Business Purchase


In my last newsletter I offered some tips on issues to consider when buying a business.   The ink well isn’t dry yet…so here are a few more:

3. Ask the Seller to stick around.

When you buy a business, you are not just buying the Seller’s assets, you are buying their relationships, their goodwill, and a part of their life.  Having the Seller stay involved in the business for some time as a consultant or employee (a few months or even a year after the purchase) can be invaluable in ensuring a smooth transition.  The Seller may be the only one who knows where to find the extra set of keys to the cash register, or the Seller may be the key to keeping several big customer relationships.  These are the kinds of issues that can’t be completely addressed in the purchase documents and require continued cooperation from the Seller.  Of course, the Seller will expect to be paid for this service, but this is usually negotiated as part of the purchase price, so the Seller’s continued involvement is an integral part of the deal.  Often the Seller welcomes the opportunity to stay involved; they may seek the continued interaction with employees and customers and they will certainly want the business, their pride and joy, to continue to succeed.

 

4.  Watch out for surprise liens or judgments.

If bank financing is involved in your purchase, you can rest assured that your attorney will be required to make sure that the assets are free and clear of liens.  However many transactions these days do not involve bank financing and in those cases it is important  to have your attorney do a basic lien and judgment search as part of your due diligence.  If your Seller has a bank equity line of credit, the bank may have a UCC lien filed against all the Seller’s assets and unless that lien is released at closing it will follow the assets even though you as Buyer may have nothing to do with that equity line.   There are also possibilities of tax liens or other judgments which the Seller may have “forgotten” about.  Don’t rely simply on the representations and warranties given by your Seller in the purchase documents; those provisions are not binding on a third party creditor and will not help you when you are trying to get a release from the creditor so that you can get your own equity line in the future.

 

5.  LLC vs Corporation.

As you are making plans on a business purchase, you’ll have to decide the type of entity you want to use.  I don’t have space here to give you a full comparison of the options, but generally you will be looking at using either an LLC or a corporation.  If real estate is an asset in the business then an LLC will almost always be the preferred choice; remember my general rule – never put real estate in a corporation – if you need a refresher see my Nov 09 Newsletter on my blog.  A corporation is still the most common form of entity for operating businesses and can occasionally offer some tax savings opportunities.  Your best resource on this decision will be your CPA, since they will be handling your tax filings.

 

Give these issues consideration before you get too far into negotiations and don’t be afraid to call your attorney; your attorney can advise on these and other things to consider before you ever start discussions with the Seller and will save you time and expense in the long run.

 

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Thomas Tusser is attributed with the astute observation — A fool and his money are soon parted.  This holds true not only when you are trying to impress your 6 year old at the midway games at the fair, but also when buying a business.  From my view as an attorney there are a number of basic legal issues that should be considered early in the process of buying a business and I’ll review two of these this month with more to follow:

1.   Buy assets and leave the liabilities alone.

One important threshold decision is how to structure the legal form of the transaction.  The two basic options are to acquire the assets of the business or to acquire the entity that owns the assets such as a corporation.  As a buyer it will most often be preferable to buy the assets and not the entity.  Buying the entity means buying the assets and liabilities of the business including unknown liabilities.  Imagine a few weeks after closing, you get a call from an attorney representing a customer that slipped and fell on the icy stairs a few months before you bought the business; if you bought the entity you bought that law suit along with it.  However if you only acquire the assets you can limit your exposure to the business liabilities and even if you agree to assume some liabilities you can establish a specific list so you understand your exposure.

In addition to liability protection, an asset purchase will give you, as buyer, a better income tax  result.  When you purchase assets you will establish a new tax basis for the assets which will allow you to depreciate the assets in the future for tax deduction purposes.  On the other hand, if you purchase an entity the assets may already have been depreciated by the entity and your purchase will not allow you a basis increase, so you will not have the same tax depreciation opportunity.

Fair warning — an asset purchase can be a little more complicated than an entity purchase, because the assets and business relationships must be transitioned over to the buyer.  For example, if there are numerous assets with ownership title (such as a fleet of cars); each title will need to be transferred to the buyer.  If the buyer desires to continue existing customer and supplier relationships, the buyer will need to enter into new contracts for this purpose.

2.     Don’t pay everything up front.

As a buyer, one big concern you have is how to recover against the seller if you have any claims arise after closing.  Usually the seller is asked to make certain representations about the business and assets and if those representations are later found to be wrong (or even worse…lies)  then you will have a claim against the seller for any loss incurred as a result.  Also, even where you have limited liability exposure through an asset purchase, you can still be entangled in litigation associated with the seller which requires you to incur the costs of a defense attorney.  If you have already paid the seller in full, you may have a hard time recovering especially if the seller is relaxing on some Caribbean island far from your concerns.  By requiring that some portion of the purchase price be held in escrow for a reasonable period (sometimes a year or more), you will have a ready source to collect your claims against the seller.  You can also reserve this leverage if the seller is willing to take a promissory note for part of the purchase price; however be sure you reserve the right to offset your claims against your note payments.

Next time we’ll look at a few other ways to avoid the “fool” rule.

 

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That’s a quote from one of my clients after sitting through a recent loan closing —  stacks of papers with no end in sight.  Why so much paper?  That is your government at work trying to protect you.  This excess paperwork  problem is particularly true with a home mortgage or an SBA business loan, where government regulation reigns supreme.  Admittedly most of you are not going to read all the pages you are asked to sign; however there are four important documents that each of you  should carefully consider whenever you are part of a loan closing:

 1.             Promissory Note.  This document is the heart and soul of any loan transaction.  It sets out the amount of loan principal, the interest rate, the payments terms, and the due dates for the loan.  Review all of these items carefully before you sign the note because this one document will usually control all others if there is any dispute later.  The Promissory Note has been specially developed under the law to allow the lender to obtain a quick judgment in the event of a loan default.  This is why confirming the accuracy of the terms of the Promissory Note is so important.

 2.             Deed of Trust or Security Agreement.  Almost every loan will require some form of security such as real estate or business assets; this provides the lender a resource for collection in the event of a loan default.  In North Carolina a Deed of Trust   is filed with the Register of Deeds to provide the lender with a security interest in your real estate.  For equipment or business assets, you will sign a Security Agreement and the lender will file a UCC notice form with the Secretary of State in the name of the borrower.  Make sure you look carefully at the description of the property or assets being pledged in either of these documents to confirm that it does not include any property not intended as security. 

 3.             Guarantee.  I reviewed the ins and outs of Personal Guarantees in my  April 2010 newsletter.  This is often a standard document included in business loans.  The business owners are required to sign Personal Guarantees to ensure that the lender can collect on the Promissory Note if the business doesn’t have sufficient assets to pay.  Signing a Personal Guarantee is effectively the same as signing the Promissory Note.  Remember that a Personal Guarantee will usually obligate you to repay the lender regardless of any attempts to collect on the Promissory Note or against the security interest. 

 4.             Loan Agreement. Many business loans also include a Loan Agreement, which includes various covenants concerning the operation and continued financial performance of the business.  Please pay attention to these covenants.  Do not assume that if you make your loan payments on time, you are in good standing with the bank.  If the bank believes that your loan may be at risk in the future, it can and will enforce the various loan covenants and call the loan for immediate repayment.

If you are flipping through a large stack of loan documents, as you come to the items discussed above please slow down and look at everything carefully.  These  documents will have plenty of boilerplate terms, but pay attention to the main points noted above to make sure what you are signing is accurate.      By all means, if you find a mistake, have it corrected before you sign anything.  It is much easer to correct everything before the transaction is closed, even if that imposes a little delay.

My parting request — the next time you refinance your home mortgage, be sure to plant a tree as well.

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