PART 2 OF 2 SERIES
In last week’s blog, we learnt how to find the perfect business when buying a business in Canada. This week, we will dive into the specifics of what to look out for when purchasing one.
You have found the perfect business. Now what? Time to get real and follow these steps.
CONTACT THE VENDOR
When searching for a business, always verify the vendor’s identity. You have an option to explore on your own or hire a professional to guide you. The initial communication with the vendor is to ask for more information. Many times the listing will not disclose the address and specifics of the business.
SIGN A NON-DISCLOSURE AGREEMENT
You will sign an NDA – a Non-Disclosure Agreement with the vendor. This agreement protects both parties from disclosing sensitive information. The NDA is the first of a few documents you will need to review. It is not an agreement to purchase; it is just an agreement where you promise not to divulge any information you receive upon signing this. Expect to receive exact location, pictures of the business, balance sheets of at least one year, what’s included in the price, etc.
CHECK THE BOOKS
When buying a business – a ‘cheap’ price tag should not be your focus. You can only purchase a business at a low price if you can scale the business and make returns. Always ask why the vendor is selling the company.
- Was the business not profitable?
- Do they have any lawsuits?
- What is the Annual Revenue?
Ask for records, its financial statements from 3 years to 5 years. What is the EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization)? Sometimes EBITDA is described as “Cashflow” in a seller’s listing. In very simple terms, this is the annual amount the company keeps after paying all expenses except interest charges from any bank loans, taxes, equipment depreciation and amortization.
Some businesses sell based on its EBITDA. The asking price varies by industries – some industries price their businesses twice the EBITDA or three times its value. Do your homework on the industry. Hire an accountant to look at the financial statements of the company to make an educated decision.
CHECK THE LEASE AGREEMENT
Another record to look out for is the Lease agreement of the existing business. If the lease agreement comes for renewal in less than two years, confirm the vendor has an option to renew in the lease. You don’t want to be in a situation where you buy a business and then realize the landlord will not renew the agreement. Hire a lawyer to review the pre-existing lease agreement.
One thing most people ignore is the commercial assets of the business. To grow a business, you will need to invest in its marketing structure. You must review if the marketing practices suit the business.
- Is it sustainable for future growth?
- Is it flexible enough to change?
- Do they own marketing assets such as a website, engaging social media channels, client email list? Do they have an existing marketing plan/strategy?
- What are their Google/Facebook/TripAdvisor reviews like?
- What are their Glassdoor reviews like from previous staff?
OTHER QUESTIONS TO CONSIDER
- How involved is the existing owner in the operations of the business? Can the business run without the owner?
- Does the business have a strong team of loyal staff?
- Will it be challenging to get its current employees onboard with the new management?
- What state is the company’s performance?
- Does it have repeat customers?
- How is the ‘goodwill‘ of the business?
In most cases, you should consult with the seller if they are willing to offer a transition period to train the new owner. What would that look like?. Fun Fact, my Dad acted as a consultant when he sold his veterinary business. Yeap! You can hire the previous owner or include the transition period as part of your offer.
THE BUY & SELL DANCE
Before you start the art of negotiating – the buy and sell dance – you must submit a Letter of Intent (LOI) to the vendor. The LOI stipulates your interest in buying the business. It reassures the vendor that you intend to buy the company. It usually includes a few clauses when signing—details of the payment plan, parties involved, the clause for withdrawing and the period of negotiation. An LOI also contains information on how you intend to close the transaction.
After you present your LOI, you negotiate the price value based on the result of due diligence. Once the final purchase price has been agreed on, finances need to be aligned. There are many possible scenarios on how to purchase a business:
- Full cash payment
- Down Payment in cash, a portion financed by a bank (, please note that in Canada, no bank will lend 100% of the business’s value. Expect to require a cash investment of at least 25% – liquid. That means lines of credit don’t count. Your investment needs to be unencumbered cash)
- The vendor takes back when the seller is willing to finance a portion of the business’s value over time. The buyer usually puts a sizeable down payment in cash and negotiates a takeback arrangement amortized over a period of time directly with the owner.
Remember to leave enough funds in the business after purchase. It will do you no good to have no money left after buying a business. Remember, Cash is King.
Another point to consider when negotiating, sign a non-compete agreement with the seller. This contract prevents the seller from being a competitor to your business.
BUYING A FRANCHISE?
If you want to buy an existing, turnkey franchise from a franchisee, you must first check with the franchisor. In most cases, the Franchisor has to approve the potential buyers before entering into any negotiations.
TYPES OF PURCHASES
A vendor has a choice to sell its business as an asset or create a list of assets for interested buyers. As a buyer, you get to decide what you prefer to buy and are not liable to any debt or liability incurred by the seller. Canada Revenue explains more about this when purchasing a business in Canada.
This type of purchase is a preferred choice by most business vendors and for a good reason. As the name implies, you buy the company’s shares. Unlike Asset purchase, you, as a buyer, may buy past debts and lawsuits.
Now, why do sellers prefer this? In most cases, sellers are eligible for a lifetime capital gain exemption – that means they will be expected to pay taxes on the capital gains up to a maximum amount. When purchasing a high-ticket business, confirm if it’s an asset purchase or shares. Talk to your lawyer/accountant about this.
This is it! This is the big legal document that has all the details of the transaction. It must specify details on purchase price, what’s included, lease agreement, transition period, and any other things that were negotiated during the “dance.” This document MUST be reviewed by a lawyer as you want to make sure you are not leaving anything behind. This is the key to you new venture and you want to make sure you understand absolutely everything. Once both parties sign – congratulations – you got yourself a business.
Buying a business is not an easy task; neither is it an overnight transaction – it is not uncommon to take anywhere between 3 to 6 months before closing a deal. Patience is key.
Download the checklist below to identify the mistakes to avoid when buying a business in Canada. Connect with a Business Advisor to help you identify a business that fits your needs and promises to be profitable in the long-run.