SIXTEEN STEPS TO PURCHASING A BUSINESS
Roger Harman, MBA,
Licensed US Customs House Broker
WA State Certified General Real Estate Appraiser
WA State Real Estate Broker
WA State DOL Real Estate Instructor
THE FOLLOWING ARE THE MAJOR MILEPOSTS IN A TRANSACTION.
Business Opportunity transactions are some of the most exciting transactions in all of real estate. They are also the highest risk. There are few if any secondary financing markets. The valuation and or appraisal before or during the sale values something that does not exist; the future cash flow (smoke and mirrors)? Intangible assets require a licensed and experienced professional to make a probable estimate of the value, current or prospective, of an intangible asset. Remember, “numbers lie and liars number”. Failure to have licensed professionals help you, with Errors and Omission Insurance (E&O), who are specifically experienced and who have a history of competence leads “sheep to wolves”, likely adds liability to the future for either side and is comparable to “buying a cheap parachute”, most times it works but the one time it does not work is very costly. A $1,000 to $5,000 for advice and help from your CPA, attorney and business broker or appraiser working together is well worth it for a transaction usually over significantly over $100,000; a transaction filled with risk that will come back to haunt you. A bad decision often results 3 to 5 years of servitude before you could get out of a mistake without a loss of principal.. The process requires the most professional of agents and other advisors with a detailed understanding of all aspects of a real estate and or intangible asset transaction. This is the arena where the free market reigns; where the buyer must beware (caveat emptor), and where few understand capitalization rates, risk factors or the ways to build bridges of agreement between such disparate parties; buyers and sellers.
For the purposes of this article a small business is defined as less than 100 employees. It will generally have less than $10,000,000 in annual sales. There will be three or less owners with no stock transactions having been executed in the preceding five years. There will be sufficient records prepared in accordance with Generally Accepted Accounting Principals to support the process. The business must be at least 5-years old. If there are any exceptions to the above they need to be addressed on a case-by-case basis as they require special handling.
The buyer makes a commitment to buying a business or franchise. That commitment must assume a personal risk, financial and skill assessment as to the value the buyer can bring to the table. If the business or franchise is to be purchased with credit of any kind the buyer must realistically know how they are going to generate the revenue or reduce costs to retire the debt. The buyer must make an assessment about the industry in which they intend to seek an opportunity. A buyer’s winning frame of mind begins with “know yourself”. A buyer’s success will be a function of realistic planning for the process and subsequently the business opportunity. “Those who plan succeed those who don’t, don’t”. Only after proper preparation is a buyer ready to make a commitment.
Prior to making a commitment every buyer should contact their attorney and accountant to inform them of their plans. They should ask their attorney or accountant what suggestions, requirements or needs they would have to protect the buyer’s interests and to facilitate a transaction. A good agent will strongly suggest that the buyer do so.
Unfortunately many real estate agents see a higher than average commission and a higher than average transaction price. They push for “a deal” and action before proper preparation has been completed. Buyers of small businesses are different than real property buyers and buyers of additional locations, distribution channels or merger opportunities. They usually seek a business after other opportunities in the marketplace have diminished or their financial condition has been reduced. There is no substitute for doing the job correctly. The buyer has a an in depth process to go through before they make the commitment to purchase a business at a price and terms that are consistent with the reality of the marketplace.
A potential buyer needs to be prepared to sign a non-disclosure and non-compete for any business for which the buyer is given access to internal records, trade secrets, customer lists or the like. The confidentiality is a sacred trust that can be easily violated even by casual comments to friends, family or associates. THE SALE OF A BUSINESS IS A SECRET AFFAIR BECAUSE OF THE NEED TO PROTECT THE BUSINESS! The buyer and their agent must sign an agreement to maintain absolute confidentiality concerning information provided before they see any such information.
3. BACKGROUND INFORMATION
Professional listing agents will prepare a confidential, no-name offering for a business reflecting performance charts without specific data except for gross sales, gross margin and earnings. The offering package will also include a ratio analysis of all key components so those potential buyers may ascertain the general quality of the business before they are exposed to its name or specifics. A second package reflecting net cash flow, financial statement adjustments, earnings, excess earnings, assets, capitalization rates used and their determination needs to be available for a buyer’s scrutiny when it is warranted to share such specific information. No buyer should even consider paying any more than book value for any business without such information available. “A fool and their money are soon parted.”
A potential buyer needs to have a personal profile financial statements and credit information available for financial qualification and initial seller scrutiny. An agent can readily present data without the identification of the potential buyer for the seller’s review. Unless a cash sale is assured at the outset, all involved in the financing will want to check out the capacity, stability, and durability of the potential buyer’s financial condition as well as their credit history. In all cases, real estate agents need to understand the law as it relates to non-compete, confidentiality, marital estates and liabilities, real and potential, and as they relate to a business transaction.
Upon the review of data and the potential buyers “clandestine” visit and inspection of the site and surrounding areas “as a customer” or “as the general public” it is time for a face-to-face meeting and internal inspection of the property with the seller. In all cases the buyer and seller’s agents should attend all meetings. Often buyers and sellers think they do not need the agents present. In reality they do not know what they do not know. The agent, whoever they are, has significant legal and fiduciary responsibility for the relationship between the buyer and seller, the transmission of information and the determinations of price and terms. There are reasons in the marketplace that agents generally receive a 10% commission with a $10,000.00 minimum commission. Such commission levels demand the highest levels of competence, capability, transaction processing skills, and professional efficiency. The seller’s agent is responsible for articulating the opportunities of the particular offering. The buyer’s agent is responsible and will be held accountable for using industry practices in assessing risk, assessing information and challenging unverified or questionable information.
5. BUYER AND SELLER MEETING
The buyer and seller meet in person with the agents present. There should be a written agenda for the meeting. Both parties should submit to others in writing a list of questions generated from the provided materials. The agents should keep a written record (minutes) of all meetings for everyone’s benefit and for the history file. A sign-off and acceptance by all parties attending will help the process greatly as most people have selective memories in an after-the-fact situation.
6. OFFER TO PURCHASE
With their agent’s assistance, using a properly constructed business opportunity Earnest Money Agreement form, the buyer needs to write an offer to purchase. The offer must be contingent upon inspection and acceptance within a specified time period of the business’s financial records, assets and internal data. The Earnest Money should not be binding until all contingencies are removed. Failure of timely contingency removal negates the offer unless an extension is obtained.
7. OFFER PRESENTED
When the offer is presented to the seller it should be given, without comment by the buyer’s agent with the seller’s agent present. Silence should follow until the seller and their agent has full opportunity to read the offer in detail. Body language, facial expressions, tone of voice and interpersonal skills are critical for a successful offer presentation. A successful presentation is usually one where reasonable people can see the opportunity to build a bridge between the buyer and seller thus keeping negotiations open. Without an acceptance a buyer’s agent should exert every effort to obtain a counter offer, in writing, with information to substantiate the seller’s perspectives.
8. OFFER RESPONSE
Seller accepts the offer as written. They may writes a counter offer. The potential buyer is notified expeditiously, as soon as possible, with urgency. It is important that the buyer and or seller with their agents only speak face-to-face during this aspect of the process. Fax and telephone interaction may work to the detriment of a “meeting of the minds” and unnecessary liability on anyone’s part
9. MUTUAL ACCEPTANCE
When both parties agree to all the terms and conditions of the sale and sign all amendments and counter offers, there exists a Purchase and Sale agreement (Earnest Money Agreement or Purchase Agreement).
The buyer, their agents, real estate and otherwise, meet with the seller and their agents to inspect the Seller’s financial records, assets and offering claims. This is a time in the process when unprofessional agents often leave the buyer and seller to themselves. Such a situation is not good for either client, furthermore, it increases their potential for risk and liability.
11. CONTINGENCY REMOVAL
Upon completion of inspections, verifications of claims and a background check buyer and seller agree to remove all contingencies. Upon the removal of contingencies, in a professionally orchestrated transaction, there is a binding agreement (meeting of the minds).
12. CONSENT TO ASSIGN
If there is a lease preliminary work had to have been done by the seller to prepare for either a sublease, new lease or other arrangements. Most landlords execute a sublease or new lease and submit it to closing with a contingency that it only becomes effective at closing. The escrow attorney at closing then processes everything for the benefit of all.
13. OPEN ESCROW
Given that fees will be incurred escrow is usually not opened until all contingencies have been removed and arrangements have been made for any leases, distribution agreements or other external approvals needed to execute a transaction. Usually the selling agent prepares the documents for submission to the escrow attorney. Both parties must approve the opening of escrow in writing to assure liability for charges to be incurred.
14. APPOINTMENT SET
An appointment is set for signing of the closing documents drawn by the Escrow attorney at his/her office. The time from the opening and closing of escrow is usually a function of the review time needed by each party and their respective attorney or accountant. The primary complaints of escrow processors is that either terms and conditions were not clear, contingencies had not been removed, negotiations had not been completed and that there was not a “clear meeting of the minds” necessary for an enforceable contract.
Prior to closing arrangements are made for the buyer and the seller to take inventory, to assign inventory value and to inspect equipment as it applies to the ownership of the business.
All parties, seller and buyer legal counsel and accountants are usually present, as are the real estate agents, attend a closing meeting with the escrow processor. Seldom is anyone excluded Usually meetings are not held separately as in residential real estate as the escrow attorney needs to assure themselves that there is a clear meeting of the minds as well as of proper form processing and recordation.