Starting a business can be a risky endeavor – not knowing whether the local market will support the new business, whether there are unforeseeable costs that your business plan did not include, whether you have an accurate prediction of revenue or whether you can find a good location to establish the endeavor.
Purchasing an established business can be a great alternative to help minimize some of this risk. During the course of a transaction, a purchaser will have the opportunity to review the books of the business to get an idea of profits, losses, revenue and expenses. Often an existing business will have a long-term lease in place that may be transferable, or real property that will be sold as part of the transaction. There may also be a client base or other contracts in place. If the business has a history of success, the buyer may pay more but have instant revenue. On the other hand, a struggling business could provide a bargain start-up price, while providing an opportunity for creativity in rehabilitating the business.
Once a buyer has found a business to purchase, the first step is to determine whether to purchase the assets, acquire the stock if the business is a corporation, or acquire a membership interest if the business is a limited liability company. Purchasing the stock or membership interest of the business puts the buyer in the shoes of the seller and can open the door to unanticipated liabilities, such as past sales or employment taxes that may be owed, or claims that may have arisen during the seller’s ownership. The assets may already be substantially depreciated for tax purposes.
Limited situations arise in which a stock purchase may be necessary. For example, a seller may require a stock sale to minimize taxation, or the business may rely on contracts or government permits that may be difficult to transfer to a new owner as part of an asset purchase. In that case, steps should be taken to ensure that obligations for any pre-existing liabilities remain with the seller, or to adjust the purchase price to address these potential liabilities. Any known liabilities, such as company debts, should be addressed in negotiations and expressly allocated as the parties agree.
In most cases, an asset purchase will be the safest bet for a buyer. By purchasing the assets rather than the stock of a business, the new owner can set up its own entity to run the business and will avoid taking on unwanted liabilities. The assets may include tangible items such as furniture, computer equipment and inventory, but may also include things such as customer lists, advertisements, trade name, an assignment of leases and goodwill or “blue sky.” Once the asset list is completed, the buyer and seller should negotiate a purchase price for each of these items. The parties should consult financial advisers to determine the best allocation from a tax perspective as well.
A covenant not to compete may be negotiated as part of the sale. While non-competition agreements are generally void under Colorado law, they are permitted in certain circumstances, including the sale of a business. Without a covenant not to compete, the value of the business being sold could be diminished significantly if the seller were to open a similar business right around the corner that competes with the one just sold. The covenant not to compete must address the length of time and the geographic distance to be covered. For example, if the business is a restaurant, it may be sufficient to limit the geographic distance to the city limits or a 30-mile radius. However, if the business sells goods or services to other towns or counties, the geographic area of the non-compete may need to encompass a greater area.
Another factor to consider is whether the seller’s unique knowledge and experience is a key to the success of the business, or whether the business is a turn-key type operation. If it is the former, then the buyer might consider negotiating a consulting agreement with the seller.
Once the parties negotiate the terms of a contract, all of the key terms of a business sale should be memorialized in a written contract. Typically a “due diligence” period follows in which the buyer has the opportunity to analyze the books and operations of the company. As part of this process, the buyer should consider the contracts necessary for the operation of the business. Is the location of the business subject to a lease? Is it assignable? What is the duration of the lease? Do the lease terms permit any changes to the business? Does the seller have contracts with vendors? Are these assignable or can the buyer negotiate new terms? Does the business have employees? Are the wages appropriate for the work being done and will these employees continue working for the new owner?
The buyer should also research whether any of the assets are subject to liens, and if so, how these liens should be addressed. Does the purchase price contemplate assets being free and clear of liens, or does the price reflect loans to be assumed? Are there government or judgment liens that need to be released?
These questions should be answered to the buyer’s satisfaction so that the business value is protected and the odds of future success increase. Buying a business can be a rewarding experience by providing an opportunity for a buyer to purchase a successful operation that they can continue or grow, or to purchase a struggling endeavor at a bargain price to breathe new life into it. The likelihood of success in either case can be increased significantly with a little knowledge, planning and diligence.
Nancy Agro is a lawyer practicing water, real estate and business law in Durango. Reach her at firstname.lastname@example.org.