Analyzing the Seller’s Operations: Learning All The Facts
July 28, 2007
Most of us are brought up not to be too nosy. We develop an instinct to mind our own business and stay out of other people’s affairs. This attitude can be deadly when you’re thinking of buying a business. Everything concerning the target business’s operations is your affair, because you’ll have to live with it all should you buy the business. You should take the position that absolutely nothing about this business is going to surprise you after you buy.
You must drive yourself to learn everything you possibly can before you buy it. This means being very nosy. It means asking embarrassing questions and pressing for details if the answers don’t satisfy you. Only after you’ve convinced yourself that there’s nothing more you can learn should you even consider closing the sale.
The problem with this approach is that sellers will often be unwilling to bare their souls (and books) to you before you’ve committed to buy. Even sellers who have nothing to hide may not want to divulge the business’s operations, profits, or trade secrets unless there’s some assurance that the end result from all this time, effort, and disclosure will be a sale. Any savvy seller will realize that if the word leaks out the business is up for sale, it may affect the morale of employees, relations with suppliers, and even the collectibility of accounts receivable. The seller’s reticence may be reinforced by a prior experience with a prospective buyer who spent a lot of time snooping around without buying, especially if that prospective buyer later bought or started up a competing business. You, on the other hand, shouldn’t be willing to consider buying until after you’ve received all this information. It’s a classic chicken-and-egg problem.
Is there a way out? Often there is. We’ll review the letter of intent later, which should be the first document your attorney prepares and which gets the ball rolling. The letter of intent spells out, in very general terms, the buyer’s moral (i.e., legally nonbinding) obligation to buy and the seller’s nonbinding obligation to sell. There’s one provision in the letter of intent that can be made legally binding: the buyer’s promise not to disclose to anyone anything the buyer learns in the course of the buyer’s investigation.
It is becoming increasingly common for a seller to require a potential buyer to sign a confidentiality or nondisclosure agreement before the seller will share any information about the business with the buyer. These agreements generally provide that buyers will be liable for damages if they disclose information they learn during the course of the investigation. You need not fear signing one of these; it’s a legitimate protection for the seller.
As we’ll see in this and the next few post, there are plenty of areas of investigation you’re not likely to have expertise in. What you learn in this and the next chapter isn’t designed to replace the roles your attorney and accountant should perform. Rather, it’s designed to show you all the things your attorney and accountant should do.
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