10
Things to Look Out for When Buying a Business
By Cliff Ennico
If you're thinking about purchasing a business for
sale, this legal expert tells you what you need to be wary of to protect your
investment.
A reader sent in the following question recently in regards to buying a
business:
"I've been working on and off with a local building contractor for 17
years. Last week he told me he's thinking about selling his business and asked
if I'd be interested in making an offer. I did, and he accepted. Now what do I
do?"
First off, get a good business lawyer and an accountant to help you with the
paperwork, because even with a small business like this, there's going to be a
ton of it. Frankly, it sounds like you should have asked lots of questions
before you made your offer, but it's not too late since your deal with the
seller is only a "handshake" at this point. Here are some things you
should insist on--and be clear about--before you close on the deal:
1. Make sure you're buying the assets, not the business. If the seller
is a corporation or LLC, under no circumstances should you buy stock in his
business. Instead, offer to buy the assets of the business, and form a separate
company to act as the purchaser. Why? Two reasons.
First, you get a better tax treatment, since your "tax basis" in the
assets will be the amount you paid for them, rather than the amount your seller
paid for them long, long ago. Second, if he owes money to people or is being
sued by someone, you won't assume any of those liabilities if you buy the
assets.
2. Ask about sales taxes and payroll taxes. In many states, even if you
buy a business's assets, the state tax authority can come after you if they
find out the seller owed sales, use, payroll and other
business taxes. If the seller has employees (other than himself), ask if he was
using a payroll service, and make sure he's current in his employment tax
payments. Then ask the state tax authority to issue a "clearance
letter" saying the seller is current in his sales and use taxes on the closing
date. This may take a while, but it'll save you tons of heartache down the
road.
3. Determine who will deal with the accounts receivable. Chances are, some of the business's customers will owe the seller money
on the closing date. Who will be responsible for collecting these overdue
debts? There are only two ways to handle this: Either you purchase the accounts
receivable at closing (for a discount, to reflect the fact that some of these
folks won't pay up), or you let the seller collect them at his leisure. My vote
is for you to buy the accounts receivable at closing--that way, if the
delinquent customer wants additional work done after the closing,
you're in a stronger bargaining position.
4. Find out if you can assume the seller's lease. Is the seller leasing
the premises where he conducts his business? If so, you should find out (1) how
much time remains on the lease term and (2) whether the landlord is willing to
let you assume the seller's lease "as is," without an increase in
rent. If the lease has less than two years to run, you might want to spend the
money now to negotiate a new lease with a five- to 10-year term. Also find out
if the landlord is holding a security deposit (usually two months' rent, but
sometimes more). Your seller will probably want you to purchase his security
deposit on top of the agreed-upon purchase price for the business assets. If
the seller is including the security deposit in the purchase price, make sure
that's spelled out in writing somewhere.
5. Are there prepaid expenses? Take Yellow Pages advertising, for
example. When you buy a Yellow Pages ad, you normally pay for a whole year in
advance. Chances are your closing will take place sometime during the year, and
the seller will want to be reimbursed for the portion of the year when you're
running the business and benefiting from the Yellow Pages ad. Prepaid
expenses--like the seller's security deposit--usually aren't included in the
agreed-upon purchase price but are tacked on at the closing. Ask the seller now
for a list of "closing adjustments"--amounts the seller has prepaid
that will have to be "pro rated"--so you can budget for them
accordingly and there'll be no nasty surprises at the closing.
6. Negotiate a "letter of intent." Also called a "term
sheet," a letter of intent (or LOI) is a short, two- or three-page
agreement between the buyer and seller of a business that spells out all the
important terms and conditions of the sale. For example, it will include the
purchase price, how and when the purchase price will be paid, the assets that
will be sold to the buyer (and those the seller will keep for his own use), the
terms of the seller's noncompete agreement, and so
forth.
While LOIs are technically not binding on the
parties, it's well worth your time and effort to hammer out as many of the
business issues involved in an LOI before the lawyers begin drafting the
"definitive" legal contracts that will document the sale. A
well-drafted LOI helps the lawyers get the sale documents right on the first
(or possibly the second) draft, since most of the important terms and
conditions will already have been dealt with in the LOI and aren't subject to
further negotiation. Without a LOI, you'll end up negotiating the business deal
and the "legalese" of the definitive documents at the same time,
requiring multiple drafts of the sale documents and tons of money in legal
fees.
7. Watch out for bulk sales laws. Most states have done away with these,
but many states still require the buyer of a business to notify the seller's
creditors that the transaction is going on. Failure to get a list of the
seller's creditors and send "notices of sale" to them may give the
seller's creditors a shot at undoing (or "rescinding") the
transaction in order to prevent the seller's assets from being sold out from
under them. Even if the seller has no creditors at all, which is a rare
occurrence, the state tax authority generally wants a copy of the "bulk
sales notice" so it can determine if the seller owes any sales, use or
other business taxes. If the seller does, he'll have to pay them before the
closing takes place.
8. Get an indemnity from the seller. Even if you and your advisors have
torn apart the seller's books and records, sometimes things get overlooked and
you find yourself getting sued because of something the seller did (or failed
to do) before you took over the business. Get an indemnity from the seller,
promising to defend the lawsuit and pay all judgments and fees if that should
happen. Likewise, you should be prepared to give the seller an indemnity if he
gets sued because of something you do--or fail to do--after the closing takes
place.
9. Make sure the seller sticks around for a while. In many retail and
service businesses, the customers have a personal as well as business
relationship with the owner. Be sure the seller continues to make an appearance
at the business for a few weeks after the closing to introduce you to
customers, help you figure out the books and "ensure a smooth and orderly
transition of the business." Consider paying the seller for his time so he
has an incentive to stay off the golf course--at least until you're comfortable
you know what you're doing.
10. Get to know the employees. Before you buy a business, make sure the
"key employees" are willing to stick around, since they're often the
ones who see the customers day to day, operate all the tricky machinery and
know "where the bodies are buried." Many sellers will be reluctant to
let their employees know the business is up for sale, for fear they'll quit en
masse. In that case, put a provision in the sales contract that reads as
follows: "Seller and Buyer will announce the proposed sale to all
employees of the Business within forty-eight hours before the Closing, and
Buyer will be given a reasonable opportunity to meet with each employee
individually before the closing date to determine, to Buyer's reasonable
satisfaction, the employee's willingness to continue working for the
Business." Then add a provision allowing you to walk from the deal if you're
not totally satisfied that the key employees will stay on board at least long
enough for you to learn what they already know.
Cliff Ennico is a syndicated columnist, author and host of the
PBS television series MoneyHunt. His latest book is Small Business Survival Guide (