This is the sixth and final post in a series of posts about buying a small business and purchasing our first one. If you are catching this series mid-stream, I recommend you start at the beginning of the series with Buying a Small Business: Overview.
In the first post in this series, I covered the benefits and downsides of buying an existing small business. I also mentioned the fishing lure business that my wife was unenthusiastic about purchasing and that one week later, she found the perfect business to buy.
In the second post in this series, I talked about how you might go about finding a business for sale and establishing selection criteria. I also shared where we found our business and the selection criteria that we used.
In the third post in this series, I explained debt financing and borrowing money to purchase a small business.
In the fourth post in this series, I explained equity financing and tapping into your retirement accounts penalty-free to get the equity you need.
In the fifth post in this series, I talked about how to go about conducting your preliminary due diligence and making the seller an offer.
In this final post, I’ll explain the confirmatory due diligence phase and closing the deal.
Confirmatory Due Diligence
Assuming that you and the seller have agreed upon the deal terms outlined in your Letter of Intent (LOI), now is the time to confirm all of the important information that you gathered during the preliminary due diligence phase. It’s also time to start spending some money on accountants and attorneys.
Most importantly, you will want to find both an accountant and an attorney that are familiar with small business transactions. If they are, they will know the common areas to examine for issues and red flags.
An experienced accountant will have a good sense of the common risks in smaller firms’ accounting practices. They will focus on areas like taxes, and proper accounting for non-cash expenses. Some examples of non-cash expenses are bad debt reserves or accruals for sales bonuses earned, but not paid yet. Leave these items to a professional.
Similarly, an experienced lawyer will know which contracts to focus on, and typical terms and conditions. They will also help you with the final purchase agreement and related documents. You need to conduct this due diligence economically, so hiring experienced professionals who know where to focus is important. They will be able to get the work done efficiently.
There are six fundamental areas to assess during the confirmatory due diligence:
- Honesty of the seller
- Any issues with the accounts and finances
- Any issues with the contracts or other legal matters
- Customer and supplier perspectives
- Employee perspectives
- Any specialized due diligence that may be specific to this company (e.g. engineering assessments)
The list above is self-explanatory, but I do want to highlight the first item – seller honesty. If in going through the due diligence process, you get the feeling that you cannot trust the seller, my advice would be to abandon the deal. If someone is determined to try to “pull a fast one on you”, no amount of contract language will protect you. How do you get a sense for seller honesty?
A this point in the process, you should have had many conversations with the seller and be starting to get a sense for the type of person he or she is. You’ll get even more of a perspective as you talk to customers and suppliers. Have they been treated fairly? How do employees feel about the owner? Does he/she pay suppliers on time and in full? You’ll learn a lot about the seller from all of these conversations.
One lesson I learned from our attorney when we bought our first business, is that it could very well cost you more in attorney’s fees to enforce the contract than the actual money you would receive in any judgement. That’s an interesting thing to consider. It’s simply not worth trying to do business with someone who you do not trust or who you believe to be dishonest. There are enough honest sellers out there that it is worth waiting until you find one of them.
During this phase of confirmatory due diligence, you are not really looking for any new information. You are just making sure that everything you were told is true and that any assumptions you made are accurate. With that information, you are validating that your financial projection is correct and that the price you offered is fair.
If you find anything that would cause you to change the initial financial projection that you made during your preliminary due diligence, then now would be the time to re-negotiate the purchase price. You will have varying levels of success depending on the seller and the situation. If you find outright fraud, then it’s time to walk away. You may find something that the owner was not even aware of, in which case it will be a negotiation as to who pays.
The rest is easy. Your attorney draws up the purchase agreement, whose main points you have already agreed to with the buyer through your LOI or later negotiations. You may discuss some finer points of the language, but once you’ve reached this point in the process, I would say your chances of closing the deal are very high.
Show up on closing day, sign all the papers, exchange keys and passwords, etc. Then, the business is yours!
What We Did
Here’s what we did back in 2010 when my wife came running down the stairs saying, “I found the P-E-R-F-E-C-T business to buy!” It turns out she was right, it was the perfect business for her.
She had found a fundraising company for sale that worked with schools and other non-profits. Why is this a good business for her? Because she loves kids and the idea of helping schools to raise money. Also, because the work lines up perfectly with her stay-at-home mom schedule. It is a very cyclical business that is busy in the fall and spring while our own kids are in school. In the summer or over the holidays, when our kids are home, there is a minimal amount of work for her to do with the business. For some people that would be a problem, but for us it’s been perfect.
There were no employees to complicate matters and the business is easily run from home. From a financing perspective we purchased it outright with our HELOC, so we did not need any debt financing or outside investors. It had a steady income for years and a high repeat customer rate. Interestingly, there weren’t good comparable sales for this business, so we ended up looking at a one year break-even on the purchase price and it worked out perfectly. In the first year, we got our money back from the purchase and for the next five years, it’s all been extra cash.
No one was more surprised than I was, when, after looking into the business, I realized that it actually was perfect for her. And yes, I’m big enough to admit, much better than my fishing lure business idea! She found it the last week of December and we closed in mid-February.
There was no way to do the topic of buying a small business justice during such a short series like this, but I wanted to at least give you a flavor for what was involved and hopefully demystify the process. I hope that you found it interesting and perhaps you’ll consider buying a business someday – it’s really not that hard.
It’s a lot like buying a house in many ways, but obviously the due diligence could be much more complex. On the other hand buying a small or simple business could be much easier than buying a house too, it just depends.
If you do decide to try buying your own small business, I recommend the following two books on the topic. Both are excellent:
- The Complete Guide to Buying a Business, Nolo.com
- HBR Guide to Buying a Small Business (HBR Guide Series), Harvard Business Review
If you ever have any questions about buying a small business or would like to discuss it further, feel free to leave a question below or shoot me a note from the contact page. And if you do take the plunge and go looking for a business to buy, then best of luck!
After reading the series, are you interested in buying a small business? Did you realize it was so easy? Is there anything else you would like to know about buying a small business?