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Buyer Beware

Purchasing a company? Avoid the mistakes that could ruin your business.

When Cindy Parks, 38, of Irvine, California, decided to go into business for herself, she thought the most expeditious way to do it was to buy an existing company. In the process, she received a valuable education in how not to buy a business. "I did everything wrong from beginning to end," she admits.

Her company is thriving now, but it wasn't when she took it over in 1995. The previous owner misrepresented the firm's financial status, assets and client base. Naively, Parks believed the information and handled the negotiations herself. Within days of closing the deal, she realized the company's actual revenue was a mere fraction of what had been quoted and half the clients the seller claimed to have didn't exist. She'd been deceived about other issues, too.

She could have sued the seller; instead she changed the company's name to Orange Coast Secretarial Service and focused on building a substantial clientele. "It all turned around, but I worked really hard to do it," Parks says. "I never should have spent the money I did [buying the company]."

Does that mean you shouldn't buy an existing business? Of course not. It's easy to avoid many of the common mistakes business buyers make. Attorney P. Christian Anderson, a partner with law firm Snell & Wilmer in Salt Lake City, offers these ways to ensure you don't do anything you'll regret:

Mistake: Failure to fully understand the real condition of the company, including assets, inventory and financial performance.

Solution: Conduct a thorough due-diligence investigation, and consider obtaining an independent valuation. If certain business information is confidential or proprietary, sign an appropriate confidentiality agreement. Don't make any commitment to purchase until your due diligence is complete.

Mistake: Buying a business with insufficient capital to take it to a self-sustaining position.

Solution: If you finance all or part of the purchase price, keep in mind that the business may be more highly leveraged than it was. If you expect immediate cash flow to be insufficient, have alternative sources of capital available. Understand the operation's typical sales and payment cycles, and recognize that you may initially see a drop in sales if customers are uncertain about the new ownership. Think about cash flow, aging accounts receivable and other collection issues.

Mistake: Failure to consider business change-over and integration issues.

Solution: Look into the relationships with primary customers and employees. Are they loyal to the business or to the seller? Make sure all contracts, licenses and permits can and will be transferred to you. If you need the seller's help, negotiate the terms of his or her availability.

Mistake: Failure to provide remedies if the seller has misrepresented the status of the business.

Solution: The acquisition agreement should include appropriate representations and warranties as to the status of the business. You should have appropriate rights and remedies against the seller if these representations are inaccurate. These may include requiring the seller to indemnify you for damages suffered as a result of misrepresentation. Or you may hold back a portion of the purchase price for a period of time, and maintain the right to reduce the final payment if there has been any misrepresentation.

Mistake: Becoming too emotionally involved and letting your determination to complete the purchase overpower sound business judgment.

Solution: Assess the company's value in advance; get outside help where appropriate. Calculate how much you can afford to pay, in upfront cash and debt service. Once you've set a price, resist additional burdensome adjustments to the agreement. Know what price you can justify and be willing to walk away if you can't get it.

Mistake: Trying to do everything on your own.

Solution: Find an attorney or advisor to represent you, help with negotiations, point out problems and provide solutions. A business broker can be helpful in finding acquisition candidates, but may be more interested in completing a transaction than in protecting your individual interests. Ask for references.

Contact Sources

Orange Coast Secretarial Service, (949) 253-4625

Snell & Wilmer, 111 E. Broadway, #900, Salt Lake City, UT 84111, canderson@swlaw.com

Strassburger McKenna Gutnick & Potter, 322 Boulevard of the Allies, #700, Pittsburgh, PA 15222, (724) 836-5429

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This article was originally published in the March 2000 print edition of Entrepreneur with the headline: Buyer Beware.

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