Buying a business can be one of the most effective ways to grow your existing enterprise or launch a new endeavour. For seasoned business owners, the opportunity to purchase a business may allow you to add new lines of revenue, expand into new territories, or approach new customers that you struggled to connect with previously.
Before you buy a business, you need to do your homework. The due diligence phase is where you’ll investigate the potential purchase thoroughly – look into the company’s history, their financials, their forecasts, and review other key pieces of information. You’ll also have to assess how an acquisition would happen – will you be buying all shares of the business but leaving it as-is, or choosing to purchase only certain assets?
What does that due diligence process look like behind the scenes? What do you need to know about a business before you decide to buy it?
What is a business worth?
If you’re chatting with an owner that’s looking to sell their business, the price will inevitably come up. The owner may have a certain valuation in mind, which may be far more than you’re looking to pay. Yet if you’ve ever seen Dragon’s Den or Shark Tank on television, you’ve seen investors yell at founders that while their business may be great, their valuations are way too high.
Most potential buyers will turn to an outside third-party valuator to get an unbiased estimation of a business’ true value. Valuators may use various methods depending on the nature of the business. They may look at the business’ earnings and their upcoming forecast, they may look at the assets that the business owns, or look at the current market that the business is in.
A business is generally worth several times more than its current financial standings. When you buy a business, you are buying not only its current holdings, but also the future revenue-generating potential. An experienced valuator can help assess what that potential looks like, so that you’re not paying too much for an investment that is unlikely to pay off.
What exactly are you buying?
There are two primary ways to buy a business – either by buying up its shares and taking control of the business as it currently is without much disruption, or by selectively buying the assets of the business while opting not to purchase others. Before making any decisions though, you need to know exactly what you are buying.
Financial statements and forecasts are obviously crucial, but a business’ assets extend beyond just what it has in the bank. Does it own any physical premises, or any manufacturing equipment or storage space? Does it own land that has been developed, or remains undeveloped? Are there owned vehicles? Is there a significant volume of inventory on-hand, and is that stock still commercially viable? Does the business own any intellectual property, and is that IP properly protected?
The business may be rich with assets across various platforms, with great financial statements and a variety of holdings. Or, it may be operating primarily through leases and receivables, with rented premises and equipment contracts that you would be signing up for. Are clients quick to pay, or is there a significant amount still in receivables? A closer look at any liabilities will also help you understand the financial health of the business.
Who Owns the Business Currently?
If you have watched Dragon’s Den or Shark Tank, you’ve likely noticed a frequent problem. A founder comes in with an incredible pitch, and what looks like a great opportunity. However, as the Sharks begin to ask about ownership, they learn that the founder has already divested significantly, and there is a slew of other controlling minds that have either bought into, or may now own the lion’s share of the business.
Part of the investigation process of buying a business is to determine the ownership structure. Is it wholly owned by the founder or founders, or are there other investors who may also be in the mix, and who may have a different idea about how things should go? Your business lawyer will help explore the current legal structure of the business, and any of the issues that may arise there.
Who’s Coming with You?
One of the most common mistakes buyers make in the purchase of a business is related to employment law. When you acquire the shares of a business, you acquire the business as it currently is, and there is no change to the staff. However, when you make an asset purchase you have more freedom to cherry pick which of the business’ assets you would like to purchase, and that could include their current workforce.
Most buyers and sellers fail to realize that an asset sale can effectively end the staff’s current employment contracts. Employees who are not being hired by the new company should be given proper notice of termination, either through working notice if there is enough time, or pay in lieu of notice and potentially severance pay. Who is going to be responsible for paying these amounts – the vendor, or the purchasing entity?
If a purchaser acquires substantially all the assets of a business and subsequently employs individuals from the selling company, the employees’ service is deemed continuous under both the Employment Standards Act and common law. This means that if an employee had worked for the predecessor for 20 years, then they retain that seniority as a 20-year employee within the new purchasing company.
Are these employees under contracts that would limit the new employer’s financial obligations in a termination scenario? Are you inheriting 20-year employees, but will only be obliged to pay them minimum notice under the law? Or are there no written agreements in place, and letting these employees go later may cost a small fortune?
Final Thoughts
Buying a business can be an exciting venture and a great way to grow your enterprise but be careful not to go in unprepared. What may sound like a great deal at a cocktail party or on the golf course may be full of bad contracts and unexpected hurdles. Alternatively, a business that may not sound exciting at first could have some real potential in the right hands and may be a great bet at a reasonable asking price.
Working with a business lawyer is critical to your success. There are many moving pieces in these types of transactions, and they require careful attention. A skilled business lawyer knows what questions to ask, and what to look for when reading between the lines. Our business law team has been operating for decades throughout the Cambridge, Kitchener, and Waterloo regions, and we know what it takes to do things right. Contact our office today to set up a consultation.