Key factors to consider when buying a business

Key factors to consider when buying a business - Crowe Ireland

Given the current strength of the economy, growth through acquisition is becoming a viable option for small and medium-sized Irish businesses. Ireland’s merger market is showing huge signs of improvement as reported in William Fry’s mid-year 2018 M&A review. The review outlined that there were 76 deals worth €70.9bn completed in the first half of the year.

The benefit of buying an existing business are manifold. Buyers can benefit from acquiring a well-known brand, a strong customer or client base, an established supply network, key management team, critical licences or a strong physical location.

However, whilst buying an established business is considered to be less risky than starting your own business, it does not come without a number of risks. We would always advise our clients to enter any negotiations with their eyes open, their homework done and an attitude of “buyer beware”.

Below we outline a number of factors for buyers to consider which can help reduce the risks when acquiring a business and help ensure you receive value for money on your investment.

Target the right business for you

Many people make the mistake of buying the wrong business. It is vital to buy a business that is the right fit for your skillset, experience or one that fits with your existing business.

It is a common misconception that if an owner decides to sell a business, there must be something wrong with it. In reality businesses are sold for a number reasons including age profile of the owner, health reasons, divesting of non-core operations, a requirement for increased investment in the business or possibly a personal financial shock can could place the business in distress if not sold.

If your own research has not found the type of business you are looking for then consider asking an advisor to help identify viable targets. They often know of companies for sale off-market or have connections with other advisors who might have suitable targets. Advisors can also help pre-screen and carry out research on a company before approaching them.

Price

An independent assessment or business valuation should be carried out to establish what the target business is worth, the future potential of the business and how much you are willing to pay.

Factors such as client retention and whether the business has recurring revenues can have a significant impact the business valuation, so it is important to explore beyond the basic financials.

We would advise that an accountant evaluate the business’s financials very carefully to make sure the historical financial performance is a true reflection of the business and correlates to the price being asked for the business.

According to industry data, businesses typically sell for between 15 percent and 25 percent below the business seller’s initial asking price. So ensure you have considered the all relevant factors carefully before submitted a bid and agreeing commercial terms.

Heads of Terms

It is imperative to focus on the Heads of Terms as it sets out the price and commercial terms and ultimately forms an important part of the final agreements.

This is a buyer’s opportunity to set out their position. Don’t forget that the seller’s initial asking price is just a starting point for negotiation. The Heads of Terms will help bring focus to the negotiations and “flush out” any misunderstandings at an early stage.

Commercial and legal advice should be sought in preparing this key document as advisors will highlight issues that had not previously been considered.

Do your due diligence

Due diligence is essential to develop a full understanding of the business you are acquiring and to identify any potential risks that might leave you exposed. A business that looks great at first glance could have a number of issues.

Due diligence will help in identifying the warranties necessary to protect the purchaser against any future liabilities. This could include possible problems in relation to employees, title to property, insurance and banking facilities.

Depending on the size and complexity of the target business the following due diligence should be carried out:

  • Financial
  • Taxation
  • Legal
  • Insurance
  • Property
  • Environmental

Depending on the outcome of the due diligence a buyer might want to renegotiate the price or adjust the timing of the payment of the full consideration.

Structure

When buying a business, it is crucial that you choose the correct structure that will allow you to scale the business without incurring significant costs. Different structures can have a significant impact on the tax liabilities a buyer could face.

Careful tax planning is a key element in buying a business and should be carried out at the early stages of the process. It will highlight the pros and cons of how the transaction is structured. For example – whether the sale of the business should be an asset purchase or a share purchase. Picking the correct structure will enable the new business to maximise growth and minimise tax liabilities.

Funding

A good time to secure finance to purchase a business is when the sector that business operates in is in a growth phase. A strong business and integration plan will also assist in securing the funding you require.

It is important not to over leverage your existing business. Consideration needs to be given to the cashflow available within the existing business and what funds it can commit. Future working capital and capital expenditure investment should be considered before making the offer to purchase. The cost of the purchase including professional fees also needs to be factored into the funding commitment needed.

In the current climate, bank and alternative senior debt lenders are unlikely to lend 100% of the funding required. As a result, you can be left with a funding or equity gap. A number of private equity partners are currently in the market place who can assist in narrowing the funding gap by way of offering capital for equity positions within a business.

Each financing source comes with its own pros and cons, so do your research and talk to an advisor to make sure the funding source you pursue is the best choice for your bottom line.

Integration and managing the change

Many mergers and acquisitions fail because of poor handling of change management and a lack of effective integration.

Company culture plays a major role in whether the acquisition will be a success or a failure. For the business being acquired, there may be a resistance to any change in the status quo or towards the new owner from existing staff.

Communication with staff is critical. As soon as possible take the time to meet with key staff and understand how the business operates day-to-day and the roles they play.

Keep a focus on your key strategic objectives and development plan and bring your key employees with you on that journey to ensure early buy-in and efficient implementation.

When looking at buying a business, an external advisor can bring a lot of added value and help protect and maximise your investment. Our corporate finance team has extensive experience assisting clients in buying businesses and providing guidance through the different steps of the process. If you are considering investing or acquiring a business, contact a member of our corporate finance team.