on the money invested. You will want to negotiate as early a review of financial information as possible. You will need to know what the business status and financial prospects are in order to know what your purchase price would be and whether you are interested at all.

     * The big picture of structure. If you are selling a business that is incorporated, will you have to insist that the purchase be accomplished as the purchase of stock? For some business owners with corporations, the only way to sell the business without getting killed on taxes is by selling the corporate stock. If you are buying a business, buying a corporation is generally a very undesirable thing. The purchase of stock means you get the whole thing - assets and liabilities - and many liabilities do not show up anywhere. You pick up the liabilities related to the employee who has not yet even complained about a problem, and the auditor who has not yet even called!

      *  Due diligence. What level of review will you insist upon? Obviously, if you are buying a business as a purchase of corporate stock, due diligence is the name of the game. You must review not only the tangible assets and liabilities, but also review all contracts, debt obligations, intangible assets, and liabilities that might arise. This is quite a challenge. You must decide early on how you will proceed to investigate the business and what you will insist upon. There is no point in leaving this to the very end and then having to decide whether to walk away from months of negotiation. Worse yet, you don't want to purchase a business and find out you have purchased a huge problem.

If you are selling a business and expect to take a portion of the payment as a promissory note, will you insist upon doing a credit check? What information will you demand of the buyers to prove that they have the ability to make all the payments to you?

      * Payment terms. If you are selling a business, and you want to be certain to walk away with a significant amount of money, you need to identify this up front. Many small business purchasers cannot come up with much money as a down payment. What do you need to make the sale attractive to you? Know what your requirements are early on. Make sure it is realistic. Make sure you know the tax consequences.

Will you take a promissory note for part of the purchase price? What type of collateral will you insist upon? What if the buyer does not have real estate or other valuable assets to pledge as collateral? Is this a deal killer? Will your decision depend upon other qualities and qualifications of the buyer? Are you then prepared to confirm those qualities and qualifications?

Can you afford to take a ten year note rather than a two year note? How do you feel about the risk of non-payment? Can you afford to wait for your payments? What interest rate would you expect?

Payment terms - at least in general - must be discussed up front. Many interested buyers are simply unable to meet purchase price and payment term expectations of the seller. There simply is no point in negotiating over assets, contracts, liabilities, training, and other critical issues if the interested buyer cannot meet the minimum requirements on price and payment.

      * Asset review. If you are purchasing assets, will you want to inspect certain assets early on? Is there a key asset that you are interested in? If it is of key importance, insist upon an early review.

     * Contract review. Will you insist upon reviewing contracts early on? Do you want to take over key contracts? You'd better make sure they are assignable. Many contracts are not.

     * Noncompete agreement. Is a noncompete agreement a key item in your transaction? If you are purchasing a business that is closely associated with the current owner, won't you want a commitment of services for quite some time from the owner? And won't you want to be certain the owner will not work for any business that in any way could reduce the value of your purchase? Your noncompete agreement may need to be quite broad. If you are selling a business and know that you want to work in a related field, define this exception from the noncompete agreement early on. For example, if you are selling a manufacturing plant, but wish to continue to do manufacturing consulting, don't wait to find out that the typical broad noncompete provision in your sale agreement will prohibit that activity.

      * Warranties. If you are the buyer, you will want to require the seller to warrant that records are correct, that inventory is not obsolete, that there are no undisclosed liabilities, and that equipment is in working condition. Do any of these issues need to be addressed up front? If you are the seller, do you have any problem making these typical warranties? If you are determined to retire with peace of mind, refusing to warrant anything, you need to make this an "up front" point. Make clear that the sale will be "as is," without any warranties. But expect the purchase price offered to be reduced!

       * Liabilities. If you are buying a business, will you insist that the seller cover certain liabilities? Will you insist that the seller pay off certain obligations or resolve certain problems? Will you require the seller to make personal guarantees or indemnify you from losses and expenses you may incur that really arose from the seller's operation of the business?

These are issues covered in the typical agreement for purchase and sale of a business. If there are problem issues, such as environment contamination, or there is reason to believe the seller would refuse to include these terms in the agreement, make this an early discussion point.

          * Contingencies. Know what your contingencies need to be. Make sure any agreements you sign make clear that your contractual obligation to buy or sell is contingent upon certain actions being taken or certain representations being true. Typical contingencies to a purchase include the obtaining of a lease, there being no major changes in the business prior to the closing, there being no unacceptable liabilities, and obtaining required permits and licenses. If there are items that are key terms to you, make the purchase contingent upon your satisfaction on those items. The purchase or sale of a business is not a "one size fits all" transaction. Your purchase or sale has to fit YOU.

Once you have made a list of what you want to accomplish by purchasing or selling a business, take two important steps to get prepared. One is to check your assumptions and flesh out your plan by having early discussions with your accountant and your business attorney. The other is to tune up your negotiating skills.

         * Get your necessary tax information from your tax advisor. If you are selling a business, your potential capital gains, earned income, depreciation recapture (taxed at ordinary income tax rates), and double taxation (if you have a C corporation) are all determined from the tax records your tax advisor should have. Use this information to determine what your business sale must avoid and what you should want from a tax standpoint.

If you are buying a business, get your tax professional's input on what you can afford and what financing you should consider. Be prepared to get the financial information on the proposed purchase to your accountant as soon as possible. You will need to analyze revenues, expenses, taxes, and cash flow to know whether you are interested in purchasing the business. In addition to these types of analysis of the business, many accountants have an insight into particular businesses and can warn you of pitfalls in your potential acquisition, such as increasing workers' compensation and other insurance premiums.

       * Learn or improve your negotiating skills. The excited business owner who meets with an interested buyer and admits that he would love to sell the business is his own worst enemy. If you don't have any experience with negotiations, then don't even meet with the interested buyer. Informal meetings can easily turn into a "blurt out" session for the unsophisticated buyer or seller.  The informal meeting is the worst kind.  Add food and alcohol and it's a disaster from a negotiation standpoint.  The seller will have the challenge of a lifetime to keep his or her mouth shut about the frustrations of management, employees, increasing tax burdens, and long hours. The buyer is likely to disclose his or her struggle to qualify for financing, and to reveal his or her lack of knowledge of the seller's industry. 

Publisher's Note

I like to begin any transaction with a "bullet list." If the parties cannot agree on a short list of key points, there is no reason to draft a complete formal agreement. It is less painful to walk away from a deal if time, emotion, and expense have not been poured into it. Agree on the big points, then the medium points. Get some of the "due diligence" investigation done. If it still looks like a "go," then take your time and bear the expense of working out the details of the purchase and sale in a formal agreement.

But make certain you have your tax advisor's and business attorney's input on the first key points. They are the most important points and the amount of time it takes to get the accountant's and attorney's input on those items is small.

Many deals fall apart, and rightfully so. It is better to walk away from a bad deal than to get into it. The challenge is to avoid investing time and money in a potential deal unless it is worth it.