The Roadmap
The Roadmap
Many searchers have never been involved in the purchase or sale of a business. This necessary step on the road to Entrepreneurship Through Acquisition is shrouded in mystery. There is new terminology to learn, decisions to be made, a deal team to assemble.
Like many new experiences, the best way to understand the process of buying a business is to view it from the top down. How does a deal unfold from start to finish? What steps do you need to take and in what order?
The following is a high-level roadmap from the perspective of a self-funded searcher who intends to fund their deal using a Small Business Administration (SBA) loan.
Just be aware, the below timelines are illustrative. It is possible to close in less than 90 days. Conversely, some deals stretch out for months. But at a high-level, all small business deals follow this roadmap.
Phase 0: Getting under LOI
After viewing hundreds of listings, cold calling numerous owners, and analyzing countless financials, you’ve identified a business to buy. Congratulations! You now need to make an offer to buy that business. This is normally accomplished by submitting an LOI.
LOIs are a crucial first step. They allow the parties to agree on material terms before investing too much energy into a deal. And although largely non-binding—they don’t commit either party to go forward with the deal—LOIs set the framework for subsequent negotiations.
In other words, now is the time to state what you want and how much you are willing to pay for it.
Because an LOI is a crucial first step, you should seek professional advice before submitting it. This will ensure it reflects the deal you actually want to do, and make it more likely that the seller will accept your offer (poorly executed LOIs often include unreasonable or unworkable terms).
Having submitted an LOI, you may wait weeks before hearing back from the seller. The seller will want to have multiple offers in hand for negotiating leverage.
If your LOI is rejected, don’t take no for an answer, understand why.
If your LOI is accepted, you are under LOI and ready to move forward.
Phase 1: From LOI to Diligence (Days 0-30)
It is time to start financial due diligence.
Financial issues are the most likely to kill a deal. Work with a suitable professional to analyze the company’s financial statements and tax returns. It may be that the company’s true financial condition is not as represented.
Deal structuring issues are also best addressed early.
The typical small business deal does not present complicated problems of this type. But they sometimes arise when a searcher is purchasing equity rather than assets. Purchasing equity can have negative tax implications, but there are ways to treat an equity purchase as an asset purchase for tax purposes.
During this phase, you should also finalize your term sheet and begin the loan underwriting process.
A term sheet is the first step towards securing financing from a lender. Different lenders will offer different terms. Aim to secure term sheets from between two to three lenders, and go with the lender who offers you the best terms while being the easiest to work with.
As soon as you have signed a term sheet, have your lender begin underwriting. Underwriting takes time, so make your lender’s underwriting requests a priority.
Phase 2: From Diligence to Purchase Agreement (Days 30-60)
When it looks like you’re set to wrap up financial due diligence, begin on legal due diligence.
On the typical small business deal, legal due diligence is light. Many small businesses are run informally with incomplete records. But by asking the right questions, your lawyer can take those unknowns and draft a purchase agreement that protects you despite this information asymmetry.
Not all issues can be addressed in this way. Some must be resolved before you can move forward. For example, if key contracts cannot be assigned to you as the new owner without consent from a third party, you may have to seek that consent or potentially restructure the deal.
During Phase 2, your lawyer should also draft and negotiate the purchase agreement.
In addition to the purchase agreement, the typical asset purchase also includes a bill of sale and an assignment and assumption. Neither are normally heavily negotiated.
If the seller is providing part of the financing, a seller note will also have to be agreed. There may also be a transition services agreement to negotiate, describing the work the seller will do to help transition the company to your leadership.
As you approach a signed purchase agreement, you should be within reach of a commitment letter from your lender.
This is the formal agreement between you and your lender, outlining the terms of your SBA loan. It signifies that your lender has completed underwriting and is willing to finance the deal.
Phase 3: From Purchase Agreement to Close (Days 60-90)
Closing will not occur simultaneously with the signing of the purchase agreement. Instead, closing will be contingent on several post-signing conditions (as set out in the purchase agreement), including a financing condition, giving you the means to withdraw if your lender ultimately refuses to fund the deal.
A sign-then-close structure may seem superfluous. But SBA lenders require a sign-then-close structure. They have their own closing process, and will want to review the signed purchase agreement.
A sign-then-close structure has other upsides. It presents an opportunity for in-depth transition planning with the seller free from the pressure of negotiating the purchase agreement.
The seller may have run the company for decades. You are going to lose that institutional knowledge in the near future. Make the most of this period to plan for that succession.
When your lender is nearing the end of its closing process, it will provide a closing date.
On that date, the final legal and loan documents will be signed. The legal documents can almost always be signed electronically. Lenders may require wet ink on a number of documents but will help organize a place for you to sign or a mobile notary to come to you.
Make sure that you and your lawyer have a copy of your lender’s closing checklist and that you are prepared to meet your lender’s requirements.
Raising Capital from Investors
In addition to relying on an SBA loan or another source of debt financing, some self-funded searchers also look to raise capital from investors. This may be because the searcher wants to do a larger deal and requires additional capital, or is looking to onboard experienced investors for strategic purposes to mitigate risks and unlock competitive advantages.
The above timeline still holds true as an approximation. But be aware: if you are looking to raise capital from investors you have additional work to do. There are term sheets, subscription agreements, and an operating agreement to negotiate.
There is no need to do these things way in advance of identifying a target business. Searchers often approach investors with specific deals in mind, perhaps even with a signed LOI already in hand. Just be mindful of the additional work that needs to be done to get to the finish line.