The 7 steps to buying another business without getting stung

Acquiring an established firm is less risky than starting your own. But it’s not hazard-free.

By Edward Byrne Corporate finance director, Crowe

THE BENEFITS OF buying an existing business are manifold.

Buyers can benefit from acquiring a well-known brand, a strong customer or client base, an established supply network, key management team, critical licences or a strong physical location.

However, while buying an established business is considered less risky than starting your own, it is not hazard-free.

Crowe always advises its clients to enter negotiations with their eyes open, their homework done and an attitude of “buyer beware”.

Here are a number of considerations for buyers that can help reduce the risks when acquiring a business and ensure you receive value for money on your investment.

1. Target the right business for you

Many entrepreneurs make the mistake of buying the wrong business. It is vital to make an acquisition that is the right fit for your skill set, experience or one that fits with your existing company.

It is a common misconception that if an owner decides to sell a business, there must be something wrong with it.

In reality, businesses are sold for a number reasons including the age profile of the owner, health reasons, divesting of non-core operations, a requirement for increased investment in the business or possibly a personal financial shock.

If your own research has not found the type of business you are looking for then consider asking an advisor to help identify viable targets.

They often know of companies for sale off-market or have connections with other advisors who might have suitable targets. Advisors can also help prescreen and carry out research on a company before approaching them.

2. Evaluate how much you’re willing to pay

An independent assessment or business valuation should be carried out to establish what the target business is worth, the future potential of the business and how much you are willing to pay.

Factors such as client retention and whether the business has recurring revenues can have a significant impact on the valuation, so it is important to explore beyond the basic financials.

We would advise that an accountant evaluate the business’s accounts very carefully to make sure the historical financial performance is a true reflection and correlates to the price being asked.

According to industry data, firms typically sell for between 15% and 25% below the seller’s initial asking price. So ensure you have considered all relevant factors carefully before submitted a bid and agreeing commercial terms.

3. ‘Flush out’ misunderstandings early on

It is imperative to focus on the heads of terms as it sets out the price and commercial terms and ultimately forms an important part of the final agreements.

This is a buyer’s opportunity to set out their position. Don’t forget that the seller’s initial asking price is just a starting point for negotiation. The heads of terms will help bring focus to the negotiations and ‘flush out’ any misunderstandings at an early stage.

Commercial and legal advice should be sought in preparing this key document as advisors will highlight issues that had not previously been considered.

4. Do your due diligence

Due diligence is essential to develop a full understanding of the business you are acquiring and to identify any potential risks that might leave you exposed. A business that looks great at first glance could have a number of issues.

Due diligence will also help in identifying the warranties necessary to protect the purchaser against any future liabilities. This could include possible problems in relation to employees, title to property, insurance and banking facilities.

Depending on the outcome of the due diligence, a buyer might want to renegotiate the price or adjust the timing of the payment of the full consideration.

5. Select the correct structure

When buying a business, it is crucial that you choose the correct structure that will allow you to scale the business without incurring significant costs. Different structures can have a significant impact on the tax liabilities a buyer could face.

Careful tax planning is a key element in buying a business and should be carried out at the early stages of the process.

It will highlight the pros and cons of how the transaction is structured. Picking the correct structure will enable the new business to maximise growth and minimise tax liabilities.

6. Fill the funding gap

A good time to secure finance to purchase a business is when the sector it operates in is in a growth phase. A strong business and integration plan will also assist in securing the funding you require.

It is important not to over-leverage your existing firm. Consideration needs to be given to the cash flow available within the existing business and what funds it can commit.

Future working capital and capital expenditure investment should be considered before making the offer to purchase. The cost of the purchase including professional fees also needs to be factored into the funding commitment needed.

In the current climate, banks and alternative senior debt lenders are unlikely to lend 100% of the funding required. As a result, you can be left with a funding or equity gap.

A number of private equity partners are currently in the market who can assist in narrowing the funding gap by way of offering capital for equity positions within a business.

Each financing source comes with its own pros and cons, so do your research and talk to an advisor to make sure the funding source you pursue is the best choice for your bottom line.

7. Manage integration and change

Many mergers and acquisitions fail because of poor handling of change management and a lack of effective integration.

Company culture plays a major role in whether the acquisition will be a success or a failure. For the business being acquired, there may be a resistance to any change in the status quo or towards the new owner from existing staff.

Communication with staff is critical. As soon as possible, take the time to meet with key staff and understand how the business operates day-to-day and the roles they play.

Keep a focus on your key strategic objectives and development plan, and bring your key employees with you on that journey to ensure early buy-in and efficient implementation.

Edward Byrne is a director of corporate finance at Crowe.

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