Best Practices that Many Buyers Ignore

Today I want to give you 5 best practices that are often overlooked by business buyers.

While these tips might seem like footnotes in your business transaction, I can ensure you that many deals have died thanks to buyers overlooking these details.

If you're a searcher, these best practices will help keep you away from avoidable mistakes that could kill your deal during the financing process.

Let's dive in!

Best practice 1: Initial communication with the landlord as early in the deal process as possible. If you are buying a business that operates out of a leased location, you need to obtain:

• A lease agreement for the duration of the SBA 7(a) loan
• Landlord agreement that gives the SBA lender bank authorization to access the property if you default on the SBA loan, in order to liquidate collateral

Basically, you need to make sure the landlord is okay with someone else owning the business! Too many buyers just assume that the landlord has no say in who owns the business. But if the original lease agreement was signed by the old owner, then the landlord needs to be okay with a new owner assuming the lease.

If you are working with an institutional landlord (rather than a “mom and pop” landlord), they will be less accommodating on signing the landlord agreement, which for you as a buyer presents a risk of your deal dying.

Ask your seller as early in the process as you can when they will allow you to initiate communication with the landlords. While there's no 100% sure-fire way to secure the landlord agreement, giving the landlord a heads up early in the game is far better than waiting until the last moment.

Ensure that your M&A attorney obtains the existing lease agreement with the seller as early in the process as possible so that they can confirm if it is assignable to you as the buyer.

If it isn't, you will need to enter into a new lease agreement with the landlord. To do that, the landlord will need to end the seller's lease early and begin a fresh lease with you as soon as you take the reigns of the business. Of course, this will need to be agreed upon by all parties ahead of the closing.

Best practice 2: Come to agreement with your seller on the net working capital peg as soon as possible.

If you are writing an LOI that requires the seller to leave cash, inventory and accounts receivable in the business at closing (which you should), it’s critical to come to agreement on this Net Working Capital (NWC) figure as early in the process as possible.

One of Pioneer Capital Advisory’s observations has been that a top reason deals die is due to disagreements on net working capital between buyers and sellers. Too many searchers leave this point until the very end to negotiate! It's no big deal, we'll easily agree on net working capital, searchers tell themselves.

Here's a nightmare scenario to consider if you ignore NWC:

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If you completely punt on net working capital until financial due diligence and you don’t set an expected range, there is a decent probability that a deal dies if your number for working capital comes back higher than seller expectations.

We also tell clients that they should work closely with their financial due diligence provider to figure out a NWC range before they submit an LOI.

Alternatively, you can obtain working capital by having it financed into the SBA 7a loan. Just figure this out ahead of time, and don't wait until the last minute to think about working capital!

Best practice 3: Have down payment documentation pulled together for the SBA lender bank as soon as possible

The SBA has very specific requirements when it comes to bank statement documentation for SBA financing.

Banks will typically want to see the bank statements from every person that is contributing towards the down payment for the acquisition, including any partners in the business or investors.

This includes the statements for the month of closing and the two prior months for each person in the buyer group.

While the SBA loosened up their guidelines on this recently, this is almost always what will be required by the lenders. You want to ensure that your investors (if you’re raising equity) are committed to investing in your deal as soon as possible so that you can pull together the necessary info and be prepared for the underwriting process.

With the sourcing and seasoning of down payment funds, surprises can and often do come up. For example, if one person in your buyer group had a massive deposit or made lots of transfers into or out of the bank account for themselves personally, the bank may ask for a lot more documentation to dip deeper into those deposits or transfers.

Best practice 4: Ensure that you have exclusivity in your Letter of Intent

I always tell buyers to obtain an exclusivity provision in their letter of intent.

The exclusivity provision explains that during the time while the buyer has the deal under LOI, the seller will not shop their business around or engage with other buyers.

Having an exclusivity provision in your LOI shows that the seller is planning to pursue your deal in good faith. If the seller isn’t willing to provide you with exclusivity on the deal, it may be an early sign that they are planning to keep the business on the market and not seriously entertain your offer.

I've seen plenty of buyers think they have a deal, only to do months of work getting ready to close just before the seller goes with another buyer.

Best practice 5: Get the tax clearance letter for the seller’s business as soon as possible.

A tax clearance letter comes from the Department of Revenue or the state tax authority for the state of the seller’s business. It documents whether or not the seller has any outstanding tax liability related to their business.

When the seller owes funds based on what the tax clearance letter shows, they either have to pay the balance before closing or they have to have a specific amount placed in an escrow account.

The bank may actually require a higher amount for the escrow amount of up to 150% of the potential tax liability estimate.

If you don't get the tax clearance letter, you may buy a business and then have a surprise tax bill come due! But most likely, the lender won't proceed on your deal without it anyway. You should always get this letter early in the process so that you can factor outstanding tax liability in to your negotiations.

Closing thoughts: By following the above best practices, you as a business buyer will help with reducing the circumstances of your deal dying. Each and every business acquisition has its own particular reasons that it will or won’t work and close, but the guidance here will help you avoid some common pitfalls that can derail your acquisition process as a buyer

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Thanks for reading! Feel free to contact us with any questions or thoughts.

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