One of the fastest ways to begin a new business, or to grow your business if you already have one, is to buy an existing company. By doing so, much of the legal and business groundwork that is necessary to start a company from scratch has already been done. However, buying a business rather than a company presents an entirely new set of issues that must be addressed, such as how to make sure that what you think you are purchasing is what you actually purchase, how to structure the acquisition, what form of continuing relationship you will have with the seller after the deal is done and more.

The first step in buying a business is to negotiate a purchase price with the vendor which will be subject to carrying out a satisfactory due diligence exercise (see below). Valuing an ongoing business is a tricky endeavour, and you may want to hire an accounting professional or valuer to help you do so. Such a professional can also assist you in negotiating the purchase price with the seller, but the more involved an advisor becomes, the more you will have to pay the advisor as well.

Once a purchase price is agreed to, you may want to sign a Letter of Intent (also called Heads of Agreement or Heads of Terms), which is a preliminary agreement in which you agree to buy and the seller agrees to sell the business (or company) subject to a clean due diligence investigation, good faith negotiation of a purchase agreement, and receipt of all necessary company and regulatory approvals. The Letter of Intent will most likely contain a confidentiality provision that says neither party will disclose the fact that negotiations to buy the seller’s business are taking place, because if word leaks out it could have an impact on both your company’s and the seller’s business operations by raising concerns with employees, lenders, customers, and suppliers.

There may also be an exclusivity period in the Letter of Intent, during which time the seller agrees not to solicit or negotiate the sale of its business or company with anyone else. As a buyer, you will want this provision included because you will be spending a considerable amount of time and money investigating the seller’s business and negotiating the share purchase agreement (in the case of a company purchase) or business purchase agreement (in the case of a business purchase). In return, the seller may request a break-up fee if you decide to walk away from the deal without good cause. You may want a break-up fee as well, to cover your time and expense should the seller cancel the deal.

Your valuation of the seller’s business will be based on the assumption that everything in the seller’s financial statements that you have reviewed is materially accurate and there are no issues or liabilities that are not reflected that could adversely affect the seller’s business in the future. For this reason, the next step in buying a company is to thoroughly investigate the seller’s business in what is known as a “due diligence” investigation.

Due diligence consists of financial due diligence and legal due diligence, which go hand in hand with each other. Financial due diligence investigates the systems and controls, policies and assumptions underlying the seller’s financial statements and projections to make sure they can be relied upon. It also investigates all matters that could affect the company’s balance sheet, results of operations and cash flow going forward. Legal due diligence consists of a thorough review of the company’s books and records, contracts, potential claims or lawsuits and the like. The goal is to determine whether the company owns what it purports to own, has the right to transfer its shares, contracts and property, and is not subject to any liability, or potential liability, that is not disclosed on the seller’s financial statements.

If the due diligence investigation turns up any previously unknown facts that change the assumptions you made when valuing the seller’s company, you can either renegotiate the purchase price or walk away from the deal.

Another key factor which must be considered when buying a business is how to structure the purchase. The optimal legal structure will be driven by many considerations, including tax, liability and accounting concerns and whether you wish to purchase all or only a portion of the seller’s assets and liabilities.

Professional accounting and legal advice is a must at this stage, because the issues can be very complicated and choosing one structure versus another can lead to vastly different financial outcomes. Normal deal structures for the purchase of a company involve the purchase of the entire issued share capital of the company from the seller or, if there are more than one, the sellers. In the case of the purchase of a business, you will agree the assets and liabilities that you will purchase from the seller and those that you will not – which will retain with the seller. In a business purchase, you will also need to consider how you deal with any existing employees of the business. In considering this, you will need to take legal advice as the European Communities (Protection of Employees on Transfer of Undertakings) Regulations 2003 generally provide that the employees of a business will transfer to the purchaser of that business automatically.

In addition, you and the seller must agree on how the purchase price will be paid. Options typically include cash, loans and shares in the buying company. Once again, however, the tax and accounting implications of using the different forms of consideration need to be thoroughly understood by both the buyer and the seller. Tax advice should also be taken when considering whether to buy a business directly or whether to buy the company that owns the business as there is a difference on the level of stamp duty (tax payable on legal documents) payable in each case (1% of the higher of the purchase price or market value of the sale shares for share purchases and 2% for business and asset purchases, although no stamp duty is payable in respect of assets which can be physically transferred by delivery or in respect of the transfer of intellectual property rights).

Under all of these scenarios, a set of agreements that lay out the terms of the purchase and sale of the company or business, as well as the relationship between the two parties going forward, will have to be negotiated.

With respect to the purchase agreement, one of the key issues will be the representations and warranties (these are assurances about facts relating to the business – such as it has no debt, liabilities, etc) that the seller is willing to make about his or its business, and what type of indemnification will be provided if those representations and warranties turn out not to be true. In addition, the purchase agreement will normally require the seller to operate its business in the ordinary course until the deal closes, and require both parties to use their best efforts to obtain any required approvals for the transaction. Finally, the purchase agreement will list what conditions must be present for the buyer and seller to be obligated to complete the sale and purchase. For example, if the seller’s business takes a sudden downturn because a key customer leaves, the buyer may want the ability to cancel the deal.

Regardless of whether you hire professional investment, accounting and legal advisors to help you buy a company or business, it is essential that you be familiar with the purchase process, legal options available and documents required. This is necessary because it will allow you to make the necessary decisions with confidence, and because you are the person best situated to understand what you want in your target business.

To assist you in this process, we will now walk through in more detail the key issues involved and documents related to buying a company, beginning with the due diligence investigation of the selling company and its business operations, and moving on to acquiring either the shares of a company or the assets of a company or business.