You've evaluated the pros and cons of starting a new business from scratch versus acquiring an existing enterprise, either by buying a franchise or purchasing an independent existing business.
Now that you've decided to purchase an existing business, and know which company you want to buy, you need to formally solidify the transaction with a business purchase agreement.
Buying a business
Any purchase of an existing business should be done with a written business purchase agreement. This is a legal document that sets forth the terms of the transfer.
Although it's called a business purchase, it may be more appropriate to call it a business asset and liability purchase. It is not possible to effect a transfer by simply stating, for example, "Joe's Auto Repair is hereby transferred to Bill." What is really being transferred are various types of assets and liabilities. One of those assets is the name "Joe's Auto Repair," and the reputation and goodwill that is attached to that name.
Therefore, the business purchase agreement needs to specifically list what assets and liabilities are being transferred. This is true regardless of whether the business is structured as a sole proprietorship, some form of partnership, a limited liability company (LLC), or a corporation.
Content of a business purchase agreement
A well-drafted business purchase agreement will set forth all of the terms of the sale, including:
- The financial terms of the transfer, such as the purchase price, and the time and manner of payment; this may involve an initial deposit, with either a lump sum payment of the balance at closing or installment payments if the seller is financing the sale
- A description of what is being transferred, such as specific physical assets, customer and supplier lists, and the company name, as well as any copyrights, patents, trademarks, trade names, or other intellectual property; this may include the manner in which assets will be transferred, such as with a bill of sale executed by the seller at closing
- A description of which, if any, debts of the business are being assumed by the buyer
- The date, time, and place of closing
- Protections for the seller, for example, by providing that physical assets are being transferred in "as is" condition, or that certain assets are not being included in the sale and will remain the property of the seller
- Any contingencies that must be met before the purchaser is obligated to complete the purchase
If appropriate to the transaction, the business purchase agreement also may include provisions:
- Stating any warranties or guarantees the seller makes; these are discussed further below
- Prohibiting the seller from competing with the business, commonly referred to as noncompetition and nonsolicitation covenants
- Requiring the seller to maintain confidentiality as to certain information, commonly referred to as confidentiality and nondisclosure agreements
- Providing for the transfer or assignment of any leases (and related security deposits), licenses, or permits; telephone and other utility accounts may need to be transferred to the purchaser's name, or new accounts may need to be opened
- Requiring the seller to provide the buyer with specified training as to the operation of the business
If the business being purchased is a corporation, it also may be necessary to have a small business stock purchase agreement. A transfer of the assets of a corporation may have different tax consequences from a transfer of stock, so it is important to seek out competent tax advice as part of your purchase process.
Purchase price and terms
The purchase price should consider various factors, such as the value of the assets and debts being transferred. A less concrete consideration will be each party's evaluation of the income potential of the business.
The agreement may state a single purchase price, or it may allocate the total price among several categories, such as merchandise or inventory, accounts receivable, equipment, goodwill, etc. Allocation is typically done for tax purposes, or to allow for an agreed-upon recalculation on the date of closing.
Warranties, representations, and contingencies
There are certain warranties, representations, and contingencies that are common to the sale of a business. These generally represent factors that may allow the purchaser to get out of the purchase agreement.
Although the specifics will vary with the business being transferred, the following are fairly common warranties and representations that are made by the seller:
- The seller is the true owner of the business.
- The seller has marketable title to the assets being sold.
- There are no undisclosed contracts, judgments, liens, legal actions, tax liabilities, environmental violations, government investigations, or other claims relating to or against the business.
- All taxes, including estimated taxes and employee withholding taxes, have been paid.
- As of the date of closing, the premises and equipment will pass any and all inspections required by government regulations.
Common contingencies include:
- The purchaser's being able to obtain financing of a specific amount, at a specific maximum interest rate, over a specific maximum amount of time
- The ability of the purchaser to obtain the consent of the lessor to assume a lease, if leased property is being transferred, or to obtain a new lease on certain terms
- The seller's providing the purchaser with various documents, such as financial statements and records, copies of leases and contracts, tax payment certifications, and asset ownership documents
Buying a business is not a simple matter. Competent legal advice and tax advice are essential to creating a good small business purchase agreement—one that will protect your considerable investment and help contribute to your future success.