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Before you purchase an existing business, be sure you understand exactly what you're buying. There are two basic methods of buying an incorporated business: purchasing assets or shares. You should determine which of these two means you intend to use because the evaluation assessment will vary depending on the method.
Perform a due diligence
In any acquisition, you will need to examine the financial statements, legal status and assets such as inventory, equipment and accounts receivables with in-house and outside experts in these areas. If the reported facts are accurate, you can then proceed with the transaction.
You should confirm the vendor's good faith and the soundness of the business. For instance, if the majority of sales are generated by only a few customers, you should confirm that they intend to continue to do business with the new owners.
Although difficult to do, your assessment must also take into account any changes you intend to make to the company after the acquisition. These changes may be essential, but keep in mind that their cost may substantially reduce the return on the capital invested.
Evaluating assets
The vendor should supply you with a detailed list of what is being offered for sale in order to complete your due diligence. Assets may, but do not have to, include: land, building, equipment, inventory, business name, customer list, contractual agreements with employees and suppliers, prepaid expenses and intellectual property.
The condition of the purchase
- Equipment: Be sure you have model numbers, dates of purchase, functionality, maintenance schedules and warranty details.
- Inventory: Determine the age of the stock and its condition. Are the items obsolete? If the items are perishable, are they within their "best before date"?
- Accounts receivable: Determine the quality of the receivables. Are they old? Are they collectible? Is there an adequate provision for bad debts? Are there any disputes associated with the receivables?
Company's liabilities
Depending on the nature of the assets, there may be loans or unpaid liabilities that will become your responsibility as a buyer. A lender might even seize the assets, repay the loan and leave you with nothing. You need to know if the company has signed any agreements that may affect the value of assets or limit your freedom of action.
Determine fair market value (FMV)
Depending on the type of asset being purchased, there are a number of ways of determining FMV. For large assets such as real estate or major pieces of equipment, or for specialized inventory, an appraisal may be appropriate. For accounts receivable with a large number of customer accounts, you could engage the services of a collection agency to determine a reasonable valuation of the receivables.
Implications of buying shares
In a capital-based transaction (buying shares), you are owner of a business with everything that comes with it. You are actually purchasing all of the assets of the company as well as assuming all of the liabilities of the company, whether recorded in the books of the company or not. Here, the purchase agreement may include a provision that states you are directly involved in the management of the company or that you remain a silent partner. By doing this, you can make a smoother transition to business ownership. You won't have to raise the entire purchase price, and the existing ownership can show you how the business is run. Ultimately, you could buyout the remaining shares and become sole owner.
This is a possibility if the target business is publicly traded on a stock exchange and if you've purchased enough shares to exert an influence. On the other hand, the owners may opt for an outright sale if the business is privately owned.
There are some risks involved:
- Not getting along with existing owners who may have strategies that conflict with yours.
- Becoming responsible for existing liabilities of the business such as unrecorded income tax reassessments, lawsuits, and warranty claims, which may have not been recorded in the financial statements.
- Being bound by existing depreciation schedules already in the business. If you purchase assets, you can depreciate those assets according to the purchase price.
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