By William Bruce, President, American Business Brokers Association.
Let’s say you have looked at several businesses for sale and narrowed it down to the one that you want to pursue. You think you might want to make an offer to buy this business, but you’re not quite sure. You have a little anxiety about the unknowns.
The problem, bluntly stated, is that the seller of the business does not want every Tom, Dick and Harry going through his private books and records, some of which might be very sensitive for one reason or another.
Let me ask you at this point to stand in the seller’s shoes for a moment. He has taken the big step of putting his business up for sale. This may have been a tough emotional decision for him. And he probably has the same heightened level of anxiety as you do about the future transaction.
Now his business is up for sale and before long, he’s got all sorts of strangers asking him to let them look through his most private records.
As a business broker, I can verify that this is a real problem. Some people who look at businesses have no real intention of ever buying one. They are what we call “tire kickers.” They will look forever and never make a purchase. Others may have a real interest, but when push comes to shove, they lack the financial capacity to make the purchase. Still others may have the financial capacity, but are unwilling to pay the owner anywhere near an acceptable price for his business. There have also been instances in which a competitor sent in a stranger to check out the business. And all of these people will demand to paw through the seller’s private books and records.
Now you may step back into your own shoes. The brief visit to the seller’s side of the desk, I hope, gives you an understanding of the problem.
The solution is the contingent offer to purchase.
Simply stated, it works like this. You, as the prospective buyer of the business, assume for the moment that the preliminary information furnished to you on the business is accurate. You should by now have at least the annual revenue and cash flow of the business plus the other important numbers.
You then base the amount of your offer to purchase the business on those numbers, but with the following verbiage written into the contract as a condition of the offer:
This offer to purchase said business is fully contingent upon buyer’s inspection of all the books and records of the business and the buyer’s satisfaction with the information contained therein.
This verbiage in the contract fully protects you. If you find, during your inspection of all the books and records, including the tax returns, that the numbers furnished you were not correct, then you have the perfect right to terminate the contract and walk away with no further responsibility. Any earnest money deposit held in trust is promptly refunded.
This procedure also protects the seller, as he knows that you are now serious about the transaction. You and the seller have come to an agreement on price and terms – possibly after some counter offers – and you have put up an earnest money deposit. The seller should now regard you seriously, and accordingly will open up all of his books and records for you to inspect. This inspection phase of the transaction, by the way, is referred to as due diligence and is covered in this article.
The contingent offer is actually a win-win situation for both parties. It assures the seller that the buyer is serious and it protects the buyer in case the information that has been furnished is not accurate.
The Other Contingencies
There are other contingencies that you also might want to include in the contract. For example, if you are borrowing the money with which to purchase the business, you would need to include the following language to protect yourself if you don’t already have the loan approved:
This offer is fully contingent upon the buyer obtaining satisfactory financing for the purchase of the business.
And if the business operates from leased premises, you would want to include the following proviso:
This offer is fully contingent upon the buyer’s assumption of the existing lease for the business premises or otherwise negotiating an acceptable lease with the landlord for said premises.
Other items that should be included in the purchase contract
- The Closing Date and Place. Pick a closing date that will give you enough time to inspect the books and records of the business, get your loan approved and take care of any other issues.
- Inventory Level. If the business carries inventory for resale, this is where you agree on the amount of inventory that must be on hand on the date of closing. This should be the amount of inventory normally carried by the business in the normal course of doing business. Your broker should have this figure. The purpose of this provision is to prevent an unscrupulous seller, between the date of the agreement and the date of closing, from selling out the inventory and leaving the buyer with empty shelves. You and the seller jointly take inventory on the day of closing. If the inventory level, at cost, is below the figure specified in this paragraph, the purchase price of the business goes down by the amount of the shortage. Conversely, if the inventory is over the specified level, the price of the business is adjusted upward by the amount of the surplus. This is fair to both parties, and if the inventory discrepancy is small, the difference is usually waived, as both parties understand that it is impossible to quote an exact inventory figure in advance for any given day. But the provision is there for protection if it needs to be invoked.
- Training. You and the seller need to agree on the number of days training you think you will need from the seller. Normally, this ranges anywhere from one to two months.
- Non-Compete Agreement. You don’t want to buy Ms. Jones’s gift shop and then next month see Ms. Jones open a competing shop right down the block. This provision prevents that possibility. You simply agree on the distance and time limitation in this paragraph of the contract.
- Removal of Contingencies. Remember all of the discussion above of the contingencies: inspection of the books, the lease and loan approval. At some point, these contingencies are satisfied or waived by the buyer. This part of the contract is where you decide how much time you’re going to need to accomplish any work needed to satisfy yourself as to these contingencies. Ten to 15 days prior to the closing date is customary. After satisfaction of the contingencies, the contract then becomes binding on both parties, and the closing documents can be prepared.
- Offer Deadline. This provision gives the seller a deadline for response (acceptance or counter-offer) to your offer. If there is no response from the seller by this date and time, your offer is legally null and void and you have no further liability. Two or three days are long enough here, unless there are unusual circumstances.
Readers can request by email a copy of William Bruce’s 67-page booklet, “How to Buy a Business in a Safe and Organized Way.” The booklet contains a sample of an Offer to Purchase Agreement. The email address is Will@WilliamBruce.org.
Now, take a deep breath. It’s really not as complicated as most folks seem to think. And we’re just getting to the fun part – the negotiations, which is covered in a separate article.
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William Bruce is a business broker, an Accredited Business Intermediary (ABI) and a business appraiser assisting buyers and sellers of privately held businesses in the transfer of ownership. He currently serves as president of the American Business Brokers Association.
He is available nationally to advise on issues involved in the sale or purchase of a privately held business. He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org.
His article on how to analyze a business that you may be interested in buying can be read by clicking here.(C) Copyright William Bruce. All rights reserved.
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