Buying Issues of Note
By Dustin H. DeVore, Franchising
The following article appeared in the October 1-7, 2007 issue of Inside Business:
Buying a relatively small business, even one with few assets or little revenues can involve complex issues that often come back to “bite” a buyer or seller, after-closing when the other party (and the money!) are off to greener pastures. A number of these issues are not easily recognizable to someone that does not deal with them on a daily basis, including knowledgeable businesspeople.
What follows is a list of a few of the issues that if not dealt with in a properly drafted and negotiated agreement can result in long-term issues between the parties in a small to medium-sized business sale and purchase transaction:
Accounts Receivable: Who gets the money!?!?! How will accounts receivable be treated? If a check arrives post-closing for goods or services provided by the business prior to closing, does the buyer keep the funds or is the buyer required to forward them to the seller?
Accounts Payable: Who pays the money!?!?! When bills for payment for goods or services obtained by the business prior to closing arrive post-closing, how are they accounted for? If the seller is in financial trouble at the time of the sale, it may be advisable to escrow a portion of the purchase price for a set period of time in order to ensure that no “surprise” invoices appear following closing. Even if the deal is an asset sale (in which the buyer does not assume the liabilities of the seller), the buyer may not want to anger a key supplier by refusing to honor the debts of the seller. The buyer should attempt to get the seller to supply a list of such accounts payable prior to closing; however, in my experience, one reason businesses that are in financial trouble often are in trouble is because their organizational skills are lacking and record-keeping is inadequate.
Financial Records: Just how much money is there!?!?! I advise all of my clients involved in the purchase of a business to have an accountant review the books and records of the business. This is not just to determine the bottom line of the business, but also to see how meticulous the sellers were in their accounting methods and procedures and obviously to determine if there are any improprieties.
Real Estate Matters: Does the business own or lease any real estate? Will a landlord or lender’s consent be necessary to sell property to the buyer or assign a lease to the buyer? The buyer will want to consider having a Phase I Environmental Survey conducted to ensure property involved in the business does not have environmental problems.
Purchase Price Allocation: How will the purchase price be allocated? Parties often fail to determine upfront how much of the purchase price will be allocated to goodwill (going concern value), equipment, etc. Allocation can have a significant impact on both parties post-closing.
Customer Lists: Are customer lists available in electronic form? If so, it is always advisable to request a hard copy also. The buyer should always ask to review the customer list prior to closing. The business may not have information on customers that the buyer considers crucial. The seller should also be willing to assist in introducing the seller to customers and helping to make a smooth transition.
Franchise Issues: Is the business a franchise? If so, the franchisor will typically have the right to approve the sale and the new owner (and will likely charge a fee!). The franchisor may also require that any sale be contingent on renovating the business’ property and operating systems to the franchisor’s current standards. The franchisor may be able to terminate the franchise if this step is ignored.
Gift Certificates: If the business sells gift certificates how will they be accounted for when customers redeem them? How did the business account for the gift certificates when they were purchased?
Non-compete Agreement: A non-compete agreement prevents the seller (and sometimes certain key employees of the seller) from competing with the business post-closing. This is especially crucial in the sale of a business that is client or customer relations intensive. The primary goal of the buyer in obtaining a non-compete should be to avoid having the seller decide after six months that he now wants to get back in the same line of business and start a competing business in the same general location.
Inventory: The agreement between the parties will usually contain a list of the seller’s inventory. When will the buyer account for the inventory the seller is purporting to sell in the transaction? It is advisable to accomplish such an accounting as close to the closing date as possible in order to ensure an accurate count. Sometimes the accounting of the inventory will even take place on the closing date itself.
Lien/Judgment Search: It is important to conduct a search of applicable records to determine if the seller has any judgments against it or if there are any liens or financing statements filed against the inventory, property or equipment of the seller.
Employment Agreements: Are there any key employees of the business that are critical to its success? If they do not have employment agreements with the business the buyer should consider having such employees sign employment agreements so that they do not jump ship the day after closing. Also, do the employees have binding non-competition agreements?
Financing: How will the purchase be financed? Often a buyer does not have the down-payment, credit, etc. necessary to obtain a bank loan. Is the seller willing to finance all or a portion of the purchase price? If so, what security will the buyer provide to the seller? There are numerous ways to structure a transaction to make it “work” for both parties.
Post-Closing Consulting: Will the seller provide the buyer with post-closing consulting services? This can be a critical element in the success of the buyer in assuming the operations of the business. The seller can introduce the buyer to key customers, vendors and suppliers, and help the buyer learn the “ins and outs” of the business.
All of these issues illustrate the importance for an entrepreneur to assemble a team consisting of an experienced attorney, accountant, business banker and other professionals in order to effectuate a successful transaction for the seller and to put the buyer in a position to succeed in their new endeavor.
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2023.