While many entrepreneurs dream of starting their own business, just as many would rather buy one that is already a success. To get the most out of your investment, there are certain things you need to know before the sale is final. Before buying a business, potential buyers should consider a checklist to ensure that they do not miss any critical details. If you are considering purchasing an existing business, the experienced California business attorneys with L.A. Tech & Media Law at (310) 751-0181 may be able to assist you in doing your due diligence.
What Is the First Thing To Do When Buying a Business?
In some cases, a potential buyer becomes interested in purchasing a business only because they learn that a particular business is available. These buyers know exactly which business they want; they may not even consider alternative purchases. In other cases, however, an individual or company comes to the conclusion that purchasing an existing business will be a sound strategy for expanding their portfolio, and looks for one that will be a good fit. In these instances, the selection process forms an important first step. Buyers should make sure the business they are considering buying is primed to be profitable with either a positive cash flow or a clear path to positive cash flow.
Buyers should also be sure that the business they are considering is in an industry they are familiar with or could quickly learn, as well as one they could see themselves enjoying personally or one that fits well with the company’s existing brand and mission. The business should have a diverse customer base with no single client making up more than 20% of the business’s revenue and a clear, long-term growth plan. Ideally, buyers will give themselves plenty of options so they can choose the best fit instead of settling for whatever happens to be available.
What Do You Need To See Before Buying a Business?
Business owners will be hesitant to share all the details of their business with a potential buyer. Trade secrets, patents, and other intellectual property are often protected until a sale is almost complete. However, there are some crucial elements that buyers need to see before buying a business so they can be sure they want to move forward.
Some sellers may not want to share all the details of their business’s financials until they know a buyer is likely to go through with the purchase. However, at a minimum, they should share key indicators such as profits, debt, sales, expenses, and cash flow. This information helps the buyer have confidence that financial trouble is not the reason behind the sale.
If the business is a corporation or limited liability corporation (LLC), the buyer should look at the entity documents and some of the related records such as resolutions, bylaws, and operating agreements. If the business is registered in California, the buyer can confirm this information with the California Secretary of State. If the business is registered in another state, the buyer should confirm the state the business is registered in and whether it operates as a foreign corporation in that or any other state. This confirmation should also include that the business is in good standing and that the owner can legally sell.
An unfortunate reality of the commercial world is that at some point, any business may face a lawsuit. However, if you purchase a business while it is actively in litigation, you then become part of that litigation and may be responsible for any judgments against the business. Buyers should confirm that there is no ongoing litigation as well as no unpaid judgments or liens from past litigation against the company or any of the executives that they may hire. Buyers can begin this search with the Superior Court of California County of Los Angeles. L.A. Tech & Media Law may be able to assist with the search for legal liabilities as well.
Business and Industry Outlook
While the business may not be currently in financial trouble, it is important to consider the business and industry outlook to ensure that it will continue to be viable. Buyers should look at factors such as:
- Market outlook and trends
- Competitive advantages
- Client base
- Customer satisfaction
- Why the seller is selling
The day-to-day operations of the business may be one of the easiest aspects of the business to examine. Buyers will want to consider:
- What do they manufacture or provide?
- Where do they manufacture or provide it?
- How do they manufacture or provide it?
- How much working capital do they have?
- How is the supply chain structured?
- What are the manufacturing and operations processes?
- What proportion of annual revenue does the business reinvest as capital expenditures?
How To Do Due Diligence Before Buying a Business?
Once these initial evaluations are complete, if the buyer is still interested in moving forward, they may submit a letter of intent (LOI). This LOI simply assures the seller that the buyer is ready to commit to the purchase and move forward, but it is non-binding if something should go wrong during the due diligence process. Once the LOI has been submitted, the buyer begins doing due diligence, or delving deeper into the business’s details. At this point, to facilitate the sale, the seller usually providers much more information, including access to intellectual property that is part of the sale.
Organization, Governance, and Good Standing
If the buyer did not already see these documents when looking at the business’s entity status, they should look at:
- Identifying shareholders, directors, and officers
- Minute book
- Communications with shareholders
- List of business names and locations
- Any permits or licenses issued or applied for
- Corporate policies and procedures
Ownership, Control, and Change of Control Restrictions
Purchasing a business means a change in ownership. In some cases, a buyer may prefer to be hands off and leave the business in the capable hands of those already controlling it. In others, the change in ownership also means a change of control. When this happens, there may be shareholders or others who are affected and who, as a result, may choose to sell their shares, void contracts, or otherwise make changes. Buyers should understand the full range of rights the business formation documents grant to stakeholders at all levels, as well as what exactly may happen if the stakeholders exercise those rights en masse, before buying a business.
Buyers should look at:
- Capitalization tables
- Outstanding shares
- Convertible securities
- Options and warranties
- Dividend or distribution policies
- Voting agreements
- Transfer restrictions
- Pre-emptive rights
- Consent requirements
- Related party transactions
Seller Financial Information
Buyers should have already seen some financial information, but now they should be getting detailed information, including:
- Statements and projections
- Sales and revenue
- Cost analysis and balance sheet
- Cash flow
- Debt schedules
- Loan financing and security agreements
- Payments and defaults
- Bank or investment accounts
- Owned and leased real estate
- Inventory or valuations
- Equipment and other tangible assets
- Intangible assets including goodwill, customer lists, software and intellectual property rights
Taxes may be included in other financial information, or they may be provided separately. When looking at tax information, buyers should ask for:
- State, federal, and international tax returns for all locations where taxes are paid
- Payroll taxes
- Sales taxes
- Accruals, withholding, and FICA
- Any correspondence with taxing authorities
Any business a buyer is thinking of purchasing is likely to need at least one type of insurance, if not multiple types. Buyers should ask to see the following policy documents, as applicable:
- General commercial liability
- Professional liability
- Product liability
- Workers’ Compensation
- Directors and Officers (D&O)
- Employment practices
- Summary of all claims made on any existing policies
How Long Does Due Diligence Take?
Buyers should always do their due diligence before buying a business. In the excitement of finding a business that they want to buy and seeing initial indications that the purchase is a good idea, they may want to rush through due diligence. The more thorough a buyer is in doing due diligence, the better the chances they will buy a viable business that continues to thrive.
Depending on the complexity of the deal, due diligence typically takes 45-180 days. For more complicated deals, due diligence could take six to nine months. However, these numbers are not firm. A buyer may ask for a longer due diligence period, but the seller can negotiate it down.
Are You Thinking About Buying a Business?’
Due diligence is an important step in the business-buying process. Before buying a business, buyers should create a checklist of the most critical information they need to see and confirm before going through with the purchase. This checklist may vary depending on the industry, location, and size of the business. If you are considering buying a business, you may want to speak with one of our knowledgeable attorneys at L.A. Tech & Media Law. Call (310) 751-0181 today and schedule a consultation to discuss your legal options.