Tips To Consider When Buying a Business

If you want to work for yourself, you may well be thinking about purchasing an existing small business. It could be a printer, restaurant, distributor, etc. The current business owner may be looking to retire or is simply tired of the stress of owning and managing a business. Chances are the business doesn’t own any real estate, but rather leases its location. Many times, negotiations occur directly between buyer and seller and then lawyers and other professionals are consulted. All too often, however, the parties themselves fail to discuss any number of issues that may thereafter crater a potential deal, resulting in everyone losing time and money. So, if you are thinking about buying a business, here are some issues you will want to address up front.

What are you buying?  Once you agree on a purchase price, you will want to decide if you are buying assets or stock. Most buyers prefer to purchase assets for the depreciation benefits. Sellers, on the other hand, prefer to sell stock or other ownership rights to their entity. From the buyer’s perspective, purchasing stock increases the likelihood that you will also be obtaining “legacy” problems such as claims that may have occurred under the old owner’s watch but which aren’t advanced until after the closing. Consult with your legal and accounting professionals and decide what makes sense for you. Finally, if buying assets, make sure that you are buying the name of the company, telephone number(s), website domain, client lists and anything else that might be essential for continuing success.

Allocation of Purchase Price.  Assuming you are buying assets, you will want to discuss how that purchase price will be allocated. Again, it’s best to get input immediately from your accountant. Generally, the purchase price will be allocated between goodwill, hard assets (e.g. equipment) and leasehold improvements. As a buyer, you may well want to allocate the purchase price to items that can be quickly depreciated, which generally speaking will result in tax advantages. Of course, due concern has to be given the fair market values of the assets being purchased. Differences will most often occur when the seller wants to allocate more of the purchase price to goodwill. Address the issue up front before spending time having your lawyer draft a document only to find out that there’s no agreement to be reached on this issue. 

Landlord Consent.  Many businesses have value because of their location. If you are purchasing a business operating out of a leased location, you will want to make sure that the landlord will consent to an assignment of the lease. Expect that landlord to ask for financial information about you as well as your experience. It’s usually quite common for purchase contracts to be conditioned on such landlord approval. 

You will also want to get a copy of the existing lease immediately. Pay attention to how many years are left on the lease and whether there is a right of renewal. If the lease is coming due in the near future, it’s probably in your best interest to see if a new lease can be negotiated now. Pay particular attention to the terms of the lease with regard to additional rent provisions – such as CAM, insurance, maintenance obligations, etc. Be sure to factor in those extra costs, which can be substantial, in deciding whether the lease is affordable based upon the type of business you will be operating at that location.

Employees.  It’s important to determine if there are any key employees that will be essential to running the business and whether they will continue with the business after the purchase. Also, determine whether the current owner is going to expect you to hire other employees you might not otherwise want. If you do, you may well become liable as a successor employer for various obligations. Most purchase agreements require the previous owner to terminate all employees prior to your acquisition, and this is usually the safest course.

Warranties.  The well-advised purchaser requires adequate warranties that all of the financial information regarding the business is true and will be true as of the date of closing. Likewise, you should request warranties that all taxes have been paid, that there is no litigation pending or threatened, etc. The larger the transaction the more detailed the warranties and representations should be. In addition, you should make sure that the seller will provide you an indemnity should any of the warranties or representations turn out to be false.

Contingencies.  If you are planning on financing your purchase, you should make sure the seller knows that the purchase is conditioned on your ability to get financing. Further, if you plan to change the business model and as a result will need certain licenses or zoning changes, you should make sure that those are conditions as well. Without those conditions, you might find yourself in breach of the sales agreement.

Bulk Sales.   Although Illinois no longer has a bulk sales law, make sure that the seller will agree to go through the bulk sales process with the Illinois Department of Revenue and Employment Security. If not, and if the Seller didn’t pay its trust fund taxes, it’s possible that the State can take the assets you just purchased in satisfaction of those unpaid taxes. Sellers generally don’t want to go through the process as it requires a certain amount of money (as determined by the Departments of Revenue and Employment Security) to be held back in escrow pending clearance by the State. Make sure this is acceptable now, as the savvy buyer shouldn’t proceed without it.

Non-Competition Clauses.  Get an agreement immediately with the Seller that it won’t compete with you after the closing with a similar business. For example, if you are buying a hair salon, you don’t want the seller opening up a similar business across the street. There are limits (both in terms of time and geography) to what is acceptable in the eyes of the law.  Your lawyer can flesh out the actual terms of the agreement, but make sure the seller is amenable to the concept.