The Second-Hand Purchase
Buying an existing business can be tricky, as seen in the case of a laid-off employee who decided to go into business for himself and contacted several business brokers to find an existing small business for sale in his area. He’s excited about one business in particular, but the business has a troubled past.
The would-be entrepreneur explains: “The original owner sold it three years ago, but the buyer made a total mess of things and ended up fleeing the state, owing a lot of people a lot of money. The original owner took back the business a little over a year ago and has cleaned up most of the mess. He’s offering me a very attractive price — basically $1 plus the amount necessary for him to repay a couple of loans — and I’m very tempted to make him an all-cash offer to buy the business. I’m a little worried, though, that there might still be some ‘skeletons in the closet’ that could come back to haunt me once the business is mine. What can I do to protect myself against that happening? I don’t mind being liable for my own messes, but I don’t want to be liable for anyone else’s.”
There is no way you can be 100 percent sure that all of the previous owners’ messes have been cleaned up. Given that the original owner has been running the business for over a year, it’s probably a pretty safe bet that all the dominoes have fallen and that any remaining cleanup will involve only small amounts of cash. Having said that, though, there are a couple of things you can do to make sure there are no big surprises with this business going forward.
Do lots of “due diligence” before you buy. It’s always prudent to look at the seller’s financial statements and tax returns before you buy a business. With a troubled business like this, though, you will need to do a lot more. Have your attorney perform (1) a “tax lien search” for any unpaid federal, state and local taxes; (2) a “judgment lien search” for any outstanding lawsuits (including a check of the local small claims court records); and (3) a “UCC search” for any liens held by business creditors. Also do an online search for blog postings and other “negative feedback” by people who were cheated by the business, as they could be potential plaintiffs in a lawsuit.
Get a personal indemnity from the seller. If the seller is a corporation or limited liability company, don’t rely on just the seller’s indemnity to “hold you harmless” if something bad happens after you take over. Get an indemnity from the owner personally, as well. If he knows he might lose his house if the deal goes bad, he will make sure to tell you everything he knows.
Pay the business’s existing creditors directly. Since some of your purchase money will be used to pay down the business’s existing debts, don’t rely on the seller to do this. Get “payoff letters” from each of the creditors showing all amounts and accrued interest due to and including the closing date, and then get bank or certified checks drawn for each of those amounts. At the closing, overnight these checks to the creditors directly and pay any balance to the seller.
Hold back some money. I’m not sure you should pay the entire purchase price for this business up front. Consider holding back 10 to 20 percent of the purchase price for six months to one year after the closing, and put a clause in the sale agreement allowing you to “set off” this amount against any surprise liability you may have to deal with during that period.
Get releases from all known creditors of the business. For continuing obligations (such as the monthly rent due to a landlord), ask each creditor for a release. Many landlords will issue a document called an “estoppel certificate” — basically, an affidavit by which the landlord states exactly how much is owed by the business each month, how much the landlord is holding as a security deposit and certifies that there are no lease defaults. For other types of creditors, the release should state as broadly as possible that you will never be liable for anything that may have occurred “from the beginning of the world” to and including the date of the release, whether “known or unknown” at this time.
Publish a notice of sale in local newspapers. It used to be the law in most states that when a business changed hands, the buyer had to publish a “bulk sales notice” in local newspapers, putting unknown creditors on notice of the sale. While no longer legally required, it’s still a pretty good idea, especially if the business’ suppliers and customers are mostly local and likely to read the local newspapers.