What Does It Mean to “Buy a Business”?
Have you ever wondered what it means to buy a business? Now, the term “buy a business” can be a bit confusing. This is because you don’t really buy a business — you’re actually purchasing the assets and assuming certain liabilities associated with that existing business entity.
Before we go further, I want your first step to be to form your own legal entity (then get your free EIN and open a business bank account). This legal entity will be the one you’ll use (as the buyer) to negotiate the terms of the asset purchase agreement with the seller. However, you should know that having the protection of an entity during the negotiation, due diligence, and purchase process will streamline and cut out any last minute red tape when you begin the process.
What happens when you start negotiating with a seller?
Now that you have an entity (and bank account), let’s talk about what happens when you start having conversations with a seller of a business.
1. Due Diligence
First, there will be disclosure of confidential information oftentimes on both sides. The seller will be disclosing the sensitive information regarding trade secrets, financials, product and service offerings, marketing plans, employees, business assets, various liabilities, and so much more. On the other hand, you (as the purchaser) might be disclosing confidential information like your financial capacity to fund the purchase or assume existing liabilities.
So before any of this is shared, expect to be asked to sign a Non-Disclosure Agreement. Why are Non-Disclosure Agreements so important? Because the seller is (justifiably) concerned that you’re just going to come in and use this as a fact finding mission to launch your own business. While you should be concerned that without the Non-Disclosure Agreement, they may not be as forthcoming.
From my experience with clients, the sooner you can get into the nitty-gritty details and begin due diligence, the sooner you’ll understand the complexities of the business and whether it’s the opportunity you expected it to be.
Those complexities include reviewing all the contracts (both that generate revenue and are liabilities). An example of a liability you may assume (if there is a physical location) is a Lease Agreement. Tip: You might want to review the Lease Agreement as soon as possible, so you can begin the process of a Lease Assignment with the landlord.
After due diligence, the next step is negotiations (they two even happen simultaneously). You’re going to use your due diligence to inform the negotiations and terms you’re looking for. These may include the following:
Beware: When you are considering buying a service-based business, as opposed to a product-based business, the intangible assets (like goodwill are hard to value), tend to complicate using strictly revenue and expenses. With that said any business likely has sentimental value to the seller, but you want to ensure that is not creating an unrealistic premium.
As mentioned above, due diligence will inform the negotiation process for your Asset Purchase Agreement, which will get into the details of any contingencies. For example, if it’s a physical location, the Lease Assignment (I mentioned above) will become a contingency. If the transaction is associated with a franchise, the transfer of the Franchise Agreement will also be a contingency. A contingency simply means that the success of the transaction closing hinges those contingencies being completed as expected.
5. Public Disclosures
With a Non-Disclosure Agreement in place you might be wondering… “At what point will it be okay for the seller to disclose the change in ownership to their employees and customers or can I tell the world the exciting news?” There is a strategy behind public disclosures. For this reason, ensuring you and the seller are on the same page is crucial.
The material to the valuation of this business is whether the seller is able to recreate the same business and become a direct competitor. Of course, this is something you don’t want to happen. So, make sure your Asset Purchase Agreement includes clear non-compete guidelines, such as radius, industry, and a reasonable time length to protect your interests in your pending investment.
7. Intellectual Property
Like confidential information, intellectual property drives a business (copyrights, trademarks, trade secrets, and patents). Ensure that the Asset Purchase Agreement grants you ownership to all of the intellectual property rights, including the assignment of any registered trademarks.
When it comes to buying a business, don’t forget the small stuff. Take the process slowly and don’t get caught up in moving too fast— you must sink your teeth in the details. Get to know the business intimately. Use that due diligence to inform a negotiation that puts you in a great place to become the new owner of a business. This due diligence should also set you on the right foundation to scale the business and embody your new vision for the next chapter of your business.
If you ever have any questions about what it means to buy a business because you’re eyeing one yourself, please don’t hesitate to reach out to our team. Buying a business is exciting, but like every other big milestone in life or business, it’s one that comes with valid concerns.