How to Buy Companies

Co-authored by Jack Herrick

Last Updated: September 28, 2021 References

Buying a company can be a smart way to go into business for yourself, expand your current business's operations, purchase new technologies, or invest in the company's potential. Regardless of your motivations, buying an existing company give you the advantage of the hard work that the other owners have already done. You get to inherit a customer base, employees, and even equipment, fixtures, and real estate. While buying a company is a process that requires attention to detail, research, and some outside help, it is a process that can be navigated by anyone with the desire and resources to see it through.

Part 1

Part 1 of 4:

Identifying Target Companies

1
Identify your reasons for purchasing a company. There are many reasons why an individual or company might decide to purchase a company. An acquisition can be an opportunity to expand the market share or geographical reach of the acquiring company or to obtain a unique or patented technology. A company might also be desirable for its intangible assets, like a well-known brand or skill employees.^{[1]
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- Alternately, an investor might buy a company with the intention of selling it for a higher price.
- Whatever your reason for seeking a company to purchase, identify them clearly. Knowing why you are buying a company will help you more clearly articulate what type of company you want.
2
Analyze your existing skills or capabilities. Spend some time thinking about what exactly you are bringing to the table in the acquisition. What is your or your company’s strengths and weaknesses? Are you looking for companies in your industry or outside your expertise? Your answers to these questions will help you figure out what type of company you need to find.
- Specifically, if you are seeking to acquire new technology or skills, consider how they will be integrated with your current operations.
- Think about your own abilities, particularly if you are an individual buying a company. Do you have the managerial and organizational talent needed to manage a company?^{[2]
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3
Analyze your financial capabilities. Estimate how much funding you are able to provide or borrow to finance your acquisition. Consider your financing plans. Will you sell equity in the company, use debt, or buy the company outright? Will you expect the current owner to finance a piece of the purchase price? Knowing these terms from the start will allow you to narrow your search by company value.
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Determine the optimum industry. A key factor in deciding what company you want to buy will be the industry it operates in. Start by considering why you are looking to buy a company. Are you familiar with an industry and think you can successfully operate a company in it? Alternately, does buying a company in this industry allow you to gain new technologies, markets, or strengths you do not have presently?
- Consider what you stand to gain by entering the industry and how it will work with your present experience or operations.^{[3]
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Identify potential purchase candidates. Think about the qualities of the type of company you are looking to purchase. For example, within your chosen industry, what size company are you looking to buy? Is location an important factor in your decision? Consider any other qualities that you need a company to have. You can then use this information to narrow down your search.
- Ask friends and business associates for recommendations. You can also browse trade publications for your chosen industry to identify candidates.^{[4]
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- Search online to locate candidate companies and information regarding each one.
- Analyze all publicly available information regarding each candidate. For example, look at SEC filings (if the company is publicly-held), their website, mentions in the media, legal proceedings, and other sources.
- You can also hire an investment banker or a business broker to help you locate suitable companies.
- Your goal should be to assess each company's ability to help you achieve your acquisition goals.^{[5]
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Prioritize your potential candidates. Rank the potential candidates by order of attractiveness - size, financing, location, etc.
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Contact your choice. When you've found a suitable company that best meets all of your requirements, contact their management and announce that you are considering purchasing their company. If the offer is well-received, you can now set up meetings to take a tour of the company and its facilities. Then, you can enter the due diligence phase of the process, in which you and your team of experts will work to figure out if the company is a good investment.^{[6]
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Part 2

Part 2 of 4:

Performing Due Diligence

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Employ external consultants. Due diligence allows you to investigate the company to determine the actual value of what you are buying and any identify existing issues that you need to be aware. In this endeavor, you will need the help of a team of experienced professionals to make sure you gain a thorough understanding of the candidate company. The professionals you need on your side might include:
- A lawyer experienced in corporate acquisitions.
- An investment banker and/or a CPA.
- HR and IT experts.
- Someone to manage public relations for the acquisition.
- Industry experts and other professionals as needed (for example, someone purchasing a trucking company might need a mechanic to assess the condition of the trucks).^{[7]
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2
Review company financial statements. Work with your financial expert to review the company's financial documents, including financial statements, tax filings, and general ledger. Obtain audited versions of these documents, if possible. Ask for "pro forma" financial statements detailing projected future performance.^{[8]
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- An investment banker can help you construct a valuation for the company using their financial statements.
- Look over tax records and financial statements for the past five years.
- Look for delinquent or late accounts payable. If there are any, it may be a sign that some other entity holds a lien on the company's assets. ^{[9]
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3
Audit customer accounts. Look through the company's sales and financial records to assess its relationship with customers. Identify their 10 largest customers and make sure the company's relationship with these customers is still strong. Calculate accounts receivable turnover and compare it to industry averages. This will help you know how effectively the company can get payment from its customers.
- Check the creditworthiness of the top customers.
- Ask for any other customer information the company has, such as a percentage of first-time customers.^{[10]
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Check physical assets. Investigate the company's inventory, machinery, buildings, and rolling stock. Check for any for liens on company assets. Have your team assess the condition, book value, and market value of each asset. Make sure inventory is not suffering from spoilage or unaccounted-for inventory shrinkage. Obtain a list of fixed assets, like machinery and vehicles, to aid in your appraisal.^{[11]
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Review HR records. Get a list of all employees of the company, complete with details about benefits plans, agreements, contracts, and compensation. Ask for an organizational chart detailing employee interactions. Obtain records of any past or ongoing employee lawsuits or complaints. Calculate employee turnover and employee duration. Look at how employees are paid compared to similar employees in the industry.^{[12]
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Review legal documents. Obtain copies of all the company's existing legal documents so that you can analyze them. Work with your lawyer and industry experts to identify any issues that might arise as a result of existing agreements. Some of the documents you will need include:
- Founding documents like the articles of incorporation, operating agreement, and name statements.
- Insurance coverage.
- Documents covering intangible assets, like patent filings, trademarks, or copyrights.
- Operating agreements like building leases, vendor and distributor agreements, union agreements, and employee contracts, among others.^{[13]
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- Confirm that existing financing (like bank loans, for example) will stay in place and survive the transfer of ownership.
7
Confirm your right to intangible properties. Make sure that all rights to the name, logo, patents, trademarks, copyrights, royalties, and other intangible property will be transferred to you upon sale. Have your lawyer review the procedure for the transfer of ownership of intangible assets. Then, you can work with your financial professional to figure out whether or not the value of these assets will figure into your valuation and, if so, their actual value.^{[14]
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Make an initial offer. Once you've completed the due diligence, you'll need to come up with an initial offer. Your offer price should reflect your team's valuation of the company with room for negotiation. You may wish to come in lower than your valuation (80 or 90 percent), but the best move here will depend on the situation. A very desirable company might end up selling for much more than an initial valuation suggests.
- In any case, don't make a lowball offer. This can insult the present owners and lock you out of further negotiations.^{[15]
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Adjust the contract price to reflect missing or false information. Some owners may seek to limit investigation into their company. In such cases, the owner should be held liable for damages unless you have agreed to buy as is and are taking your chances.

Part 3

Part 3 of 4:

Funding the Acquisition

1
Establish intermediate and long-term cash flow needs. In addition to purchasing the business, you will also need to finance its operations until the company's income can be used. Work on saving about three month's worth of company operating expenses for this purpose. You should also factor in paying for any improvements or modifications made to existing company assets. Through all of these considerations, figure out how much money you need to come up with right now and in the long term.^{[16]
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Pursue seller financing. Many company acquisitions are carried out through seller financing. That is, the seller of the company finances part or all of the purchase so that the buyer repays them (instead of relying on a bank or investors). Seller financing can also be used as a supplement to other options, like debt financing. Work with the seller to open up negotiations regarding seller financing.^{[17]
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3
Arrange necessary equity financing. Equity financing involves the sale of ownership in the company in the form of common and/or preferred stock. Stock can be sold to individuals, institutions, or investment groups like private equity or venture capital funds. This money is then used to finance the purchase of the company and its operations. Equity financing also includes money provided by you and your partners.^{[18]
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- Selling shares of stock to the public requires that the company register with the SEC. This is a very expensive and complex process and can be nearly impossible for small companies.
- However, you may be able to sell equity securities through a Regulation D offering, which is a specific kind of private placement sale. This provides exemption from SEC registration requirements.^{[19]
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- Hire a lawyer experienced in Reg D filings to guide you through the process.
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Arrange external debt financing as needed. Debt financing includes traditional loan financing as well as the sale of debt securities (bonds). However, you'll need to carefully check the terms of any debt agreement to make sure that your future cash flows will be adequate to cover the debt payments.^{[20]
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- Debt may be secured with collateral or unsecured. Secured debt is easier to obtain, but you risk losing the pledged asset in the event of default.
- Debt may also be classified as recourse and non-recourse. Recourse debt allows the lender to pursue the borrower until the debt is paid. This includes pursuing further payment after collateral is seized. However, non-recourse debt limits debt collection to the collateral.^{[21]
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Part 4

Part 4 of 4:

Closing the Acquisition

1
Finalize contract terms. Work with your team to draw out a contract that fully explains all aspects and conditions of the purchase. The contract will likely be subject to a large amount of further negotiation and revision before signing. Make sure to document each decision made so that you can confirm each agreement when the time comes to finalize the contract.^{[22]
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2
Negotiate seller involvement. Work with your lawyer and the seller to draw up the seller’s non-compete agreement. Discuss what assistance the seller will provide during the transfer of control. The seller will typically stick around to help you transition, even if they retain no ownership in the company. This transitional period can be anywhere from a few weeks to a few months and gives the seller time to train you and your team in operating the company.
- The contract will dictate the length of this period, the responsibilities of the seller during it, and their pay. Negotiate these terms to ensure a smooth transition for both you and the seller.^{[23]
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Get the seller to sign off on the final purchase contract agreement. Have your team, specifically your lawyer, review the finalized contract before bringing it to the seller. Meet with the seller to finalize the deal and sign the agreement.^{[24]
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Pay the purchase price. Complete the deal by paying the purchase price as defined in the contract agreement. At this point, you (or your company) are the legal owners of the acquired company and all of its assets.
5
Complete legal filings and notifications. Work with your lawyer and financial professional to meet all requirements for reporting the acquisition and changing the ownership of the company. This may include a public announcement, documents filed with state and federal authorities, and many other requirements. If the company is publicly-held, the requirements will be much more stringent and complex.^{[25]
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Meet your new employees. Hold individual meetings with management and larger meetings with all of your new employees. Reassure them that their jobs are secure (unless they aren't) and explain your plans for the company's future. This will help to assuage any fears about their job security and get your new employees back to work as quickly as possible. Involve new employees in your planning and transition as much as possible to foster an air of cooperation and friendliness.^{[26]
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Expert Q&A

Question

How do you calculate the valuation of a company?

Jack Herrick
Founder of wikiHow
Jack Herrick is an American entrepreneur and wiki enthusiast. His entrepreneurial projects include wikiHow, eHow, Luminescent Technologies, and BigTray. In January 2005, Herrick started wikiHow with the goal of creating "the how-to guide for everything." He has a Master of Business Administration (MBA) from Dartmouth College.

Jack Herrick

Founder of wikiHow

Expert Answer

The value of companies ranges so greatly that it’s really important to know the market, know exactly what you want, and know exactly what it’s worth. You have to have seen a lot of companies before you know what the value of these things are.
Question

How do you know if a company is worth buying?

Jack Herrick
Founder of wikiHow
Jack Herrick is an American entrepreneur and wiki enthusiast. His entrepreneurial projects include wikiHow, eHow, Luminescent Technologies, and BigTray. In January 2005, Herrick started wikiHow with the goal of creating "the how-to guide for everything." He has a Master of Business Administration (MBA) from Dartmouth College.

Jack Herrick

Founder of wikiHow

Expert Answer

Do your due diligence to find out what you're getting. Just like employees, the difference between a bad company and a good company is massive. Really knowing what you’re getting is a big deal.