Wednesday, November 16, 2011

What to Think about when Buying a Business

Let's say you have been approached about purchasing a small business but you are not sure if it is a wise investment. What are the right questions to ask and legal issues?  What is the best structure for the deal?  

You need to ask certain questions and get sufficient information before deciding whether to proceed.  In business terms, this means do your due diligence by considering the following non-exhaustive list of issues. 

I.  Understand What You are Buying 

     A.  What type of business is being purchased?

         1.  Is it a business that is regulated by any particular federal, state or municipal laws?   Does the owner and/or employees need any special license or permit.  For example, a beauty salon, auto mechanic or a restaurant/deli all require certain state licensing. 

         2.  Do you have prior experience operating a similar business, and if not how do you plan on educating yourself. 
    B.  What is actually being purchased?  Yes, a business, but what does that mean.

         1.  Is it the business lock, stock and barrel or does the seller intend on keeping any of the assets.

         2.  Determine what are the assets of the business.

                 a.  Hard/tangible assets:  i.e., equipment, furniture, computers, inventory, supplies, fixtures

                 b.  Intangible assets: 

                        (i)  Customers, customer lists, databases
                        (ii) Intellectual Property:  patents, trademarks, tradenames, business names, copyright.
                        (iii) Website and website content
                        (iv) Domain names
                        (v) software and related licenses

                c.  Cash and Accounts
                d.  Contracts: customer agreements, licenses, vendor agreements
                e.  Loans/Guarantees
                f.   Accounts Receivable
                g.  Permits and licenses
                h.  Claims/Lawsuits/Judgments
                i.   Books and Records of the business; marketing plans, etc. 

  C.  Liabilities:  what obligations are being assumed, if any?

      1.  Loans/Guarantees
      2.  Accounts Payable
      3.  Leases
      4.  Claims/Lawsuits/Judgments
      5.  Contracts
      6.  Employment related obligations
II.  Is it a Good Buy/Valuation Issues.

   A.  Review the financial information of the business

     1. Revenues (are they growing, decreasing or stagnant, and ask yourself why)
     2. Expenses
     3. Liabilities
  B.  Understand the market for the goods and services

  C.  Understand the customer/client base
  D.  If the business is not doing well, is there a reason and is it something you can address  

  E.  Obtain professional advice:  accountant, consultant who understands the business, a business lawyer who can assist with the valuation

  F.  Gut Check:  consider what attracts you to the investment, is there something telling you that it is not a good idea (or a fair price)

III.  Legal Due Diligence

  Before signing any agreement to purchase the business, be sure a lawyer conducts proper legal due diligence, including the following:

 A. The legal requirements for operating the business 

 B. Ensuring the business actually owns the assets (and not someone else)

 C. Are all of the assets assignable/transferable

      1. Permits 
      2. Licenses:  intellectual property licenses, software licenses, product licenses
      3. Customers/clients: are there any legal/privacy issues with respect to the customers/clients
      4. Contracts:  not all contracts are assignable or may require consent of the other party

D. Liabilities/Obligations
     1.  Loans, Obligations, Guarantees
     2.  Contractual Obligations
     3.  Employment Obligations
     4.  Lawsuits/claims/judgments
     5.  Contractual rights with respect to the business itself:  warrants, rights of first refusal, options
     6.  Tax liabilities   

E. Employment contracts

    Aside from the obligations, you need to make sure that all employees/consultants have signed  confidentiality agreements and invention assignments (see

IV.  Deal Structure/Taxes

  There are different ways to structure the purchase of a business, and it is essential you work with legal counsel who can determine the appropriate structure.  Below are the two general methods to purchase a business, but the actual structure of the transaction can vary based on legal and tax issues. 

 A.  Stock Purchase

    1. Transaction explanation:  the purchaser buys from the owner(s) the stock/equity interests in the business entity that owns the business.

    2. What this means:  you own all of the assets as well as all of the liabilities of the business, even those arising before you purchased the business.

B.  Asset Purchase
  1.  Transaction explanation:  purchaser buys all or some of the assets of the business and may or may not assume some or all of the liabilities.

  2.  What this means:  purchaser owns the purchased assets and is only liable for those obligations it expressly assumes.

C.  Taxes:  make sure you have considered all of the possible tax issues relating to purchasing the business.

Final Thoughts:  Please understand that the above discussion is certainly not an exhaustive explanation of all of the issues that need to be considered in buying a business.  Issues as to what the purchasing is buying, valuation, due diligence, tax matters and deal structure should be addressed in consultation with an accountant, an experienced business/corporate lawyer and perhaps other consultants  The important point is know what you are buying, due your due diligence and make sure the deal is properly structured to best protect you and your new business.   

Disclaimer:  As always, the above discussion is for informational purposes and does not constitute legal advice or create an attorney-client relationship.

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