Dear Alex:
I am in negotiation to buy a printing business in Sonoma County.
I have never bought a business before, so I don’t know what legal issues to look out for before I finalize the purchase.
Any tips?
When you buy an existing business, you should know all of the potential rewards and liabilities that will come along with the business.
The process of weighing these factors and evaluating a business prior to completing the purchase is called “due diligence.”
During due diligence, a review of profit and loss statements, prior years’ books and records and a physical inspection of the assets are first steps.
A Uniform Commercial Code (UCC) lien search on the assets of the business should also be conducted and may be done through the California Secretary of State’s office.
There will be obvious assets and liabilities, like equipment and accounts payable, but there may also exist liabilities that are harder to identify and quantify.
These difficult to identify risks are of significant concern to business buyers.
Long-term contracts can be great sources of value or great sources of liability, depending upon their terms.
A long-term lease for below market rent may help the company be profitable for many years in the future, however a long-term lease recently executed and signed at full market rent may be a significant operating cost of the business which makes profitability difficult.
Similarly, long-term client contracts must also be carefully scrutinized.
Long-term contracts may result in stable streams of reliable revenue, but if the terms are difficult to satisfy, long-term contracts may just as easily create a monthly struggle to produce product at a profitable rate.
There may also be liabilities that are unknown or unknowable at the time of the sale.
There could be potential lawsuits which have not yet been filed against the business. For example, the present owner may not know that a prior customer was injured by a product of the business and has been working with an attorney to file a lawsuit.
For this reason, many business purchasers will attempt acquire only specific assets of the business — not the entire business entity — and form a new business entity that will then utilize and implement the assets of the old business.
Business sellers generally want to sell the whole business, from soup to nuts, including any pending liabilities. It is always a point of negotiation.
Generally speaking, the market for business sales is fairly illiquid, there are not usually many qualified buyers looking for a particular type of business, and serious buyers will have strong bargaining power.
These are only a handful of common due diligence considerations.
The due diligence process can seem painstakingly slow, but can save a buyer from making a costly mistake, or identify additional value in a business or asset purchase of which the buyer was not previously aware.
Take your time and maintain communication with the sellers during due diligence to reduce your risk exposure as much as possible.
