Understanding the Realistic Value of a Business
Before committing to a purchase price for any business, you need to understand its realistic value. This is not simply a matter of accepting the seller’s asking price or making assumptions based on revenue. At some point before you lock in on a purchase price, you should consult with someone knowledgeable in business valuations to ensure you are in the proper range for what you are buying.
Business appraisals can be obtained for as little as $5,000 and typically take about a month, depending on how quickly information flows between parties. While this may seem like an added expense, consider the alternative. If you are spending one million, five million, or six million dollars on a business and you are off by half a million dollars, that business appraisal was absolutely worth the investment.
Beyond the formal appraisal, you should be reviewing the financial statements, tax returns, and accounting software records of the business. QuickBooks or similar platforms contain valuable information about how the business actually operates day to day. More importantly, you should have a CPA or business valuation professional reviewing these documents alongside you to provide additional insight and catch potential issues you might miss.
Assessing What Can Actually Be Transferred
One of the most overlooked aspects of buying a business is determining how much of the business value can actually be transferred to you as the new owner. Not everything that makes a business valuable automatically comes with the sale.
Consider a professional business such as a law firm or medical practice. A significant portion of that business’s value may be tied to a specific individual—perhaps the founder whose name is on the door. Customer loyalty and professional relationships attached to that individual may or may not transfer to a new owner. When you buy the business, you may find that clients leave because their relationship was with the previous owner, not with the business itself.
The same principle applies to key employees. Before purchasing a business, you need to know whether those key employees will stay with the company after the sale or whether they plan to go their own direction. Losing critical staff members can dramatically reduce the value of what you thought you were buying.
Licenses and distributorships present similar challenges. Is the business license transferable? If the company holds a distributorship agreement with a manufacturer, can that agreement be assigned to a new owner? These are questions that must be answered before you finalize any purchase.
Planning for When Things Go Wrong
No one enters a business purchase expecting it to fail, but prudent buyers plan for that possibility. Before closing on any deal, you should have a clear understanding of what happens if, for whatever reason, the sale goes bad.
If what you thought was the case turns out not to be the case, do you have recourse? Can you offset part of the purchase price against problems you discover after closing? Will the seller back you up if you get sued over something related to the business that occurred before you took ownership?
These questions need answers before you sign any agreement. Having a plan for unexpected problems protects your investment and gives you options if the business does not perform as represented.
Essential Documents in Every Business Sale
No matter how a business sale is structured, certain documents are essential to protect both the buyer and the seller. At the core of every transaction is a purchase agreement that describes exactly what is being purchased and sold. This could be the assets of the business, or it could be stock or other ownership interests. The agreement must clearly state what is included in the sale and what the purchase price will be.
The purchase agreement should also document the facts of the business as both parties understand them and specify what happens if those facts turn out to be incorrect. This is a comprehensive document that addresses contingencies and protects both sides.
From the seller’s perspective, if the business is being purchased over time rather than in a lump sum, a promissory note is essential. That promissory note should be secured by a security agreement where the buyer pledges collateral—at minimum, the assets being purchased, and ideally additional collateral as well. Sellers typically also request one or more personal guarantees to provide additional protection.
Collateral agreements accompany the main purchase agreement and handle specific aspects of the transfer. These include a bill of sale, assignment of intellectual property, assignment of contracts, and similar documents that formally transfer various business assets to the new owner.
From the buyer’s perspective, most protections are encapsulated in the purchase agreement itself. Buyers focus heavily on what happens if something goes wrong. Can part of the purchase price be held back in escrow? Will the buyer be compensated if something represented as true turns out to be false? Is there a mechanism to unwind the deal entirely if it becomes a disaster?
Talk to Sierra Crest Business Law Group Today
Buying a business is an exciting opportunity that can change your life and your family’s future. But the complexity of these transactions requires proper guidance and documentation. Having the right professionals on your team helps you navigate the process, avoid common pitfalls, and set yourself up for success.