How to Buy an Existing Business (8 Steps)

Having your own business is great. Building one from scratch can be hard, which is why some business owners opt to buy an existing business outright instead.

There are other reasons to buy a business too, like acquiring an up-and-coming competitor, acquiring scale or just building your investment portfolio.

Whatever your reason, the process of buying a business follows the same pattern. From finding and evaluating the right business, to closing the transaction, we’ll walk you through the whole process on how to buy and existing business so you know what to do and what to look forward to.

How to Buy A Business. The 8 Steps - Sapphire Bay Partners

At a glance - How to Buy an Existing Business

In today's feature article, we will walk through the 8 steps of acquiring a small business. In summary these are:

1. Find a business to purchase

2. Value the business

3. Negotiate an indicative purchase price

4. Submit a formal offer document

5. Complete a due diligence

6. Develop an acquisition and holding structure

7. Obtain financing and finalise remaining commercial terms

8. Close the transaction

So lets dive in and explore these steps in more detail

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Step 1: Find a business to purchase

The first step is not just finding an available business, but finding one that’s worth buying. There’s plenty of businesses for sale. But ones with financial promise that actually hold your interest aren’t so common. You need to find a business that’s primed for profitability, and isn’t hiding any (major) skeletons (every business has skeletons; its the major ones you need to be careful about).

When you’re ready to buy a business you should look for these things:

• Positive cashflow and profits (or the ability to achieve positive cashflow and profits)

• An industry you’re familiar with

• A diversity of customers (care should be taken to ensure no one customer accounts for too much of the revenues and profits. A good rule of thumb is more than 20%, however, it depends by business and industry)

• A long-term growth plan

• A business that you could see yourself enjoying

Important - Understand your purchasing capacity EARLY

While we will cover financing in Step 7, you should by this stage have submitted queries to your financial broker to understand your capacity to purchase a business and how much you can offer. While it is little bit circular to ask about financing capacity now, when you don't know the specific business (and the specific business will often determine the exact financing capacity), a well-versed broker can at least give you guidance on what you could purchase and for how much depending on certain assumed metrics.

Make sure you complete this sub-step: the last thing you want is to progress deep into the process only to discover you will have financing challenges which could have been understood and potentially avoided or mitigated early in the process.

Step 2: Value the business

Once you’ve identified a business you’re interested in, it’s time to figure out how much the business is worth. You’ll find plenty of sellers that overvalue their business given their emotional investment, and it’s important to mitigate against overpaying.

When valuing a business you have two options:

1. Do it yourself

2. Hire a professional (i.e. a buyer's advocate)

The problem with hiring a professional is it can be expensive. But if you’re not confident in your ability or if the size of the business is sufficiently large, it may be worthwhile.

Alternatively, check around to understand the types of multiples the business in your preferred industry is going for. And there are plenty of articles around about how a business should be valued. However, with a little bit of effort you should be able to find a knowledgeable source to assist with this.

This can include lawyers with experience in this industry, your accountant or your advisor. Another common source is your finance broker. And even if they don't know exactly, when they submit their application to the bank, the bank will very often know the required metrics and valuation methods (but you should go to a broker with experience in your industry anyway - this isn't the time for a advisor or broker to be learning on the job with your transaction).

As some general guidance, a business valuation is typically calculated as a multiple of either business revenue, net income, or EBITDA. However, be mindful that each industry values differently (e.g. professional services is commonly based on a multiple of revenues, whereas manufacturing is based on adjusted profits).

Step 3: Negotiate an indicative purchase price

Once you’ve decided you want to move forward with a business acquisition and you think you have a good idea of what the business is worth, it’s time to negotiate the price. You’ll typically do this by making an Non-Binding Indicative Offer (NBIO), either written or verbal.

If your offer is close to what the seller is willing to sell for, they will start negotiating with you.

With most business transactions, you’ll go back and forth, negotiating different purchase prices and terms before you come to a tentative agreement. These terms can be changed later if you find something during due diligence that changes your opinion on the company’s value.

As part of the negotiation, you’ll decide whether you want to purchase the assets of the business or if you want to purchase the company or entity in trades in (i.e. buying the share capital of the entity).

Be mindful that if you acquire the company, you are also acquiring its history and obligations. While warranties from the vendor in the contract are helpful, it requires you to pursue the vendor, potentially years later. This is why many businesses choose to extract the operations and assets of the business and place it into a "cleanskin" (i.e. a new company or entity formed for the purpose of this acquisition). That said, acquiring the shares of a company is still a very common way to acquiring an entity and may be the best method depending on the situation.

Step 4: Submit a formal offer document

Once you have a general idea of the terms and structure of the business purchase, you’ll submit a Heads of Agreement (HOA) or equivalent document. This is a letter that outlines everything you’ve previously negotiated, and includes other information also, including indicative purchase price, and states your intent to buy the business.

This document furthers the business acquisition process and could potentially require the payment of a deposit. It shows the seller you’re ready to commit and move forward in the process.

If agreed, this stage will also typically give you exclusive rights to buy the business for a time period. This means that you’ll be the only one that can purchase the business during the time frame, and the seller has to act in good faith to close your transaction if you’re able to meet the terms of your HOA.

Step 5: Complete due diligence

When the LOI is signed by you and the seller, then you’ll get access to more information about the business. Typically, when you first show interest in purchasing a business you’ll get a basic overview of how the business is performing. But when you enter due diligence, you’ll get access to any financial or legal information that you feel is needed to close the transaction.

You will also have the opportunity to ask questions of the business. Your accountant, lawyer and/or M&A advisor can assist with this process, but at the very least, you should ensure you are comfortable with the following aspects of the business:

• How the business is run

• How it has performed historically

• How it is projected to perform into the future (make sure this is objectively calculated - very often we see vendors who have put together a "finger in the air" assessment which has very little objectivity. Needless to say, it often promises key metric results far in excess and much larger of what an objective assessment would suggest).

• Any liabilities attached to the business

• Assurances that the business will continue to operate as it is currently (or in the way you are hoping it will run). This includes team member and customer / client retention.

• Any major contracts it has (rental agreements is commonly a big one)

• Any risks to the business, including any legal, government or industry-specific factors

We suggest making sure you review the following documents, at a minimum, before you close:

• Organisational documents for the business (e.g. incorporation docs, certificates of good standing, business licenses, etc.)

• Previous 3 years of business tax returns

• Year to date income statements, balance sheets, and cash flow statements

• Revenue broken out by major customers for the last 3 years

• Information on existing business debt

• Customer lists with proprietary information blocked out as necessary

• Existing contracts—can these be assigned to the new owner?

• Commercial lease or other property documents

• Employee information

• Marketing and advertising materials

• Legal records for pending litigation, if any

Step 6: Develop an acquisition and holding structure

This is a critical step which is often not given the attention it deserves.

You need to clearly consider your goals with the business and how this will fit with your entire portfolio of investments. Key factors to consider in this step include:

• Mitigating your tax bill

• Providing flexibility to split (or stream) earnings across your investment portfolio as and when you want it

• Protecting you from legal risk and the threat of litigants

• Your exit strategy from the business (even if you have no plans to ever sell the business, you need to consider this. You never know what could happen in the future. We have seen many clients acquire businesses, turn them around, make them highly profitable and receive incredible, unsolicited offers to sell the business - it's a wonderful outcome)

• Succession planning and legacy

As a general rule, we seldom suggest holding the company or the business in your sole name. Unless the business is very small and cash very tight, you will nearly always be well advised to hold it in a structure which can more readily accommodate the abovementioned factors.

Step 7: Obtain financing and finalise remaining commercial terms

While this is Step 7 on our list, this step should be started early, namely around the Step 4, Formal documents stage, and run in parallel with the other steps. And, as we note in Step 1, you should have commenced preliminary financing queries at the very beginning of the process to understand your purchasing capacity.

In terms of financing, most businesses are purchased with a combination of debt and equity, meaning you’ll come up with part of the purchase price and the rest through a loan.

In terms of negotiating the detailed commercial items, you will also work with the vendor to draft a final purchase agreement. This usually involves a lot of back-and-forth with the vendor and their lawyers. Depending on how commercially and legal savvy you, you may be able to complete the Formal Letter of Intent yourself, but when it comes to the final contract, we strongly recommend that you hire an experienced lawyer to help you complete this part of the process. At the very least, they can review the purchase agreement to make sure you’re getting what you negotiated through the contract and highlight any key risks (e.g. encumbrances) to be mindful of.

Step 8: Close the transaction

After both parties sign the purchase agreement, you’re ready to choose a closing date and have your lender fund the purchase. Your funds will typically go into trust (meaning a bank or law firm will hold the money for safe keeping) on the day you’re supposed to close, until all documentation is final.

Once both parties give their approval then the money will be given to the seller and you’ll own the business outright.

The Closing Word

Buying a business has many positives. It is also very exciting! The most important thing is to make sure you truly understand what you are buying, the potential opportunities and mitigated your risk and exposure.

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The Sapphire Bay Partners team has had extensive experience helping clients buy businesses of all sizes and we are always delighted to help clients with this exciting endeavour. It's one of our favourites!

If you would like assistance, feel free to reach out to us.

Even if you have an accountant, but need referrals to other advisors, such as experienced lawyers, brokers or even mentors, feel free to reach out. We are happy to refer you. We do NOT receive any incentive; we just like to help!

Tel: + 61 3 9563 4666

Email: letstalk@sapphirebay.com.au

Important Information

This is general information only so it doesn’t take into account your objectives, financial situation or needs. Sapphire Bay Partners is not giving you advice or recommendations (including tax advice), and there may be other ways to manage finances, planning and decisions for your business.

Carefully consider what’s right for you, and ask your lawyer, accountant or financial planner if you need help. Alternatively, feel free to reach out to Sapphire Bay Partners for assistance or referrals to an appropriate professional. We’re always happy to help!