9 Things to Consider When You’re Buying a Business
By: Craig T. Watrous
The acquisition of a business is one of the most complicated transactions a business (or entrepreneur) can enter into. Deciding between buying the new business under an asset purchase or a stock purchase arrangement could occupy a series of blog posts in and of itself. For the time being below is a list of some critical, but often overlooked legal issues that a Buyer should consider and address in an asset purchase deal.
1. Non Competition Agreements from the Owner(s) and Key Employees:
In Colorado non-competes are considered void except under certain exceptions, one of which is in connection with the sale of a business. Take a look at some of our prior blog posts regarding non-competes. Provided that a non-compete is reasonable (as to scope, geography, consideration, time period, etc.) Colorado courts will usually enforce it if it’s in connection with a business purchase. Keep in mind that part of the purchase price should be allocated towards the various non-competes and that such allocations should be reflected in the purchase price allocation agreement. There’s always a temptation to push for an extremely restrictive non-compete, but going overboard can lead to enforcement problems down the road. It should be reasonable but broad enough to protect the legitimate business interests that being purchased.
2. Sales and Transfer Taxes:
Who is going to pay for the transfer and use taxes related to the assets being purchased? This issue is often overlooked and can result in a sizeable tax burden. Don’t leave money on the table, negotiate the liability for such taxes early in the transaction.
3. Who is Drafting the Documents?
Who is going to draft the first round of documents? Traditionally, the Buyer puts out the first draft. The upside is that Buyer has the drafting initiative and creates the blue print for the transaction. Of course the downside is that this creates additional upfront costs for the Buyer.
This topic generally takes up a significant portion of the negotiations surrounding the deal. You should consider at least getting indemnifications for: any breach of a representation or warranty made by the Seller, claims resulting from the operation of the business prior to closing, and any Seller liabilities not assumed by the Buyer. There are a lot of others you will want. These are tricky provisions to negotiate, and you should consider pushing for the right to a defense, reimbursement of any expenses or damages, and the ability to settle claims on terms the Buyer deems is appropriate.
5. Reps and Warranties:
What are these? They’re essentially promises about the business that you’re buying. Keep in mind that they are different things. A representation is a statement as to facts about the assets and business as they are known to exist. A warranty is a promise that certain facts are now true or will be true at some future point. For example: the Seller should represent that it has good marketable title to the assets that it’s selling you. It should represent that there has been no material change to the business since your due diligence. The assets should be in good working condition. The inventory that you’re buying is not in excess of the Seller’s normal business practices. Etc. Etc. Once these are negotiated, make sure that these promises don’t get washed away with terms like “to Seller’s knowledge”.
6. Condition of the Assets:
This relates to the reps and warranties but you should explicitly clarify what the condition of the assets you are buying is. Are any warranties and representations being made about their condition? Are there any existing warranties that can be transferred to you? Prior service records? Are they being sold to you as-is? Be careful.
Goodwill and other intangibles (websites, phone numbers, trade names, trademarks, etc.) are often an important part of the total business deal. You need to negotiate the valuation of goodwill and make sure it’s accurately reflected on the purchase price allocation. Significant impacts on the tax benefits of the Buyer.
8. Assignability of Key Contracts:
Not all contracts can be assigned without consent; in fact most can’t. Often times companies use purchase orders and oral contracts and may have not actually have long term contracts with their customers. If there are important Seller contracts that you must have in place to take the business forward, make sure that they can be assigned to you and get assurances that they will be assigned.
9. The Misnomer of GAAP:
There is a general misunderstanding of what GAAP actually is. Generally Accepted Accounting Principles may mean one thing to the Buyer and another to the Seller. Make sure your asset purchase documents make reference to a specific type of accounting process. How have the Seller’s books been done in the past? More often than not, it’s not done according to GAAP. Has it even been consistently applied over the course of the years being reviewed? Getting the input of an accountant is invaluable and can ferret out inconsistencies in the Seller’s accounting practices that may translate into overly optimistic economic forecasts for the business you’re buying.
Asset Purchase Agreements are nuanced, long and complicated. These are just a few of the key areas that a Buyer should consider in an asset purchase transaction. I hope they’ve provided some food for thought.
(Mallon Lonnquist Morris & Watrous, PLLC, is a business, employment, real estate, and litigation law firm. Craig T. Watrous is a Colorado business attorney and partner at MLMW, based in Denver, Colorado. Craig regularly represents clients on both sides of business purchases. Craig can be reached at email@example.com.)