3 Phases of Business Evaluation
Buyers have many questions about the business they plan to purchase, so it's natural to come up with a laundry list of items that need clarification. However, there may be several buyers looking at a particular business, each with their own laundry list, so for a Seller, responding to all questions from all prospects could be a part-time job for someone who is hoping to work less, not more. :-)
Here is a 3-step process that will get the big rocks out of the way so you can eliminate the mismatches and continue to drill down on the details of the remaining businesses that you're evaluating. And remember, as a Buyer, you have the option to OPT-OUT of a purchase during due diligence if you find something not to your liking, so don't be afraid of a Letter of Intent or Contingent Purchase & Sale Agreement in order to be taken more seriously.
STEP 1 - PRE-OFFER
Before you've made an official declaration of interest, certain information is essential to know if you'd like to proceed. At this point, you have signed a non-disclosure agreement, obtained basic financials such as a P&L, Balance Sheet, and Inventory estimate, but to unlock the next level of information, the Buyer supplies an explanation of interest - Something informal like an email, with some basics about the Buyer's background, whether they are an investor or owner/operator and most importantly, the plan for funding the transaction - "how do you plan to pay for the business?" This can be short. It might look like this:
I am an individual buyer with executive-level experience within larger companies
managing teams of over 100. I started as a software developer with have a strong
technical background along with sales, marketing and ops leadership. This
acquisition will replace my current executive role and I will plan to work in the
business. I plan to put 20% down; obtain a bank loan for which I have applied,
and will request a 10% seller note.
In return, the Seller supplies: Answers to essential questions - say there are major expenses that cause questions, the seller can elaborate. A major expense is typically one that makes up more than 10% of the overall expenses. Items less than that can be considered in the next step.
Q&A: Thank you for your background, Jim, here are answers to your key questions:
- Our staff consists of 12 W-2 and 6 1099 employees who are paid $100/hr
- 2019 professional expenses = one-time atty fee to submit our patent.
- The fleet has maintenance records on file; a new van should be added in 2023.
STEP 2 - CONTINGENT OFFER
Now that the major expenses are accounted for, the next step is to describe the framework for an offer and, most importantly, the associated contingencies. If you don't feel confident in making a dollar-value-based offer, you can revert to a multiplier of earnings as your offer price. This can take the form of: a) Letter of Intent (least commitment which allows the Seller to continue to entertain offers) b) Letter of Intent with Earnest Money where you can include a no-shop clause or; c) A Contingent Purchase & Sale Agreement (stronger in that it secures a no-shop clause and includes more detail so you can move swiftly to closing).
*If any of your contingencies are not met, your earnest money is returned and you can pull out of the sale without consequence.
Based on my understanding of the business from the materials provided, I would
like to pursue this transaction further. Since I will be asking for additional
materials and more of your time, I want you to know that this effort is
worthwhile, and my intent is to purchase the business at the end of this process
if my due diligence results are positive. Here are the principal terms and
conditions of the transaction:
___Asset or ___Equity Purchase. I plan to acquire the assets owned by and in
connection with COMPANY with a offer price of 3X adjusted EBITDA. (adding back
discretionary or one-time expenses). The transaction would be funded as follows:
__% down; __% cash at closing and __% requested as seller note. We would ask you
to stay on for 6 months during the transaction and will negotiate a fair salary.
We would aim to close by January 15, 2020.
This offer is contingent on:
- Bank financing approval
- Lease assumption
- Verification of financials/taxes
- Transfer of certifications/credentials
- Any additional contingencies that are a concern of yours
STEP 3 - DUE DILIGENCE
This is the stage that, with earnest money and a stated offer will give you access to nearly all documents needed except private information or trade secrets such as customer and vendor contacts and formulation/recipes. Once the contingencies have been evaluated, you then move to closing where the formalized offer is mutually signed and a closing date is established.
As brokers, we have templates and suggestions to streamline the process so look to us for help!
-Kris