Business Acquisitions Checklist

Business Acquisitions: Due Diligence Is the Key to Success

August 2004
Robert W. Stocker II The acquisition of a business is a critical moment in any entrepreneur's business life. Proper structuring of the transaction is critical to the ultimate success of the transaction. As is so often the case, the devil is in the details. Buying a Business Buying an existing business is an exciting event. The very essence of the willingness to make the acquisition is the buyer's belief that the business will provide the buyer with substantial income, an improved quality of life and control of his or her own destiny. Belief in the ultimate success of the business is a fundamental element of the capitalist spirit. Keeping that spirit in check and doggedly performing the requisite due diligence in connection with the acquisition is a major ingredient in maximizing the likelihood of the ultimate success of the business endeavor. The due diligence investigation of the business before consummating the acquisition should include, at a minimum, a comprehensive investigation of the business based upon a checklist that the buyer prepares and works from before commencing negotiations. At a minimum, this checklist should include the items below. 1. Obtain and review: • Financial statements of the business (3-5 years) • Tax returns of the business (3-5 years) • Asset list • Business records (Articles, Bylaws, Operating or Partnership Agreement, minutes, etc.) • Ownership confirmation data • Contracts, loan agreements, supplier agreements, franchise agreements and customer agreements entered into by the business • Licenses issued to the business • Employee benefit programs of the business • Uniform Commercial Code search • Tax lien search • Credit report on business 2. If real estate is being purchased, obtain and review: • Title search • Survey • Phase 1 Environmental Report 3. If the business is required to be licensed by any government authority: • Identify licensing authority • Determine licensing requirements • Determine time frame for obtaining license • Determine whether the licensing authority may require physical plant upgrades of the business as a condition for continued licensure and, if so, the probable cost of such upgrades 4. Request detailed information on existence of any threatened or pending: • Lawsuits • Contract or franchise agreement breaches • License violations/citations • Government regulatory violations/citations 5. Review employee roster and determine key employees that must be retained by business on a going-forward basis 6. Determine need for covenant not to compete and consulting agreements Finally, the buyer should work with an accountant who is knowledgeable in business transactions to obtain advice on structuring the acquisition from an accounting perspective in a fashion that maximizes the buyer's tax structure and tax advantages. Selling a Business When preparing to sell a business, the seller should first assume that the prospective buyer will be requesting all of the information set forth above. Therefore, the seller should collect and prepare this information in an orderly fashion before commencing negotiations with a prospective buyer. By taking this step in advance, the seller can identify potential problem areas and deal with them before the prospective buyer commences the due diligence process. In essence, the seller should prepare the business for sale using the same concepts that a smart home seller utilizes (i.e. spruce up the business before it is put on the market to maximize the sale price). In addition, before giving business data to a prospective buyer, it is imperative that the seller have the prospective buyer execute a confidentiality agreement. The purpose of the confidentiality agreement is to prohibit the prospective buyer from retaining or using information provided by the seller should the prospective buyer not purchase the business. Most small business sales are seller financed (i.e. the seller accepts payments from the buyer over an agreed upon period of time – often 5 to 10 years) rather than cash sales. A seller financed sale requires special attention to the financial strength and the business integrity of the prospective buyer, as well as to the structure of the sale transaction, to maximize the likelihood of the seller's receipt of the full purchase price as agreed upon. The seller's checklist should include, at a minimum, the following: 1. Obtain a credit report on the buyer (including owners of the buyer if the buyer is an entity) 2. Perform litigation and license checks on the buyer (including owners of the buyer if the buyer is an entity) 3. Structure the sale transaction to include the following: • Security interest (preferably first priority) in all assets being sold plus any after acquired assets of the business • Mortgage (preferably first mortgage) on real estate sold or, in the alternative, sell real property on land contract • Cross-collateralization of all promissory notes and mortgage notes • Access to buyer and business during regular business hours while buyer's payment obligations remain outstanding • Copies of financial statements of business on regular basis while buyer's payment obligations remain outstanding 4. Obtain personal guarantees by individuals and spouses of payment in full of all promissory notes, mortgage notes and land contracts The seller's business accountant should also be consulted for advice on structuring the sale from an accounting perspective in a fashion that minimizes the seller's tax obligation arising from the sale. Transaction Documents As prepared by knowledgeable business legal counsel, the final transaction documents should address at a minimum the checklist items set forth in this article, as well as the customary representations and warranties that are included in any well-structured transaction. When the transaction is ultimately consummated, both the buyer and the seller should be able to depart from the negotiating table knowing that their respective interests are properly protected and adequately secured in a fair and reasonable matter. Never lose sight of the fact that a successful business transaction is one where both parties obtain what they have bargained for. Robert W. Stocker II is a Member in Dickinson Wright's Lansing office, focusing his practice on corporate law, mergers and acquisitions, insurance law, and gaming law. For more information, please contact him at 517-487-4715 or rstocker@dickinsonwright.com.
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