“Entrepreneurship”
is frequently defined as “starting” or “developing” a business venture or
idea. While many entrepreneurs do start
a business from “scratch,” others purchase a going concern or selectively buy
assets that can enhance their own opportunities to grow. Growing through acquisition – which
frequently makes financial headlines – is not just for publically traded, high
profile companies. Medium and small firms can use acquisitions to implement
strategic objectives and build their business. Acquisitions may make strategic
sense
·
to
jump start entry into a new product line
·
to
access or expand a customer base or distribution channels
·
to
acquire technology or expertise
·
to
facilitate entry into a new geography
·
to
increase sales or reduce costs
The
recent economic downturn has had the effect of making many respected and well
run firms take a look at core competencies and shed assets or divisions that no
longer “make sense” for their business model. Such divestitures create
opportunities for entrepreneurs willing to devote the time and attention
necessary to maximize value. Even in the best of times, business founders
frequently look for opportunities to “cash out.” Acquiring businesses from the folks who built
them – frequently with the opportunity to tap the experience and talent of the
founders as part of a well planned transition – gives entrepreneurs a
competitive and strategic advantage in the market. Moreover, increased access
to both private and government funding allows even small and mid-size firms to
take advantage of growing through acquisition.
Acquiring
a business is an important decision. Not
only does the purchaser risk losing his investment, undisclosed and unanticipated
liabilities might affect the bottom line for years to come. However, with
planning and counsel, purchasers can avoid many of the pitfalls associated with
an acquisition. Some important steps to consider:
Assemble
A Team
Business
acquisition is not a “do-it-yourself” venture. Even an experienced manager may need qualified
experts to help make a strategic decision about the value of the business and
whether it meets his needs.
A fundamental understanding of the financial
infrastructure of the business being purchased is critical. An accountant can
be instrumental in helping to understand the financial health of the business
and in navigating the tax implications of the transaction.Transactional attorneys skilled in the purchase and sale of businesses of comparable size can assist in identifying and reducing risks. Attorneys can assist in negotiating the purchase; identifying and evaluating critical issues; and drafting the operative documents. In transactions with post-closing obligations – such as subsequent payments to the seller or non-competition agreements – knowledgeable counsel can assist in assuring that the buyer realizes the value in his purchase.
When financing an acquisition through debt, early contact with the lender is important to understand the availability of funds and the terms and conditions that will apply. Careful review of loan and financing agreements will eliminate the risks of hidden fees and provide a clear understanding of any other financial obligations.
Retaining
a business broker or consultant may also be of great assistance when valuing a
possible acquisition target. Valuing a
business can depend on a number of factors including sale prices of comparable
businesses; the industry in which the business operates; and estimated
growth. Access to a broker or consultant
– particularly during the process of valuing the business – can avoid “buyer’s
remorse” if you believe you have overpaid.
Depending
on the type of business, other expertise may be beneficial. For example, if the business has trademarks,
service marks or patents, intellectual property counsel is advisable. If real
estate is part of the transaction, the team may include inspectors and environmental
engineers.
Decide On Assets or Stock
One
of the early decisions in the acquisition process is the decision whether to
purchase the equity of the business or the assets. The decision on how to
structure the transaction has a significant impact on how the transaction is
taxed; what liabilities are assumed; and whether the contracts of the business
continue in effect after the transaction.
While purchasers frequently prefer an asset sale where they can select
the specific assets they wish to acquire, the decision on the form of the
transaction should be made with an understanding of the business as a whole, including the potential reaction
on suppliers and customers.
Decide
On Your Purchase Price
The
final price that is paid for a business is usually result of a negotiation process.
Nonetheless, buyers should have a good sense of how to value the business and
how much they are willing to spend to acquire it.
The
price of a business usually consists of a base price and a number of
“adjustments” that are made to reflect the changes to the base price.
There are a number of ways of determining the base price. One of the most common is a price equal to a multiple of sales or income. For example, a business whose annual in income is $3 million dollars might carry a multiple of 5 in one industry for a total sale price of $15 million, but carry a multiple 8 in another industry, with a resulting sale price of $24 million. In some industries, sale price is a function not of income but of other parameters – such as customer acquisition or profit. Multiples are also dependent on economic conditions – both in general and in specific industry. Whatever the process, a consideration of recent multiples used in valuing comparable businesses provides an external validation that the business being acquired has as much value to the market as to the individual purchaser.
Engage
in “Due Diligence”
Due
diligence is the investigation undertaken by the buyer prior to purchasing a
business. Frequently buyers will not be allowed to engage in due diligence
until they have executed a Non-Disclosure Agreement. The Non-Disclosure
Agreement (NDA) obligates the buyer to maintain the confidentiality of any
information that he receives from the seller as part of the due diligence
process. Due diligence provides the buyer with an opportunity to better
understand – and appraise – the business that is being purchased. The scope of
due diligence varies widely and is sometimes the subject of negotiation between
the buyer and seller. Some important areas of inquiry include:
·
Identification
of key assets and assessment of their condition
·
Review
of financial statements for current and preceding years, with particular
emphasis on bad debt and other expenses
·
Identification
of key employees and employment agreements
·
Review
of any past or pending litigation and any notice of claims that might lead to litigation
·
Assessment
of environmental liabilities associated with products or real estate
·
Review
of employee benefits and outstanding liabilities
·
Review
of customer contracts, licensing agreements and supplier agreement
·
Identification
of key suppliers
·
Identification
of future capital needs
·
Interviews
with customers, suppliers and key employees
·
Evaluation
of insurance coverage
While a comprehensive due
diligence process will not eliminate all risks for the buyer, it does offer an
opportunity for the buyer to assess such risks, and if warranted, seek an
adjustment in purchase price.
Document
The Transaction
“Papering
over” a transaction – drafting the legal documents that describe the
transaction and transfer the business – may occur at different stages of the
transaction. Parties sometimes execute a “Letter of Intent” indicating their
intent to proceed to a final Purchase and Sale Agreement, subject only to
certain identified conditions. Letters of Intent can present legal challenges.
Parties sometimes sign such agreements, believing that they are not undertaking
any legal obligations. Despite language that sometimes implies that such
agreements are without legal effect, letters of intent have been the basis of
damage awards.
Once
the contours of a transaction have been agreed on, counsel prepares a Purchase
and Sale Agreement that identifies all of the details of the transaction,
including but not limited to the sale price and the basis for any adjustments;
a description of the assets and/or stock being purchased; disclosures of
liabilities and potential liabilities by the seller; and any post-closing
obligations of either party. The provisions of the Purchase and Sale Agreement
must take into account the risks and conditions specific to the business that
is being sold. A well-drafted document ensures that neither buyer nor seller
will be “surprised” during the transaction and provides a framework for
cooperation in the period after the sale takes place.
Buying
a business can be stressful and risky. One size does not fit all. The
most successful transactions are those that recognize the unique risks and
rewards in a particular acquisition and uses the law to accommodate the needs
of the parties. With proper counsel, even
small to mid-size firms can reap the benefits of growing through acquisition.
