Purchase and Sale of a Business

Starting up a business can be a difficult venture because of the many unknowns involved in a new enterprise. For example, there is often a significant time lag between the "grand opening" and development of a client or customer base sufficient to meet overhead expenses and generate a profit. Some potential business owners will become involved in a franchise business.  Other potential business owners will decide to purchase an existing enterprise. The business and client or customer base is in place, and the purchaser expects to rely on the cash flow of the business to cover expenses.

How Should the Existing Business be Acquired?

An existing business can be purchased by either:

• Acquiring the business entity that runs the business (for example, by purchasing all of the shares, if it is a corporation)
• Acquiring all or part of the assets of the business

The assets of a business include the equipment, real property, accounts receivable, customer lists, rights to trademarks and trade names, and the "good will" of the existing business. For example, you can buy all of the shares of "Don’s Pushcarts, Inc." and continue to operate the business in that form. Or, you can buy just the pushcarts and all (or part) of the other assets of the business. If only the assets of the business are purchased, the business can be continued by the purchaser as part of an existing business entity, or a new business entity can be formed with the assets.

The interests of the seller of the business and the purchaser of a business often differ when it comes to deciding the form in which a business should be acquired. For example:

• There may be tax and other kinds of advantages to a purchaser in acquiring only the assets of a business rather than the business entity itself
• It may be advantageous for the seller to sell the business entity itself, rather than the assets

As a result, the form in which a business is sold is often the subject of intense negotiation between the parties to the sale of a business.

There are advantages and disadvantages to purchasing a business in one form or another. For example:

• If an existing business is in the form of a corporation and a purchaser acquires all of the stock of the corporation, there is no change in the legal entity of the business. As a result, all liabilities of the business, whether known or unknown, will remain in the business after the sale of the stock.
• A purchaser wishing to avoid acquiring the liabilities of a business will probably want, therefore, to purchase the assets rather than the stock of a corporation. If only assets are purchased, the purchaser, with certain limited exceptions, assumes only those liabilities of the business that the purchaser agrees to assume as part of the deal.

There are also other ways by which an existing business may acquire another existing business or businesses, such as a merger or a consolidation.

• In a merger, one business acquires one or more other businesses and continues as the "surviving entity"
• In a consolidation, two or more businesses are combined into a completely new entity

Protecting Yourself with "Due Diligence"

"Due diligence" is the process in which the purchaser investigates all aspects of the business that is to be acquired. The purpose of due diligence is to determine whether the business is accurately represented by the seller and to ensure, to the extent possible, that there will be no unexpected adverse surprises after the sale is closed.

The extent of due diligence varies according to the nature of the business and is usually undertaken by professionals such as attorneys and accountants.

Perhaps the most important area for due diligence is in determining the liabilities of the existing business. Businesses can have many different kinds of liabilities:

• Accounts payable
• Judgments entered pursuant to lawsuits
• Unfunded pension obligations
• Unpaid taxes
• Bank debt

The existence of many of these kinds of liabilities can be determined by searching public records and other databases to identify business liabilities that the seller, inadvertently or deliberately, may fail to disclose. Sometimes a business may have "contingent liabilities", potential liabilities that are not yet determined. Contingent liabilities include, for example, lawsuits that have been filed against the business but have not yet concluded or potential lawsuits, such as when an accident has occurred but a lawsuit has not yet been instituted. Much of this information will come to light through the negotiation of numerous representations and warranties from the seller regarding the business.

The due diligence and contract negotiation process can be extremely expensive. Thus, where the asking price of a business is relatively small, the purchaser may not wish to spend money on legal and accounting fees in an amount equal to, or greater than, the purchase price of the business. Lowering the cost of the transaction by reducing the amount of due diligence usually means that the purchaser assumes a greater degree of risk.

Restrictive Covenants and Covenants Not to Compete

One concern in acquiring an existing business is whether the former owner can start a new business and compete with you, thereby lessening or destroying the value of what you bought. For example, you purchase an office-cleaning business from a person who, after the sale, immediately sets up a new office-cleaning business in the same town and takes away all of the accounts of the former business that the person just sold to you. Obviously, the value of the business from the purchaser’s point of view is greatly lessened by this kind of competition.