Starting And Managing Your Business101: The Purchase

By: Richard E. Korb and An Thien[1]

Finding the right business to purchase is not an easy task. In fact, the process of buying a business can be extremely long and challenging. But it can also be one of the most financially rewarding pursuits that you can engage in throughout your life. It is important to gather as much information as possible in order to fully prepare for and operate a suitable business, to aptly value a business, to negotiate successfully, and, lastly, to close a business deal. Being knowledgeable about what you’re getting yourself into is the key to a successful business choice and investment.

Begin by finding the right business for you. You should begin by asking yourself: Am I a genuinely motivated buyer? Being a motivated buyer entails knowing what kind of business you want to buy, having the attention to detail and experience that businesses demand, and having the ability to deal with adversity and uncertainty without losing your composure.

Making money is the most obvious reason for owning and running your business. But it is also imperative to determine other key reasons for buying and operating a business. For example, among other reasons, you may want to buy a business in order to seek self-fulfillment and have control of your own destiny.

Once you’ve determined your reasons for owning a business, it’s time to figure out what you would like to do and search for those businesses that match your skills, capabilities and knowledge. Sources for locating a business include: business brokers, classified ads in the “business opportunity” section of your local paper, newsletters such as in-house brokerage publications, word of mouth through friends and family, magazines, or, simply, the internet.

Next, is the crucial step in buying a business: doing your research. If this process is not done thoroughly and properly, your dream of having a profitable business can transform into a nightmare. It is in your best interest to seek professional assistance when it comes to researching in order to weigh the value aspects of the company and clarify any legal constraints. Here are some things to keep in mind when researching a business of interest: the history of the business, its current ability to perform as well as its potential in the future, its assets and liabilities, reputation, personal rewards, legal issues, etc. All in all, anything that you are uncertain of should be considered and answered no matter how small the issue.

In purchasing an existing business, it is necessary to consider whether you seek to buy the assets of the business or the stock of the business and assume its liabilities.

Asset Purchases

What is an asset purchase? It is an acquisition of the company’s assets, which may include facilities, equipment, and inventory. The buyer can purchase all of the assets and liabilities, some assets or a combination of both. The seller has the power to choose which assets to sell, to retain portions of the business (i.e. the company’s stock), and to remain responsible for some of the company’s liabilities. Before handing over and assuming ownership of the assets and liabilities, the seller and the buyer must formalize the transaction in an asset purchase agreement.

On the other hand, a stock purchase is when you, the buyer, pay the owner or shareholders of the business for their shares of the stock. Unlike the immunity to liabilities that comes with the purchase of assets, when purchasing a stock, you are also buying hidden liabilities, contingencies and assets that exist in that business entity.

Let’s dive into the pros and cons of an asset purchase in comparison to those of a stock purchase. One of the advantages of an asset acquisition is that the buyer can choose which liabilities he or she is willing to assume. But in a stock purchase, the buyer may be purchasing stock as well as uncertain liabilities. Another advantage of an asset purchase is that the buyer eludes problems involving shareholders who refuse to sell their shares.

With advantages come disadvantages when purchasing assets. Unlike a stock transaction, it is required for the seller’s company assets to be re-titled in the name of the buyer. In addition, asset purchases do not qualify for tax treatment as a tax-free transaction. “Double taxation” is a unique aspect to asset purchases and not stock purchases. What this means is that a business is initially taxed on the profits it makes, and the dividends paid by the business to shareholders are taxed as well. Hence, double taxation.

With the proper assistance, it is important that you value the business to prevent over compensating for it. For instance, if you over pay for a business that does not prosper in the future, you may run into financial problems. The price of a business should dependent on the degree of consistency it has at making profits, or, in other words, its ability to generate good cash flow. If you’re having difficulty independently appraising, or assessing, a business’ fair market value (the estimate of the market value of a property), it is possible to do so with the assistance of the CPA, or Certified Public Accountants. Just remember that haggling is part of the game because the original price that a seller asks for is usually never what they receive in the end. It is most often reduced in value through negotiations.

Prior to signing the final contract with your seller, it is crucial to further investigate the business through a process known as “due diligence.” This can simply be thought of as a checklist of things to assess or value before putting down your signature. For instance, you should review the business’ Articles of Incorporation, Bylaws, minute book, organizational chart, list of shareholders (and number of shares held by each), copies of agreements (options, voting trusts, warrants, calls, etc.), Certificate of Good Standing from the Secretary of State, and copies of active status reports. In terms of financial information, you should look into audited financial statements, most recent unaudited statements, the business’ credit report, projections, and schedule of all indebtedness, contingent liabilities, inventory, accounts receivable and payable.

Other categories for assessment can be: physical assets (schedule of sales and purchases of major capital equipment in the last three years), real estate, intellectual property (schedule of domestic/foreign patents, trademark/trade names, and copyrights), employees and employee benefits, governmental licenses/permits/consents, taxes, material contracts (loan agreements, contracts between the business and any officers), service lines (summary of all complaints or warranty claims), customer information (copy of purchasing policy and credit policy, major competitors), litigation (description of any threatened litigation), and insurance coverage (insurance claims history for the past three years).

It is quite an extensive checklist of things to do before purchasing your desired business, but the process is quite necessary in order to ensure satisfaction in your choice and secure your prospective business aspirations. Once all that has been done, you can form your business entity in California by filing the applicable documents/forms with the Secretary of State (whether it is a corporation, limited liability company, limited partnership, general partnership or limited liability partnership). And once the business is registered with the Secretary of State, it must obtain the necessary licenses and permits.

The final step after seeking, researching and valuing your business of interest is to close the deal. Remember that the seller has the upper hand because they know everything about the business inside and out. It is ultimately your goal to reduce their advantage by finding out as much information as you can about the business in the earlier stages mentioned above before negotiation.

Therefore, before you make an offer, make sure this business is what you undoubtedly want. Doubts hint at signs of insecurity; thus, you should take a step back, research further or seek advice in order to make your final decision a confident one. Richard Korb has over 30 years of experience in business law and can assist you in your endeavor. Richard can work with you in reviewing and analyzing your options. For a free consultation with Richard, call (510) 524 -0903.

[1] This is the first in a series of articles on legal issues related to starting a business. RICHARD E. KORB is a seasoned attorney with 30 years of experience advising businesses of all shapes and sizes. Over his legal career, Richard has successfully litigated and resolved over 300 court cases in the fields of contract law, real estate, employment, unfair competition, and general civil law and he has drafted and negotiated over 250 contracts and licenses for large and small companies alike. Richard leverages his experience as a former partner in a 100-person law firm and chief counsel for a public software company to assist individuals and companies, from start-ups to multi-nationals, with a broad spectrum of legal matters.  In addition to his legal practice, Richard is a court-approved mediator and serves on the Alternative Dispute Resolution (ADR) panel for both the Alameda and Contra Costs County Superior Courts. ©2011