Buying a business: Let the buyer beware
Buying an existing business can be an excellent way to become a business owner or to expand your present business. First of all, you can save the time and effort of building a customer and supplier base. Second, you also may avoid the trouble of locating suitable equipment and hiring and training employees. However, before buying an existing business, you should abide by the Latin slogan "Caveat emptor," which translates to "Let the buyer beware." If you are not careful, acquiring an existing business can lead to disaster. This article discusses how to avoid these pitfalls.
Do you really want the business? The first step is to prepare a business plan. A business plan will help you decide such things as the location and size of the business you want to purchase. Do you want to run a small one-person operation or a full-service landscaping firm? Many community colleges and local libraries have good resources that can help you learn how to prepare a business plan.
If you already have experience working in the business you want to buy, your decision will be easier. However, whether you want to acquire your first business or expand your existing business, you still need to know for certain that you really want to take on the added responsibility. Preparing a business plan and perhaps studying the industry will help you decide whether you are ready for the challenge.
*Locating a business for sale. When you begin your search for a business, you have several choices of where to start looking. Business brokers and classified ads are two choices worth considering. If you want to use a broker, interview several to find one who you feel respects your interests and understands your ultimate goals. The Sunday classified ads list many businesses for sale. You may even want to place your own ad in the newspaper or a magazine such as Grounds Maintenance. Finally, you can ask owners of existing businesses if they would consider selling to you, of if they know of someone who wants to sell his or her business.
*Pricing the business. You can determine the price for a business by following many methods. Often, the price is set at some multiple of the value of the assets or the amount of the earnings. An accountant who has experience in business acquisitions can assist you in determining a fair price. Again, many local community colleges and libraries will have helpful resources.
Should you purchase stock or assets? If the business you want to buy is incorporated, you must decide whether to buy the stock or the assets. The stock of a business is similar to the title of a car or the deed to a house. Buying the title or the deed automatically gives you the entire car or the entire house. The assets of a business are like the various parts of a car or the contents of a house. Buying one asset does not necessarily give you other assets.
If you buy the stock of a business, you generally become responsible for all the debts the business incurred before the sale, because you are automatically buying the entire business. These debts include those that neither you nor the seller anticipates. For example, the business's income or payroll taxes that the seller inadvertently failed to pay, unexpected customer credits for returned or rejected goods or services could all be unanticipated debts. You can require the seller to repay you for all prior debts, but you will still owe them if the seller does not pay you.
If you buy only the assets of a business, you generally will not be responsible to pay the debts of that business-unless you specifically agree to do so-because you are not automatically buying the entire business.
Most purchasers of an existing business do not want to become responsible for paying any debts the business incurred prior to the sale, especially unanticipated debts. Therefore, purchasers usually buy the business's assets, not the stock. In addition, purchasers usually only buy the stock if that is the only way to acquire a desired asset. For example, a travel agency may own a license allowing access to an airline's reservation service. This would be the key asset assuming the agency can't conduct business without access to that service. Depending on the terms of the license and the airline's rules for granting new licenses, acquiring the existing license by purchasing the business's stock may be the only practical approach.
Do your due diligence After you decide whether to buy the stock or the assets, you need to conduct a thorough examination of the business, which is often called the target. This review is necessary to ensure that you are getting what you will be paying for. This examination process is called due diligence. Your due-diligence investigation should cover the following general areas: *Financial. You should have your accountant examine the target's tax returns and financial statements for the past 5 years. He or she also should spot check the target's bookkeeping records, especially if an item in a tax return or financial statement seems suspicious. *Condition of the assets and inventory. You should examine the assets and inventory (if any) to guarantee they are in proper condition and quantity. Unless you are an expert, you'll want to hire someone to conduct this review. In any event, your attorney should check that no liens exist against any of the assets. If the assets include real estate, your due diligence should include a review of potential environmental hazards, a search to verify that the target owns clear title to the property and a survey to verify the boundaries of the property. A survey is necessary to distinguish property lines and to ensure your neighbors are not encroaching on the property and that all structures are within the building and lot lines. *Contracts. Your attorney should review the target's contracts to check for any hidden liabilities. Also, if you want to assume or take over the target's rights under any contracts, the contracts must state that you may do so. *Employment. If the target has employees, your attorney should review the target's books and records to make sure that no hidden employment agreements, union contracts, unpaid fringe benefits or under-funded retirement plans exist. *Government regulations. Ask your attorney to review all licensing requirements and zoning regulations, as well as the rules of all other pertinent authorities to make sure that no unexpected rules or fees exist. *General books and records. During your attorney's review of the target, he or she also will examine the target's general books and records to make sure that no one has made any adverse claims against the target and to verify other problems associated with the business do not exist. *The contract. Following your attorney's thorough examination of the target, he or she will prepare a written contract containing all the terms and conditions of your deal. You and the seller can sign the contract before you finish your due diligence. The contract should provide that you do not have to purchase the business if your due-diligence review discloses anything unsatisfactory about the target. You also should try to get the seller to agree to refrain from offering the target to anyone else until you complete your due diligence. Finally, the contract should cover your financing. For example, if you are obtaining commercial financing, the contract should enable you to walk away from the deal if you cannot obtain a loan. If the seller is providing any financing, those terms should be in the contract.
Don't go it alone Buying an existing business is a major undertaking and is not a do-it-yourself job. To avoid a possible disaster, you should commit yourself to sufficient study and planning, and you should retain experts for proper guidance. Hiring an attorney to assist you in all the legal aspects along the way will decrease your chances of running into financial, contractual or other legal matters down the line.
James L. Poznak is an attorney with Poznak Law Firm Ltd. (Oak Brook, Ill.). He can be reached at (630) 573-9300.
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