Kick the Tires Before You Buy

By Travis Townsend Jr.

There are essentially two types of used car purchasers in the world. First there is the “price buyer.” A price buyer typically visits various dealers, checks for prices on the car makes and models of choice, and buys the desired car at the lowest price, satisfied that the best deal was obtained … until the car breaks down several times over the next six months. The second type is the “tire kicker.” Tire kickers do what price buyers do, with the added steps of having their own mechanic inspect the cars, retrieving car histories, and peppering salespeople and prior owners with questions. Tire kickers, request price breaks and extended warranty coverage based on the items their research uncovers, and they rarely leave the lot without scoring a good deal and good protection against unanticipated breakdowns of the vehicle. Tire kickers let the items under the hood dictate the deal they will accept.

Tire kickers set a great example for those seeking to purchase a business. The deal you accept when buying a business should be dictated by a sound due diligence review. Checking transaction prices and deal terms of acquisitions involving similar businesses is a good way to begin, but it is imperative you investigate the target from top to bottom before setting a purchase price and entering into a binding acquisition agreement. An attractive offering price may very well be your good fortune. It could also be the bait for a bad deal. The only way to know is to dig into the components of the business and its operations, and see what’s what.

Reviewing the target’s financial statements is no brainer. If you’re looking to buy a business you probably understand the importance of profit and loss statements, cash flow analysis and balance sheets. But where many business acquirors get in the weeds is the legal due diligence review. A poor legal diligence review can leave an acquiror at risk of a total loss of investment dollars when the smoke settles.

A thorough legal diligence review is required to ensure, among other things, that the transaction is properly authorized and approved. This helps to limit costly court disputes regarding the validity of the transaction after the deal has closed and money has exchanged hands. A legal review is also necessary to accurately determine the current ownership of the target and its assets, and to determine who should be involved in the items transferred in the transaction. The last thing an acquiror wants is to find out it did not receive the shares or assets it paid for because there were some unaccounted shareholders or property owners out there of whom it never heard.

Additionally, a detailed legal review process can also help determine whether major contracts will be terminated, or whether penalty payments to third-parties are required in connection with the company sale. This is important because lost profits from major contracts and penalty obligations inherited by the buyer impact the value of the business. If armed with this information, an acquiror acting like a tire kicker can ask for a reduction of the purchase price or get an indemnification obligation from the business seller.

Remember, companies that look very sharp from the outside can have some real serious problems on the inside. So don’t be a price buyer. Do your homework and check underneath the hood before taking the proposed purchase price and terms. Otherwise you might be stuck with a business that’s a lemon.

 

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