Common mistakes when buying a business and how to avoid them

Buying a business can be a complicated process. There are inevitably risks involved, but many of these can be managed by avoiding the common mistakes set out below.

Failing to carry out detailed due diligence

Every buyer will inevitably carry out a level of their own due diligence on a target to determine whether it is a worthwhile investment.

Due diligence, whether carried out by the buyer directly or via their solicitors, can be a long and detailed process and it is not uncommon for buyers to look to reduce their legal costs by seeking a limited due diligence process.

Whilst a valid approach if a buyer has carried out a detailed due diligence review of the target themselves, it is often worth instructing solicitors to carry out a due diligence review as this can reveal potentially large risks (which a seller is under no obligation to draw to a buyer’s attention). For example, a thorough due diligence process could reveal:

• That the target’s statutory registers – which specifies the legal owners of the shares – have not been properly kept up-to-date. This could mean a buyer is not actually buying the intended percentage of shares in the target
• That key contracts contain change-of-control clauses, allowing customers to terminate the contracts should ownership in the target change hands, or contain certain warranties and indemnities that may change a buyer’s view as to the desirability of the target’s contracts
• That there are outstanding claims against the target amounting to significant sums, which could drastically change the desirability – or at least the suitable purchase price – of the target in the buyer’s eyes.

Failing to understand the inner-workings of the target

Each business has its own way of working and it can be difficult to fully understand the way a business operates before taking the reins, even when the buyer operates in the same or a similar industry.

This difficulty can be alleviated somewhat by proper due diligence, which can show a target’s key customers/customer contracts or its IT and tech capabilities. This can also reveal internal information such as typical employment contracts for different levels or types of staff member, information on pensions or HR policies, which can go some way towards understanding a target’s culture and work force.

With individual-owned business, we also often see sellers taken on in a consultancy basis for a period of time to assist transition in the management; such consultancy agreements can be prepared, negotiated and agreed as part of the purchase process.

It is also not uncommon to see such transition assistance be a formal part of the deal from the outset and included as a term of the acquisition agreement, with certain individuals staying on with the target to ensure its continued growth and success for a certain period of time post-completion. The seller is incentivised to do this with part of the consideration for the sale being tied in with the performance of the target post-completion i.e. the better the target performs at certain thresholds, the greater the amount of money the sellers receive when they ultimately exit.

Failing to align the target with your own business

A significant part of running a business is unfortunately administration-based. For companies, this includes filing annual accounts, ensuring the target’s internal processes align with the buyer’s own, and even simply ensuring communications reach the right person.

We often assist with these elements of aligning the target business as part of the completion or post-completion process, for example, by amending the target’s filing date so that it matches up with the buyer’s. This makes the process of filing annual accounts more convenient.

It always a good idea to review the target’s articles of association – the rules that govern how a company operates – to ensure that these align with the buyer’s. We can assist with this review and prepare the necessary documentation to update or even entirely replace these with new articles that match the way the buyer operates.

Where the target’s previous place of business is not part of the acquisition, we can also assist with changing the target’s registered office address so that it matches with the buyer’s address, facilitating the correspondence reaching the right person.

If you have any questions about the topics raised in this article, please get in touch.