Defining an ‘Offer’
An offer is the critical step that a buyer makes when purchasing a business. Legally, an offer is a specific proposal necessary to create a contract with another party. An offer coupled with an acceptance of the offer creates a contract. When purchasing a business, an offer may come in the form of a Letter of Intent or a proposed purchase agreement. Buyers should thoroughly prepare themselves before making an offer so their offer is clear, coherent, and workable. The offer should cover key terms and issues that are essential to creating a binding contract. Most buyers initially make an offer on a business through a non-binding Letter of Intent with key terms including price, terms, and contingencies followed by a more formal offer in an Asset Purchase Agreement.
Preliminary Due Diligence Prior to Offer
After a buyer signs a Non-Disclosure Agreement (NDA), financially qualifies, and receives the confidential listing information package from the business broker, they may start their preliminary due diligence. This type of investigation for a business is distinctly different from formal due diligence which occurs after the buyer and seller agree upon a written offer. Preliminary due diligence gives the buyer a sufficient amount of information about the business to enable to enable them to make an offer. There should be as little surprises as possible during the post-contractual formal due diligence phase, since all material information of the business should be disclosed to the buyer during the preliminary due diligence phase.
What is Preliminary Due Diligence?
- Preliminary due diligence primarily consists of the confidential listing information package that is presented to the buyer by the business broker.
- This information normally includes tax returns, profit and loss statements, an asset list, and specific company information (such as its website, address, and lease terms).
- All questions about this material should be written down and addressed to the business broker.
- A buyer may request further financials prior to making an offer so long as such information is available but this is somewhat rare.
- The additional financials must not be too sensitive or involved in nature.
- Otherwise it should only be disclosed during the formal due diligence phase.
- Often, a buyer also meets with the seller and tours the business as a part of their preliminary due diligence.
- During preliminary due diligence, a buyer frequently does legwork to ascertain other merits of the business such as online reviews, the location and surrounding area, foot traffic, and the competitive landscape.
Prepare to Make Offer
Once a buyer’s preliminary due diligence is complete, a buyer must decide how exactly they will make an offer. Particularly if the buyer has little business experience, he or she may wish to consult with an attorney. A professional business broker may also guide a buyer through this process. In either case, buyers should do their homework and understand the legal implications of making an offer, as well as their desired legal structure of the transaction itself.
Two Ways to Make An Offer
Buyers may either propose a Letter of Intent (LOI) or an actual purchase contract when making an offer for a business. An LOI is simply an agreement to agree on the framework of a deal. The LOI normally contains a provision for a (refundable) deposit, spells out all the key terms of the deal, and give the buyer a period of exclusivity. But an LOI is not the actual contract and is not binding on either party. Buyers typically propose an LOI for the simple reason that it is not necessary to hire an attorney to do so. Proposing an actual purchase contract which contains the entirety of the agreement is usually prepared by an attorney and is binding for both parties.
Structural Formats of the Offer
A buyer must decide whether the business transaction is an asset purchase deal or a stock purchase deal. The different structural formats of the transaction may be unfamiliar to some business buyers and is worth reviewing. Before making an offer it is crucial to understand in what legal format the deal will take place.
Asset Purchase Deal
An asset purchase deal means that the buyer forms their own legal corporate entity and purchases the assets of the business (they do not purchase the actual corporate entity of the business). This type of structural format is the norm and is used in the vast majority of business sales. Here, the buyer does not take on the liability of the corporate entity that is selling its assets. For this reason, it is the most common type of legal format when making an offer.
Stock Purchase Deal
A stock purchase deal means that the buyer individually purchases the actual corporate entity (by purchasing its shares or membership interests) of the business being sold. The buyer thus inherits and assumes all the liability of the corporate entity as its new shareholder. A stock purchase deal is rarely employed by buyers because of this liability. There are, however, circumstances where the buyer will want to retain the seller’s corporate entity – and specifically its tax ID number. In healthcare transactions, for example, buyers may choose a stock purchase deal because it will ease the license transfer process if the buyer retains the tax ID number of the seller’s corporate entity. It will also help the buyer retain the seller’s insurance contracts.
Key Terms of Offer for Business Sales
- An offer should communicate all relevant terms of the deal so that both sides are clear on the framework of the deal, as well as contingencies to close.
- The offer should have the offered price and payment terms with an explanation of how the deal will be funded.
- If the seller is asked to hold a Note, then the offer should explain the terms of the Note.
- The offer should always have a closing date and a timeframe in which formal due diligence will be conducted.
- The content of the buyer’s formal due diligence request list should be included in the offer.
- If the formal due diligence request list is not in the offer, the offer should clarify what kind of information the buyer will be requesting during formal due diligence.
- If the buyer is asking the seller to sign a non-compete agreement, its terms should be contained in the offer.
- Any post-closing training period should be contained in the offer.
- The offer should address the issue of a deposit and its refundability.
- All other terms, conditions, or contingencies of the deal should be in the offer so that there are no surprises to the seller.
The better prepared and thorough the offer for a business sale, the less surprises there will be. This greatly helps the chances for a successful transaction.
Give Martin at Five Star Business Brokers of Palm Beach County a call today for a FREE evaluation of your business.