What to look for when investing in a small business

Q: I am interested in buying a local business. I’m not sure what I should be looking for and would like some guidance on the legal steps to take.

Buying or investing in a business is a serious financial commitment, requiring a great deal of research to answer questions that you and your funder may have. The process can be complex but here we discuss the basics that you need to consider.

Know what you are buying
The first thing you need to know is whether the business trades as a limited company or as an unincorporated business, for example a sole trader or a partnership using a trading name.

If you are buying from a limited company, are you purchasing the shares in the company ie. taking over the whole company as a going concern or simply purchasing the assets of the limited company and leaving the company itself in the ownership of the seller? If you purchase assets from the limited company you will not buy the company outright. In the case of an unincorporated business you probably intend to take over the business as a going concern. Either way you will need to obtain the advice of a reliable accountant who can advise as to the nature and value of the business and therefore what a reasonable price to pay will be. In order to do so, you will need to have seen the business’ accounts but if a sale has been agreed in principle, the seller should be willing to disclose this important information.

Know the risks
Whilst it’s important to know how successful the business is in terms of turnover and profit, perhaps even more crucial is to understand its debts. To whom does the business owe money? Are there any shortfalls in the accounts? Is the business able to meet its outgoings each month? You will assume these debts on a purchase of the shares in a limited company so you need to know what your liabilities will be.

Likewise, check who owes the business money; do they have a lot of bad debt? This will reduce the value of the shares in a limited company. In an unincorporated business you don’t have to buy the business’ debts but if you do, you may be able to negotiate a reduced price to reflect the fact that not all of these will be paid.

You might also want to know why the seller has decided to sell; are they retiring? Has business faltered? These issues may affect the price you are willing to pay.

Check the business’ property agreements
If the business operates from a commercial premises, make sure you review the relevant lease or title documents to ensure that the property can be transferred to you on completion of your acquisition if necessary. In some cases, such as a full share sale, you will not need to complete any further documentation as you will be acquiring the limited company that already occupies or owns the property but if you are only buying assets you will need to ensure that leases or freeholds are transferred to you.

Agree the terms of the deal at the outset
Once you have an agreement in principle with the seller, draft and agree ‘Heads of Terms’ between you. You may wish to instruct a solicitor at this stage. This should contain all the key terms of the deal, including price, what you are buying, timescale, conditions to the deal (such as information and documents to be disclosed) and, often, exclusivity and confidentiality clauses which ensure that the seller cannot offer the sale to anyone else on the understanding that both parties will not publicise the terms of the deal.

The legal process
Once Heads of Terms and if it is desired an exclusivityand/or confidentiality agreement is in place your solicitor will draft the purchase agreement and issue this to the seller. You will need to complete due diligence and disclosure, ensuring that you have received all relevant information from the seller to enable you to consider fully your purchase. This may include financial information, details of employees, property documentation and supplier contracts. As part of the sale agreement, you may wish to request an indemnity from the seller which will cover you in the event that they have not revealed to you something which later proves to be costly.

Your solicitor will work closely with your accountant to ensure that tax issues are addressed; for example, you may need to consider Capital Gains Tax or Stamp Duty Land Tax implications on your purchase. Similarly, if you are using a lender, solicitors acting for them will need to see and approve all documentation. Once the sale agreement and the disclosure exercise have been agreed, you can proceed to completion of your purchase.