Setting up your own business from scratch is tough work. That is why, sometimes, it is preferable to purchase an existing business. But don’t dive headfirst into the first offer or prospect that comes your way! It’s important that you do your research before making any decision.
Financing Options When Buying a Business
There are several ways for you to buy a business and cover its operational costs once it’s up and running. Some common ways to finance a purchase of business include but are not limited to:
- Your own savings
- Vendor financing (loan from the owner of the business you are buying)
- Bank loan
- Venture capitalists (loan from individuals or groups that are interested in supporting startups and getting huge returns on investment)
How to Conduct Due Diligence in Business Acquisition
Due diligence or a thorough investigation is one way for you to assess the value of a business and the risks that come with buying it. Through due diligence, you can ascertain the business’ performance. Common due diligence documents and information you want to look at are:
- financial information e.g. income statements, balance sheets, tax returns
- books of accounts
- product inventory
- profit and loss records
- debt arrangements e.g. loans, letters of credit
- product stock and other investments
- existing contracts with employees and contractors
- purchase agreements
- lease arrangements
- registration certificates, licences, and permits
- intellectual property e.g. trademarks, copyrights, patents
Of course, there are specific documents to enquire into for specific types of businesses, so these due diligence documents will vary.
Skipping due diligence could result in a financial investment that you will regret. Details could be left out and numbers manipulated, and you might end up assuming responsibilities or debts you did not factor into the purchase price of the business.
With the help of advisors such as lawyers and accountants, you can verify any claims about the company or representations that the business has made.
The Documents You Need When Buying a Business
The following are the legal documents you should probably consider when entering into a sale of business:
(a) Letter of intent/terms sheet
Signing a letter of intent/memorandum of understanding/terms sheet generally means that the two parties are ready to commence negotiations.
(b) Confidentiality agreement
Since the company’s proprietary information is used to prove its value during due diligence and negotiations, the owners might ask the prospective purchaser to sign a confidentiality agreement. This way, even if the deal falls through, the owners can rest assured that none of their sensitive and valuable information falls into the wrong hands.
(c) Sale of business agreement
Often, it’s a lawyer who will draw up the sale of business agreement. This is to ensure that the information in the contract is complete and accurate. A lawyer can confirm that the contract covers all aspects of the sale, such as:
- selling price
- the assets included and excluded in the sale (including intellectual property)
- representations and warranties
- dispute resolutions options
- post-sale rights and obligations
- disclosure document
This document is really only used for small businesses. In Victoria, if your business falls under the definition of a small business, your business sale agreement needs to be accompanied by a Section 52 statement, a document that serves as a snapshot of the financials and due diligence of the company.
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The Costs of Buying a Business
Aside from the purchase price, these are the other costs associated with buying a business:
(a) Stamp duty
Depending on which state the business located in, you may need to pay stamp duty for transfers of property including businesses.
(b) Working capital
This is used to cover the business’ day-to-day expenses, such as inventory, wages, and short-term debts.
(c) Lease assignment
If the business you’re buying operates on leased premises, then the lease needs to be transferred to your name. Legal fees should also be taken into consideration if you’re transferring a lease agreement.
(d) Tax obligations
Goods and services tax (GST) is generally applicable to all business sales except when the business is being sold as a ‘going concern’. To qualify as a going concern, the sale should include everything that’s necessary to keep the business operations running.
(e) Stock take
Businesses must account for the value of their trading stock when they settle the business.. Generally, the stock value will be calculated a day before the settlement date to ensure the figures are up-to-date.
(f) Other adjustments
These can include expenses such as adjustments on employees, leases, outgoings payable, etc.
The Best Way to Buy a Business
Don’t commit right away! Given the complexity of how businesses can be purchased, it’s still best to seek professional advice instead of doing it yourself. Mistakes can be costly, and the goal is to minimise if not completely eliminate them so can rest assured that you’re making the most out of this huge financial investment.
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