The Process Associated with Buying a Business

Jun 6, 2023

IBA, over its nearly fifty-year history as a business brokerage & commercial real estate firm serving the Pacific Northwest, has been sought after frequently as a speaker by business schools, trade schools, banks, non-profit organizations, and government entities.  One of the topics we are asked to cover is the process associated with acquiring a privately held company or family business.  The presentation often starts with an analogy and images of a dry riverbed and the Columbia River, the body of water that divides Washington & Oregon, on a screen.

The analogy compares starting a business with buying a business.  The business start-up is the dry riverbed.  The established company is the river.  Why the comparison?  The reason is an existing company when purchased will, on day one, have customers, revenue, staff, vendors, facilities, and infrastructure in place that will carry it forward into the future (The flow of the river).  In comparison, all of those items will need to be acquired or created in a start-up scenario (The dry riverbed).   No purchased business will be perfect (One advantage of a start-up is the ability to execute a vision versus modify an existing structure), there may be deferred capital expenditures or antiquated marketing and customer engagement strategies, but customers will visit the website, call, purchase goods & services, generate revenue, and employees show up to serve them regardless of ownership.

It is also easier to get financing or investment for an established company with historical financials or climb to eight figures of revenue from $5,000,000 than from zero.

If you attended one of IBA’s presentations of “Entrepreneurship as a Career Path Option”, as Khasha Mekanik & Mike Nekahi did at the University of Washington’s Foster School of Business prior to buying a company through IBA,  you may leave thinking about business ownership and the advantages it offers of independence, control, and the higher income possible than working in the same industry as an employee.  The next question in your mind, if you decided you wanted to explore entrepreneurship from the platform of a mature, profitable enterprise, would be “What is the Process Associated with Buying a Business?”.

If you called IBA, like Khasha & Mike did to schedule a meeting or conversation with one of our M&A professionals, the following would be what you learned.

The first step in selecting a business to purchase is to identify what you want. Four basic elements should be taken into consideration in creating an acquisition criteria or screening process for evaluating business opportunities.  The first element is geography.  Where do you want to own a business? Factors that can reduce the area considered can include home ownership, spouse employment, children in school, and commute time.  If this element is not satisfactory, an acquisition will not be made.  IBA has a franchise brokerage division (https://ibainc.com/what-we-do/franchise-sales/) to serve those individuals with entrepreneurial aspirations who need to place a business in a specific geographic area. A franchise acquisition allows an entrepreneur to specifically geographically place an established business model with support infrastructure in an area if an existing business cannot be found for purchase.

The second element is industry.  It is recommended that a business buyer be open to ideas when evaluating industries for potential entrepreneurship.  Every year IBA is asked to sell businesses serving areas that we have never sold before, and as a firm, we have sold more businesses than any other business brokerage in the Pacific Northwest, over 4200.   Recent representation projects have included a geothermal energy business, a company that designs & installs security systems in prisons, and an escape room.  Examples of the industries our knowledgeable, experienced, highly skilled team of professional intermediaries serve and completed transactions by IBA can be found through this page of our website: https://ibainc.com/industries-served/  It should also be noted that, if a SBA loan is going to be used to support an acquisition, that relevant experience to an industry is a criteria employed during the underwriting approval process.

The third element is the EBITDA (Earnings Before Income Tax, Depreciation, & Amortization) or Seller Discretionary Cash Flow of a business.  Every buyer has a lifestyle they wish to support or goals in terms of income or return on investment.   It makes no sense to evaluate businesses offering profit below that threshold unless a willingness exists to build a business to that level.  Insider Note:  The decision to purchase a business is an investment decision.  Similar to buying stock in a publicly traded company, a complete assessment of the results of the investment can only be made when the total return can be calculated by subtracting the acquisition price from the sale value and incorporating the annuity of dividends received over the tenure of ownership. 

The fourth element is transaction size.  Many people would love to own a 5000 square foot house on the water with a boat dock, swimming pool, and tennis court.  Unfortunately, few among us can afford to own that residence.  The same is true for business acquisitions.  A buyer needs to determine the size of acquisition possible when taking into account their capital injection, financing available, and potential investment from other parties, so they can negotiate in good faith with a seller.  Although seller financing of part of a deal is common in the business brokerage world, the assumption should be that no seller financing will be available as in a competitive marketplace for a company business owners will commonly select the party requiring the smallest amount of participation from them in a deal.  Insider Note:  Another consideration in buyer selection by the seller in a sale will be the signature strength of the buyer in terms of assets possessed post-acquisition.  Signature strength is an important consideration in terms of the ability of the buyer to gain approval from landlords & vendors, the desire of a retiring business owner to finance a portion of the transaction, and the ability of the buyer to grow a company and support it, if unforeseen turbulence should occur in the business model. 

An acquisition criterion is determined, and the assessment of potential companies to purchase can start.  Company evaluation should occur using multiple metrics.  It is recommended that the assessment starts with historical financial information.  If a business acquisition does not make financial sense, cannot be financed, or the financials cannot be vetted then the expenditure of valuable time and resources evaluating the opportunity may not be prudent.  After the buyer’s completion of a non-disclosure agreement and financial qualification process, a business brokerage firm should be willing to release detailed financial information for evaluation of a company.   Insider Note: You only have one opportunity to make a first impression.  It is prudent for a buyer to make as good a first impression on an M&A intermediary representing a business for sale as possible, as that broker has the potential to advocate for or against you as a buyer in a future deal with their client. 

If a financial assessment leaves a buyer with continued interest in a potential business acquisition, the next step is to assess business operations.   It is recommended that occur with a face-to-face meeting with the business owner.  Entrepreneurs love to talk about their businesses.  Come prepared with a list of questions, including about the previously reviewed financial information.  All information should be open for discussion short of proprietary information, that could be competitively used against the company if a transaction is not completed, like customer concentration specifics and key employee compensation.  Buyers should be prepared to answer questions about their experience and background from sellers.  The best negotiations occur when both parties enter with a foundation of knowledge.  One meeting or multiple may be necessary before a buyer progresses to wanting to make an offer.  It is strongly encouraged that a buyer tour a business before making an offer to mitigate the likelihood of information that could have been known detrimentally impacting the transaction at a future date.  Similar to initial buyer engagement with a business broker, both seller and buyer should recognize that only one opportunity exists to make a good first impression on the other party.

If a willing & able buyer and seller are in place wanting to do a deal, the next step is to commence negotiations.  An obvious component of the negotiations will be the price to be paid for a business.  However, business terms that will also need to be established, frequently in a Letter of Intent negotiation, commonly include elements ranging from transition support to the post-transaction non-competition agreement provided to the buyer by the seller to how the deal will be structured for tax purposes. Insider Note:  The most common place for confrontation between buyers and sellers in negotiations is on price.  If a company is represented for sale by a business brokerage firm with the acumen and ability to properly price a business in a dynamic manner incorporating relevant industry and market conditions the potential for confrontation between the parties can be mitigated.  A buyer should ask the business broker to justify their asking price for the business.  If they do not know how and why a business was brought to market at a specific price their contribution to helping parties reach an agreement is likely diminished.  IBA is commonly recognized as one of the top firms in the Pacific Northwest related of our ability to price companies for sale.  Traditionally, the businesses we represent sell within 10% of the asking price.  Bankers welcome the opportunity to finance our deals because they know our values are consistently verified by their appraisers as in line with the market.

Reaching an agreement on a Letter of Intent (LOI) between a buyer & seller is our favorite achievement point at IBA.  If we have done our job correctly as professional intermediaries in creating an environment of full disclosure and employing best practices, the probability of a deal being completed at that point is VERY high.  It is also at that point that the transaction transitions from confrontation (Every seller wants the most possible for their business and every buyer wants to pay the least amount necessary creating a negotiation dynamic where one wins and one loses with each dollar of movement in price) to collaboration where both parties seek a common goal, a completed transaction.

It is at this point the administrative heavy lifting and utilization of professional advisors commonly are enhanced. The first buyer activity post LOI execution is to enter due diligence. To use a vehicle analogy, this is when a buyer puts the vehicle up on a hoist and checks the engine, transmission, brakes, hoses, and belts.  If an environment of full disclosure was created prior to entering into an agreement on a Letter of Intent by the business broker, this process should be a verification and not a discovery process.  It is rare at IBA to lose deals in due diligence.  That is not true at many business brokerage firms who instead of leading with substance (tax returns, meetings with sellers, etc.) rush buyers to make offers and sell the sizzle and entrepreneurial dream.  IBA desires all buyers to go into transactions with open eyes and be successful.  As a nearly fifty-year-old firm, we have sold many companies to buyers who originally purchased their businesses in IBA-facilitated transactions.  That was the case for Khasha & Mike, mentioned earlier, who experienced significant asset appreciation at the time of sale and a wonderful annuity during the ownership of their IBA-acquired company.  Successful completion of due diligence motivates a buyer to move forward and spend more money with their professional advisors related to their targeted acquisition.

The next administrative step is to transition the Letter of Intent into a purchase and sale agreement.   It is in this agreement, hopefully, drafted and negotiated by experienced, knowledgeable attorneys, that liability issues associated with the transaction will be addressed. It will also serve as a reference document for dealing with potential issues that arise post-deal.  It should be recognized by all parties that buying and selling a business is similar to jumping on and off a moving train.   Coordination and cooperation associated with the change of engineers while the business is in motion should be discussed and executed collaboratively between the buyer and seller involved in the transaction.

The final major administrative step for a buyer is securing financing or investment to do the deal.  Banks will commonly need to review similar materials as used by the buyer to complete due diligence.  Insider Note:  It is smart to have selected a banker to finance the deal prior to making an offer and request from the lender the information they will need for their underwriting process, so simultaneously with other due diligence requests that information and documentation can be included to make the process as efficient for the seller and their supporting professional advisors as possible.  At the end of the day, a deal cannot likely be completed without lender participation, so it is important to get the financing process moving forward as soon as an agreement on a Letter of Intent is reached.

In addition to the previously identified three major administrative tasks, time, effort, and experience will be utilized to facilitate employees, vendors, landlords, government entities, etc. through a transition of ownership.  At its most basic level, a business broker is simply a trusted guide through the sale process who should be an asset in the deal to both sides of the transaction, if they do their job correctly.

The purchase of a business is one of the most sophisticated transactions a person can undertake in their life.  It can also be one of the most rewarding personally and financially.  IBA welcomes the opportunity to be a resource to the entrepreneurial community whether a party is interested in buying or selling a privately held company or family business.

IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, real estate, legal, and accounting communities on subjects relevant to the purchase & sale of privately held companies and family-owned businesses.  IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.