Toronto business and technology lawyer, Sukhi Hansra, of Hansra Law, discusses the key steps and considerations in buying an existing business.
Whether acquiring an up-and-coming competitor or building your investment portfolio, buying a new business can be an exciting opportunity. Regardless of your reasons, the process of purchasing an existing business follows the same general pattern. From finding and evaluating the right business for you, to closing the transaction, this Legal Guide will walk you through the key steps and considerations for buying an existing business.
For more information about the benefits of purchasing an existing business, see our Legal Guide on the 4 Benefits of Purchasing an Existing Business.
Steps for Buying an Existing Business
1. Find a Business to Purchase.
There are several ways to find a business to purchase. Business brokers act as intermediaries between buyers and sellers, while business lawyers and accountants often have great private leads for companies that are looking for a sale. Franchisors, commercial real estate agents and bankers are other sources for good leads on finding potential acquisition targets, or you could simply canvas your network.
When looking for a business to purchase, it is important to not only look to the financial outcomes of the purchase. Other factors that are important to consider are operational history, diversity of customers, long-term growth plan, location and market competition. Finding the right fit is equally as important as the profits to be generated from a potential acquisition.
2. How to Conduct a Business Valuation.
Once you’ve identified a business opportunity, it’s important to establish a realistic and fair dollar value of the business. A solid business valuation can help you a negotiate better deal by showing you exactly why the business is worth its selling price. Several valuation methods are commonly used, from a simple Times Revenue method to the more complicated Discounted Cash Flow method. Each method has different drawbacks and levels of assurance that the result will accurately reflect your company’s worth.
For more information about choosing a business valuation method, see our Legal Guide on 5 Ways to Valuate your Business During Uncertain Times.
3. Negotiating the Purchase Price, and Other Key Terms.
Now that you’ve decided you want to move forward with the business acquisition and you have a good idea of what the business is realistically worth, it’s time to negotiate the purchase price. A simple way to start this process is to provide the seller with a non-binding offer, which means that the offer will not be set in stone yet. Remember, negotiations can change as the transaction unfolds. Oftentimes the buyer will find additional information while conducting due diligence into the background of the business, which may impact the value of the business.
As part of the negotiations, a key decision you will want to make is whether to purchase the assets of the business or the shares of the business. For more information about the distinction between an Asset Purchase transaction and a Share Purchase transaction, see our Legal Guide on Asset Purchase vs. Share Purchase. Generally, a Share Purchase is preferred by sellers due to the tax benefits, while an Asset Purchase is preferred by buyers due to the ability to avoid the seller’s business’ liabilities.
4. Submit a Letter of Intent (LOI).
Once you and the seller have a general idea on the key terms and structure of the transaction, you can prepare and submit a Letter of Intent to express formal interest in purchasing the business. A Letter of Intent to purchase a business is a short document outlining the intentions of the parties and the basic elements of the proposed transaction.
Some key items that are typically negotiated and inserted into a Letter of Intent include a list of assets or shares being purchased, the purchase price and how it will be paid (full cash buyout, bank loan or monthly instalments), the proposed closing date, negotiation and investigation time periods (often called due diligence periods), exclusivity periods, assumption or termination of employees, non-competition and non-solicitation agreements.
5. Complete Due Diligence.
When you first express informal interest in purchasing a business, you will likely only receive basic information about how the business is performing. The due diligence period is your chance to take a deeper dive into the financials, operations, customers and supplier networks, and any other pertinent matters that will help you decide whether to proceed with the transaction.
Some key documents to review during the due diligence period are financial statements for the past 3 years, customer and supplier lists, existing contracts, any commercial leases, franchise documents (if applicable), employee and manager information and legal records.
6. Obtain Financing.
Most businesses are purchased with a combination of debt and equity, which means you’ll pay part of the purchase price with cash and the rest through a loan. There are several ways to finance the purchase of an existing business including traditional bank financing, specialised small business loans (see, for example, Business Development Bank of Canada or the Canada Small Business Financing Program) or vendor financing. Vendor financing is a loan provided by the seller of the business, which is typically paid back by the buyer on a monthly basis after business transaction has been completed.
7. Prepare a Formal Agreement and Close the Transaction.
Once the key terms are finalized and any due diligence investigation is complete, the buyer and seller will prepare an Asset Purchase Agreement or Share Purchase Agreement (whichever is applicable) to formalize the final agreements between the parties. This agreement will include a final closing date, purchase price, conditions to closing and other understandings between the parties. On the closing date, your lawyer will transfer the purchase price funds to the seller’s lawyer. The purchase price will be held in escrow (meaning the law firm will hold the money for safe keeping) until all the documents are signed and the business is officially transferred over to you.
Once the closing is finalized, you will need to ensure that your corporation has all the necessary licenses and arrangements to operate the business. If your business acquisition was a share purchase, then this may not be necessary because you have purchased the seller’s corporation in its entirety.
Buying a business can be both an exciting but stressful experience. Although these are great starting points to consider when deciding to purchase an existing business, many business acquisitions can get quite complex, particularly when it comes to the degree of legal liability and risk that you are taking on.
A good first step would be to speak to someone who has been through it, or someone who has helped others purchase and sell businesses – such as an Accountant or Business Lawyer.