Table of Contents
Purchasing a business can be an effective way to grow your business. However, it is a complex process that can carry substantial risks and costs. Therefore, preparation is critical. This article will give you five tips to help you prepare to buy another company.
Note: this article assumes that:
- you are purchasing a successful business that is not in any considerable financial difficulty;
- you are purchasing a private limited company; and
- it will be acquired through a share purchase.
Research and Using a Broker
The market for purchasing and selling a business can be challenging to navigate because what is available is not always apparent. In addition, you may find access to information is limited. Even if you know what company you want to purchase, you may find it hard to approach the directors and indicate your interest. This is why experts refer to the private company market as an illiquid market.
Therefore, a good broker may be worth the cost if they understand the market and contracts. In addition, brokers can more easily match you up with a seller and provide you with crucial insights, such as how much a business might be worth (though you should always obtain an independent valuation). They can also arrange an introduction between you and the directors of a prospective target company.
Valuation and Financing
You will need to know how much the company is worth and consider how you will pay for it.
Valuation
You should instruct an account or corporate financier experienced in valuing companies. Valuation is a complex task that can produce different figures depending on your adviser’s approach.
In general, there are four approaches taken:
- net asset valuations;
- market multiple;
- discount cash flows; and
- dividend yields.
The valuation is an essential factor in the price you ultimately pay, but it is not conclusive. Other factors will include information uncovered during the due diligence process and the buyer and seller’s positions and objectives.
Financing the Acquisition
There are three ways that you can acquire a company:
- using your own cash reserves;
- borrowing money from a bank or issuing debt securities (debt finance); or
- issuing new shares to existing shareholders or outside investors (equity finance).
Call 0808 196 8584 for urgent assistance.
Otherwise, complete this form and we will contact you within one business day.
Preliminary Agreements
Once you have found a company you are interested in, the next step is to begin the transaction process. As a buyer, you will spend considerable time and money. Therefore, it is common practice to enter into a series of agreements that give you and the seller certain protections before you commence the due diligence process.
Heads of Terms
Heads of terms, also called letters of intent or memorandums of understanding, are similar to the agreements in principle you receive from mortgage lenders. In general, they contain:
- the price to be paid for the company;
- how the transaction will be structured, such as if it will be an all-cash sale or if there will be other kinds of payments like shares in the company purchasing yours; and
- the timeline of the transaction and key dates.
Confidentiality Agreements
In the course of the transaction, you will gain access to sensitive information about the target’s company business. These could include trade secrets and who their key customers and suppliers are.
Exclusivity Agreements
Whether you are a buyer or seller, the process is quite expensive. From your perspective, you will not want to enter into serious negotiations unless you are sure that you are the only potential buyer the seller is dealing with. Therefore, you should get the seller to agree not to seek out another buyer for a certain period, such as six or 12 months.
These are also called lock-outs or no-shop agreements.
All three of these elements may be contained in the head of terms or exist as separate agreements.
Due Diligence & Final Negotiation
You must follow the due diligence process (DD) before beginning the final negotiation.
Due Diligence
DD refers to the process where you investigate the target company to get a sense of all the crucial details about the company. It is also where you will try to uncover anything that might diminish the value of the business or make the purchase too risky.
DD can be broken down into the following categories:
- commercial;
- financial;
- legal; and
- tax.
As the buyer, you are the one that will need to request the relevant information. For the process to run smoothly, you should ensure that you communicate clearly and efficiently to the seller. Your advisers will be able to advise on the specifics, but in general, you will want to examine:
- all contracts between the seller and third parties, including suppliers and customers;
- service contracts for directors and other staff;
- full details of the target company’s constitution, including its articles of association;
- the company’s accounts and annual confirmation statements;
- the shareholders and the number of shares issued as well as any shareholder agreements;
- directors’ details;
- any debts, liabilities, and financial obligations like mortgages, charges, and liens;
- details of any ordinary and special resolutions passed by the shareholders;
- any property leases and land owned by the company, as well as valuing the property prices; and
- any ongoing or expected litigation where the company is a party to a lawsuit or dispute.
Final Negotiation
Depending on what the DD reveals, you may need to reconsider the final purchase price.
For instance, a common issue uncovered in the DD process is the existence of contractual prohibitions on transfer. This is where key contracts with third parties like customers or suppliers permit the third party to end the contract if the business is sold. This can substantially impact the company’s value, especially if you cannot renegotiate with the key third party.
Share Purchase Agreement
If you and the target company have agreed to the final price, you can simply pay the money in exchange for the company’s shares, and the transaction will be completed.
Representations and warranties protect you from anything the seller failed to disclose or any misrepresentations. If something later turns out to be untrue or misleading, you can sue the seller for any unexpected additional costs. SPAs also frequently contain conditions precedents and non-compete agreements that bind the seller.
Key Takeaways
Before purchasing another business, it is necessary to understand the market and consider if a broker would help you. You should also have an idea of what the company is worth so that you can figure out how to finance the acquisition. Next, understanding the important preliminary agreements and how they can protect you can save you a lot of time and money once you start the formal negotiations. Additionally, the due diligence process is one of the most important elements of the transaction, so it is important to know what it entails. Finally, you should be prepared to seek a share purchase agreement when concluding the purchase.
If you need help purchasing a business, our experienced business sale and purchase lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today at 0808 196 8584 or visit our membership page.
Frequently Asked Questions
Understanding what to expect is the first step in buying another business. You will need to know if you need a broker, how to finance the acquisition, how you will negotiate the preliminary agreements, the due diligence process, and what the share purchase agreement may entail.
It is possible to purchase a business with relatively little legal paperwork. However, in practice, because of the risk involved in purchasing a business, acquiring a business usually means there are several ongoing legal processes. These include negotiating warranties and representations, purchase agreements, and non-disclosure agreements.
We appreciate your feedback – your submission has been successfully received.
