10 Things to Look Out for When Buying a Business
You’re buying a business and have already “shook hands” on the deal. But there are some things you should insist on before you formally close.
- Make sure you’re buying the assets, not the business: Form a separate company to purchase the business assets if the seller is a corporation or LLC. First, you will receive better tax treatment since your basis will be what you paid for the assets. Second, if the seller owes money or is being sued, you won’t assume those liabilities.
- Ask about sales and payroll taxes: In many states, even if you only buy assets, the state can target you if the seller owes business taxes. If there are employees involved, determine if they used a payroll service and ensure they’re current on tax payments. Ask the state’s department of revenue to issue a “clearance letter,” noting that the seller is current with their state taxes on the closing date.
- Determine who will deal with accounts receivable: Typically, some of the business’s customers will be in arrears on the closing date. There are two ways to handle this – you can purchase the AR at closing (at a discount to reflect that some accounts will be written off). Or you can let the seller collect them. Experts recommend the first option. That way if delinquent customers need additional work from the business after closing, you’re in a strong bargaining position to obtain payment.
- Find out if you can assume the sellers lease: If the seller is leasing space, find out the term of the lease and whether the landlord will let you assume it “as is” without a rent increase. Also, determine if the landlord holds a security deposit. If so, the seller will probably want you to purchase the deposit – over and above the business purchase price. If the deposit is included in the seller’s price, get it in writing.
- Are there prepaid expenses: Does the seller have any long-term prepaid expenses, such as advertising or social media? Chances are your closing will take place during the contract period. Expect that the seller will want to be reimbursed for these expenses. Be sure to ask the seller for a list of “closing adjustments,” those prepaid expenses that need to be pro-rated for the closing.
- Negotiate a “letter of intent”: An LOI is a short agreement between the parties that spells out all the important terms and conditions of the sale. It will include the purchase price, how and when the purchase price will be paid, the assets you will buy, what will remain with the seller, terms of the seller’s non-compete agreement and so on. While LOIs are not technically binding, it’s worth the time and effort to hammer these details out so these topics are no longer up for negotiation.
- Watch out for bulk sales laws: Some states require the buyer to notify a seller’s creditors of a sale. Failure to do this may give creditors the ability to void the transaction to safeguard the assets. In addition, the state’s department of revenue wants a copy of the bulk sales notice so it can determine if the seller owes business taxes. If the seller does owe something, require them to pay before the closing takes place.
- Get indemnity from the seller: Even if you, the lawyer, and broker inspect the seller’s books and records, sometimes things are overlooked. This could lead you to being sued because of a seller’s actions. An indemnity assures the seller will defend the lawsuit and pay all judgments and fees. Likewise, you should give the seller indemnity if he is sued for something you do, or fail to do, after the closing.
- Make sure the seller stays involved in the business for awhile: In many businesses, the customers have a personal, as well as a business relationship with the owner. Develop an agreement that the seller will remain involved in the business for a period after the closing. This will allow them to introduce you to customers and “ensure a smooth and orderly” transition of the business. Consider paying the seller a stipend for this service.
- Get to know the employees: Determine if key employees will remain after the purchase, since they know the customers, operations and business procedures. Sellers avoid letting employees know a business is for sale, for fear they will quit en masse. In that case, seek a provision that you and the seller will announce the sale 48 hours before closing to the employees. Or plan a time to meet with employees to determine if they will stay on. You may want a provision that allows you to walk away from the deal if you’re not satisfied that key employees will stay on board at least long enough for you to learn what they know.
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