5 Points to Consider Before Doing an Acquisition

By Sean Kearny | October 26, 2010

Some business owners, both those managing a profitable business and those still looking for their first big success, are eager to jump into the acquisition of another business to increase revenues, to diversify product lines or just to try something new.

Before leaping, consider some key issues that experienced buyers review before signing on the dotted line.

Does the seller have what you need and can use? If you are already in the same business, compare the seller's business with yours, looking at offsetting strengths and weaknesses. If you are now in a different business, do the homework necessary to let you know if this is a long-term strategic move or just a short-term whim.

Look at whether the seller offers complementary products or services. Decide whether you can instead "grow" your own business to do the same things, for less money and in a reasonable amount of time.
Think about your own personnel and those of the seller. Consider the time and people costs of an acquisition, including disruption, training, reduced focus on your own business and corporate culture. In particular, explore the need for and desire of the seller's management to continue with the combined business after the transaction.

Before you become too set on buying (or on price or other key terms), take a hard look at the seller's business. You will usually need to sign a confidentiality agreement, and the seller may not want to disclose the most sensitive information, but make sure you see the "guts" of the seller's business, including financial information, before going too far in the process.

Early in the negotiations, the seller will want to know the price you are willing to pay. Whether you make the first offer or wait for the seller to name a price, it usually helps to know both sides' expectations. If you are too far apart on price, it usually does not make sense for either party to spend more time and money on the transaction.

Sometimes, however, differences in prices are really based on differing perceptions of the future value of the seller's business, particularly with start-ups, and you may be able to use "earn-outs" or other contingent pricing to bridge the price gap.

Keep in mind, too, that your "due diligence" review of the seller's business may ultimately allow for discounts from the price you initially set. However, it is hard (and may kill the deal) to reduce the seller's price expectations once they are set.

Both sides want to know, early on, how the acquisition will be structured. The key distinctions are assets or stock purchase, and taxable or tax-free.

Typically, buyers want to purchase assets, both for protection from liabilities of the seller and for deductibility and other tax benefits. Sellers usually prefer to sell stock, to minimize the taxes on the sale and to avoid having to get rid of the selling entity and any liabilities that remain behind. If the seller is an S corporation, the seller's need to sell stock rather than assets should be less.

Whether the transaction will be taxable or tax-free is usually of greater concern to the seller, for obvious reasons. If a tax-free transaction is important to the seller, the seller will need to be comfortable taking stock in your company in the deal, and you will need to be comfortable adding new shareholders and diluting your ownership.

Because the structure of the deal can be linked to the price a buyer is willing to pay and a seller is willing to accept, you may have a more enthusiastic seller (and better terms for you) if you take the time at the outset to find a structure that meets both your needs.

Tied in with some of the above issues is financing. If you are not paying for the seller's company with shares of your company's stock, you will need cash (now or later) to pay the purchase price. Even a deal financed with stock requires post-closing cash for operations. Explore at the outset whether you have the cash to meet those needs or whether, instead, you will need bank or seller financing to make the transaction viable.

Almost every business owner will consider purchasing or selling at some time. By discussing these five important considerations with your attorney, you can maximize your position in negotiations.

Author:Sean Kearny
Fredrikson & Byron P.A.
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