What to Consider When Buying a Business

Whether you are seeking to buy a services, manufacturing, or other type of business, there are many issues that you should consider when structuring and negotiating the terms of the transaction.

Buying a business can be an overwhelming experience, especially for the first time buyer.  However, even experienced business purchasers can sometimes miss the red flags in their quest to close the deal.

There are several key factors that you should carefully consider when buying a business, including transaction structure, valuation, financial and legal due diligence, and financing options, to name a few.  Each factor, if managed strategically, may help leverage your position.

Assuming the target business is a corporate entity (“TargetCo”), the following are some of the issues relevant to a buyer in a purchase and sale transaction.

1) Structure of the Transaction

Asset vs. Share Transaction

A purchase transaction may be structured as an asset or a share transaction.

In an asset transaction, you are able to select those specific assets which you wish to purchase.  Accordingly, you may select the specific liabilities that you are prepared to assume.

In a share transaction, you acquire the shares of TargetCo with all assets and liabilities, known and unknown.  It is the emergence of unknown liabilities at a later date that can seriously affect your operations. Therefore, you will want to negotiate certain legal protections to help mitigate their impact.

Due to the varying risk of liabilities associated with each of the structures, the seller may demand a higher purchase price in an asset transaction and the purchaser may demand a lower purchase price in a share transaction, as well as certain protective representations, warranties, and indemnities.

In addition, because each structure has varying tax implications, you should discuss the tax issues and their implications with your trusted tax and accounting advisors.

2) Valuation

You should carefully determine the valuation of the assets or shares, as the case may be, of TargetCo.  Among the many factors in determining the purchase price, you should consider:

  • Historical financial position (including, revenue cycle and profit history)
  • Future profit potential
  • Condition of the business and assets
  • Tax consequences
  • Risk and potential liabilities
  • Economic conditions

Each of the factors above can impact your understanding of the actual current and future value of TargetCo.  Accordingly, it may be desirable to use your most conservative assumptions and estimates.   You should seek the assistance of your trusted accounting and tax advisors in your determination of the purchase price.

3) Due Diligence

In addition to conducting financial investigations of TargetCo, it is important that certain legal investigations be conducted prior to entering into the transaction, for example:

  • Inspection of corporate records and commercial agreements
  • Sellers’ status and residency requirements
  • Property searches (real and personal property)
  • Litigation searches
  • Labour and employment matters
  • Tax matters
  • Required consents, approvals and/or notices

Inspection of TargetCo’s corporate records and agreements will enable you to ensure that it has the requisite licences and registrations to operate the business and to determine the status of same.  If TargetCo’s licences and registrations are not in good standing, your ability to carry on the business could be affected.

Searches confirming the existence of TargetCo are of considerable importance.  For example, if TargetCo has been dissolved due to its failure to comply with ongoing filing requirements, such an event could delay the closing as TargetCo would need to file the necessary forms/documents for revival.

Searches relating to TargetCo’s assets are necessary for determining the owner of the assets, and whether or not the assets are free and clear of encumbrances.  Depending on the situation, you may require all, or certain encumbrances, be discharged prior to closing.

Litigation searches will reveal litigation matters that TargetCo is a party.  Such information will enable you to further investigate both the rights and obligations thereunder, which could affect you after closing.

It is also important to determine any outstanding tax liabilities of TargetCo. You will want to ensure that the purchase and sale agreement properly addresses the repayment of same or that adequate reserves have been made.

Extensive due diligence investigation is an effective method of limiting risk.  Liabilities revealed during such investigation can be addressed through negotiation, with the help of your trusted legal advisors.

4) Financing

Along with determining the purchase price, you may need to determine whether you will look to the seller or to external sources to finance the purchase price.   If the seller is agreeable to finance part of the purchase price, the terms and conditions of such financing will need to be negotiated, including the term, rate of interest, payment schedule and security.

The aforesaid are just some of the key factors you should consider as a purchaser of a business.  Your trusted legal advisors can help you identify and address both potential opportunities and risks associated with buying a business.

For four generations, Mills & Mills LLP has assisted clients in the Greater Toronto Area with all of their business and litigation needs. We regularly advise business owners on business formation, day to day business operations, risk management, and all other aspects of running a venture. To benefit from the individual, customized service and the superior business law knowledge that Mills & Mills LLP offers, please contact us at 416­-863-0125 or send us an email.

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