Whether you are an old pro or if you are considering purchasing your first business there is a tried and true process which will help you to negotiate an economically sound agreement, and minimize or eliminate hidden taxes and liabilities.  This is how I approach most transactions:

 Research

Research is key. You must as much as possible about the target business before making the initial contact.  You can do this by looking at public documents, visiting the business, talking to the franchisor (if it is an existing franchise).

 Try to find out how much the current seller paid for the business and the form in which it was structured (i.e. if it was a all cash sale, or whether part of the purchase price was paid in promissory notes, noncompete or consulting agreements to the previous owner). 

 Once you have as much information as possible, approach the owner of the target business (preferably through your attorney or representative).  Explain to the seller that you are interested in purchasing his/her business and that you would like to view the past five years of the business’ financial records.  You will probably need to sign a confidentiality agreement.  This is a touchy situation if the business you want to acquire is a competitor’s business, but it can be done if the seller has some interest in selling and enough assurances are made as to confidentiality.

 Analysis

Once you have the financial data you need to analyze it.  You should take the data to a professional business valuation expert, an attorney or consultant experienced in commercial transactions or a properly qualified accountant.  When I represent clients purchasing a business, I enter the information from the tax returns and income and expense statements and generate a pro forma which gives us a better view of the business’ strengths, weaknesses and growth trends.

 From the pro forma you will able to determine a reasonable range for the purchase price.  Frequently we do this by looking at the business’ EBIDTA (Earnings Before Interest Depreciation Taxes and Amortization) from the pro forma and experiment with a variety of multipliers depending on industry standards and several other factors to get a feel for a fair price.  Keep in mind that this valuation method is based upon projected cash flow.  Most lenders will only lend on hard assets (e.g. the value of any real estate, equipment and inventory); however, that rarely results in a valuation acceptable to a seller.

 Strategy

 If the seller has communicated an acceptable purchase price and you have compared it to your analysis of the value of the business, it is time to prepare a letter of intent.  If you think the seller is asking too much, don’t give up just yet.  Work with your attorney or consultant to draft a letter of intent which includes a package with the purchase price and all of the general terms of your offer.  Although the purchase price is certainly the most important issue, do not focus on it to the exclusion of other terms.  Frequently, with the structure of the purchase price into noncompete and consulting agreements (both paid over time without interest) the present value of the combined compensation may be actually meet your expectation of a reasonable purchase price while the total of all financial components added together is closer to the seller’s expectations.  There are countless options which you can add to your letter of intent which will cost the buyer little or nothing, but which are valuable to the seller.

 Negotiation

 A letter of intent is much more effective than an informal discussion.  A letter of intent is an offer on paper which is taken more seriously than a casual conversation.  It also requires the seller to review his/her position.  A written counteroffer from the seller is more likely to be reasonable and starts a dialogue which could lead to a mutual agreement.

 It is usually best to have your attorney or consultant negotiate on your behalf.  During face to face negotiations, you can be put on the spot and you lose the ability to regroup and evaluate when you receive a counteroffer.  There are rare cases, where the buyer and seller should meet face to face, but they are rare and you should discuss the pros and cons of doing so before doing this.

 If you have formulated a good negotiation strategy which includes a reasonable purchase price and terms which may be attractive to the seller then draft a letter of intent with terms you think are fair.  After having a fair letter of intent, lower the price a bit and take out a few perks for the Seller.  In 14 years of negotiating transactions I have never had a seller accept an offer without countering it at least once.  In a perfect world, we could be up front with what we think is fair and there would be no game playing.  It is an imperfect world and sellers have become accustomed to negotiations.  The key to negotiation is reaching an agreement which results in both parties feeling as though they have “won.”  Keeping a few aces in your pocket to add to the negotiation process will help you to sweeten the deal as negotiations progress.

Due Diligence and Document Preparation

 Hopefully, much of the due diligence will be accomplished in the research stage.  Due diligence is a term of art which just means pre-closing inspections.  Due diligence varies with the type of business; however, there are some general inspections which I will discuss here.  There are by no means comprehensive. 

 Due diligence usually includes inspections of the facility(ies), inventory, leases, employee data and equipment and a lien search.  If real estate is part of the business you will want to have a building inspection, title search, a boundary survey, and a Phase I Environmental Survey to make sure there are no environmental issues which will transfer to you.  These inspections sometimes cost a pretty penny, but they are an investment well worth every dollar.  It is not an unusual that problems are revealed by these inspections.  If they are discovered after closing you will probably have no recourse.  If they are discovered during your due diligence period you can frequently have the seller correct them, reduce the purchase price to compensate for them or if they are serious problems you will have the option to cut your losses and walk away.  There are rarely problems that cannot be resolved before closing, provided they are discovered early in the process.

 If there is a lease involved, you will need to review the lease and discuss either transfer of the lease or termination and negotiation of a new lease with the lessor.  During due diligence you will make sure you have comprehensive financial and corporate records which your attorney, consultant or accountant can review.  Lien searches are essential.  In the normal course of business, owners will purchase equipment or take out loans and use the business assets as security.  Often those liens aren’t released. Any lien on the business’ property which isn’t released by closing will become your problem.  Liens pop up often during due diligence and the seller is frequently unaware of their existence.  If discovered in advance you can require the seller to either pay-off of the liens at closing or you can assume the debt if there is a corresponding reduction of the purchase price.

 During the due diligence period your attorney or consultant will be preparing the closing documents which will consist of any noncompete or consulting agreements, transfer documents, mutual indemnity agreements, representation and warranty agreements, etc.  If you are purchasing a franchise the franchisor will be providing its transfer documents.

 During due diligence you need to make a decision as to how you will hold the business.  Often you can simply merge it into your existing company if you have one, but in many cases it is advisable to form a new entity.  This requires a look at your existing business structure discussions with your attorney, consultant and accountant and an evaluation of potential risks of each option.  I like to review your estate plan to make sure that the acquisition dovetails with your personal plans.  This is a part of the process which many attorneys, consultants and accountants ignore, but I personally think it is critical and can save you money down the road.

 Closing and Post-Closing

 At closing, all of the documents will be signed, the money will change hands and the transfer of the business will become effective.  If there are no surprises and if all of the due diligence was completed on schedule, closing will be a short, pleasant formality.  Sometimes the seller throws a wrench into the works, especially if he has not been represented by experienced counsel, but we have always found creative solutions to those problems that are acceptable to both parties.  So far, I have encountered many last minute problems, but I have never had a transaction fail due to last minute problems.

 All of this may sound overwhelming, and it probably is if you have never experienced a transaction, but with a good consultant, attorney and accountant you can formulate effective strategies so that you can acquire your business under the best possible terms and leave closing without unforeseen liabilities, unnecessary taxes and problems.