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As a buyer you should find out all you can about the type of business you are interested in. The more you know the better able you will be to evaluate the particular business you are thinking of buying. One of the best sources of information is to get a job in the field for a year, if possible. You should also read all the information you can about the business. Look it up on the internet. The U. S. Government Printing Office puts out books on particular businesses and you should get the ones applicable to the type of business you are considering. There are many books on particular businesses available from commercial publishers. Ask in your local book store to let you look through their copy of Books In Print for these. Card catalogues in libraries will reveal other books and articles. You should also look for trade publications in the field. The information released by public companies in the same business is also a useful source of information. They must file annual (called 10-K) and quarterly (called 10-Q) reports with the Securities and Exchange Commission and they also put out annual and quarterly reports to shareholders. You can obtain the S.E.C. filings from the Commission or on the internet. You can get financial and other information on these companies from internet services like Yahoo. You can get the reports to shareholders directly from the companies or on the internet at the companies' web sites. It also pays to talk to other people in the business, both about the business in general and about any particular business you are interested in. Get a good accountant and a good lawyer. Figure their fees into your cash flow projections. They cost money and they are worth it. You will be making a large investment and you should take advantage of the services of people who are trained to protect you. Accountants are trained in analyzing various businesses and can be invaluable in that regard. You are going to need a lawyer to prepare the documentation if you are buying or selling a business and to handle some or all of the negotiations. The lawyer is also trained to see that provisions that protect you are in the contract. Go to the lawyer before you sign anything. If you sign a contract and take it to a lawyer, you are already bound. You must consult the lawyer before you sign. Remember the saying, "Sign in haste, repent at leisure". Lawyers are often helpful in negotiating deals or contracts. They also can help you determine how to organize a business legally and incorporate or set up any necessary entities. They can also prepare agreements between the owners when there will be more than one. These cover questions like what happens if the owners disagree or if one wants to sell or if one dies or becomes disabled. Picking a winner is hard enough without fighting the odds. So, if at all possible a buyer should try to avoid businesses with these features: - Money losers. If the seller or others in the business can't make a profit, what makes you think you can? Ideally you will know what type of business you want and you will have already have a business or experience working in the field. But many people who start or buy businesses do not have any particular type of business in mind. Once again, it helps to ask certain questions to narrow the odds. Some of the questions deal with your own skills. What are they? Can you sell? If not, stay away from a business which requires sales skills. If you have production experience you may want to consider manufacturing. Perhaps you have a hobby which you can turn into a business. The important thing is to look for a business which can utilize your skills and experience. Compare any business you are interested in to other businesses in the same area. Is the product or service competitive? Are the prices? Another possibility is a franchise. This can involve purchase of an existing franchise or the purchase of rights to a new franchise directly from the franchisor. Buying an existing franchise is like buying an existing business except that you have to meet the franchisor's requirements. Buying a new franchise can be a little different than starting up a new business. The franchisor is supposed to have a system which works. Franchisors also often provide their franchisees with a variety of business help and advice. In return the franchisees pay them up front fees and yearly fees. This is in addition to all the other costs of starting up a business. It costs a lot, but is often worth it. Just ask the holder of a McDonald's franchise. Finally, whether you buy a business may depend mainly on what is available for sale at the time and how much cash is required. If you don't see what you like, wait. New businesses become available all the time. Businesses for sale can be found through: - Brokers. The prices are usually higher than for businesses offered without a broker. The brokers also have one purpose in life and that is to get their commission. They do this by getting you to sign something. Don't! They are good at pressuring you to sign and if you learn one thing it is this - don't sign! Have your lawyer review it first. Brokers also often try to get you to put up earnest money. This makes it hard to back out of what you signed and puts you in a bad negotiating position. Don't sign or pay anything without investigating fully first. If you are told someone else is about to seize the opportunity from you - let them. Let them lose their money. It takes time to find a suitable business. Be patient and keep looking. It is not like buying a car where everything is available right now. The stable of businesses for sale is constantly changing so if you cannot find what you want, keep looking and wait. Sellers should consider: - Brokers. Their business is to find buyers. That is why they get paid. But, as with this or any contract, do not sign the listing contract until your lawyer reviews it. And never sign a contract of sale submitted to you by the broker without your lawyer's review. Brokers use forms which are usually unsatisfactory for both sellers and buyers. You should analyze each element of the business. The more you are able to anticipate its needs and cash requirements, the better you will be able to meet them. You can do this by going down a checklist like that which follows. If you are buying a business you want to make sure you are getting what you pay for and that the business has good future prospects. Using the checklist will be helpful here. You can use the checklist to evaluate each element of the business. For example, take insurance. Without a reminder you may not think of the insurance needs of the business. If you are interested in buying a retail store you should ask yourself what kind of fire insurance is needed to cover the building and contents, like inventory and fixtures. Does the business have the coverage or not? If the premises are leased this prompts you to look at the lease to see who it requires to carry and pay for the insurance on the building. How much insurance is needed? How much will it cost? You will adjust the seller's profit and loss figures by any amount which you think necessary to increase the insurance coverage to proper levels or to decrease it if the seller is overinsured. When buying a business you will be getting most of your information from the seller as historical fact. But remember that the numbers may not be the same for you. First, actually look at the business and its records and get qualified people to help you. You should also verify everything you get from a seller. Preferably from independent third parties. Many lie. For instance, they furnish false tax returns or financial statements. Have the seller sign IRS forms authorizing IRS to release the tax returns directly to you. Get similar forms authorizing the seller's bank to release information directly to you so you can conform the seller's receipts. Actually check the seller's inventory. Are the numbers what the financial statements show? Is the inventory saleable or useable? Have your accountant review the seller's books and records. Whenever you see something unfavorable investigate until you get a satisfactory answer. And if the seller won't open up any and all of his books and records for your inspection or answer all of your questions about the business - walk away. On the other hand, the seller may want you to sign a confidentiality agreement or even a sale contract before releasing information to you. This is reasonable and you should expect to do so, provided your lawyer approves the particular agreement. Also be aware that most people who start or buy a business view the facts through rose colored glasses, i.e., they are over- optimistic and deny the significance of negative information. For this reason it is very helpful to have someone else help you with your analysis. Your accountant is ideal for this purpose. The accountant does not have to review every deal you look at, but if you are seriously interested in one, take it to your accountant for review before proceeding further. No business is going to be perfect. A complete analysis will reveal problems in any business. Here is a checklist to use in analyzing a business: - Who are the competitors and how are they doing? - Retirement. Products or Services and Pricing - Does the product work?- Test it. - Who are they? - Who are the suppliers?- Few or many? - Will any skills have to be added and at what cost? - Where does it come from? - What are they - verify? - How much is needed? - Own or rent? - What is it?- A few big companies? - Have they been paid?- Especially sales and withholding taxes which a buyer may become liable for. - Are there any important contracts?- Sales. - What are they? - As a general rule - no credit other than the normal time it takes customers to pay. Let a bank finance the customers. You are not in the loan business. Machinery, Equipment and Other Assets - What condition is it in?- How old is it? - Is there adequate insurance.- Fire and casualty? - Does the business have a right to use its name or does someone else claim it or use it?- Never spend money on a name without checking it out first because someone else may have the right to use it. - Does the business have good title to these? - Patents and copyrights are disclosed and the law recognizes your right to prevent others from using them. - What are they? Financial Statements and Tax Returns - Get at least 3 years and preferably 5. - Are there any? - Are they the right hours? - What do your cash flow projections show? - If a large company or a large share of the market is involved your lawyer should check to see that the antitrust laws will not be violated. - Who owns the business? The foregoing matters should ideally be checked out before you sign anything, except perhaps an agreement with the seller agreeing not to divulge any information which you may learn about his or her business. The seller may also want to check your credit, financial statement and bank references before revealing any information to you and you should expect to cooperate. Finally, you may well be asked to sign something first. This may be called a binder, a letter of intent or something by any other name. If you do sign it, you do so at your own risk. Sometimes, and usually for larger businesses, the seller furnishes information or lets the buyer check it only after a formal sale contract is signed. These contracts are contingent on the information furnished by the seller being correct and there being no problems after investigation. If you are asked to make a deposit, refuse. Never pay a dime before investigating fully. Try getting the money back if you don't like the deal. - Buying an existing franchise is like buying any other business, except you must check the franchise agreement for the franchisor's requirements concerning resales? A franchisor is supposed to have a business system which has been tested and found to work. It is also supposed to provide its franchisees with continuing help in running their businesses. The franchised businesses are usually independently owned, but they are commonly operated under one name. Federal law and the laws of most states require that a franchisor deliver a disclosure statement to prospective franchisees. Get one and read it. It contains a wealth of information. However, it does not contain all you need to know. What you would like to know is how each individual unit the franchisor sold performed. Not just the ones in business now, but all of them. This information is not usually available. Each franchise location is different and results will vary depending on the location - as well as many other factors, such as how well you attend to the business. There are many marginal locations. The results of many locations will also be affected by competition from other units of the same franchise chain. You should also be aware that many franchisors make money by selling individual units, but that none of the units, or very few of them, make money. To check on these matters you want results of the individual franchises. You will get the results of the particular franchise you are considering buying. But results of the other franchises are hard to go. Franchisors will tell you financial information on the individual units belongs to the owners, and they are right. But you still want to know. What you can do is check with the owners of other franchise units and stick to franchisors with an established track record. Here are some of the things you can do to protect yourself: - Stick to franchisors with an established track record over a period of years. In reviewing the franchise agreement you will want to look for: - What does the franchisor promise to give you? What should a business sell for? Since there is no easy mechanical formula for determining the correct price, tons of materials have been written on the subject. And if you read all of it you will still not be able to name the one proper price for a business. If the business has stock that is publicly traded, then there is a bench mark for the price per share. However, most businesses are not publicly traded. For non-public companies you can sometimes get figures on sales of comparable companies from publications or companies which track such information. Keep in mind that non-public companies are usually worth a lot less than publicly traded companies. This is because there is no ready market for their stock. At the heart of business valuation are two factors. One is the earnings of the business. The other is the assets of the business. What does the business earn and what is it likely to earn in the future? How much would you pay for that stream of earnings? That is what the business may be worth on the basis of its earnings. On the other hand, what are its assets worth? What would you pay for the real estate, equipment, inventory and other assets? How much could you buy them for elsewhere? Does the fact that they are all assembled in a going business with a customer list and employees make them worth more? These considerations are often expressed in formulas used to value businesses such as 3 or 4 times earnings or one times sales. In some industries there are prevailing formulas which are used to value businesses in that industry. Find out what formula is used in the industry you are interested in, if any is used. If there is no formula, there are often sales of comparable businesses and those prices can be used as a guide. Assets are valued in a variety of ways. One way is book value - their value on the books of the seller. This is generally cost less depreciation. This often understates value because it ignores inflation and appreciation in value. However, it may also overstate values because assets may have become obsolescent. Assets can also be valued at replacement value - what it would cost to replace them. Or they can be valued at liquidation value - what they would bring at a forced sale. Asset valuation completely ignores the earning power of a business, but sometimes this is compensated for by adding and valuing an asset called goodwill. There are appraisers who value businesses. They are expensive, but in a larger deal they are often helpful. In the end there is no one ironclad guide to the value of a business. The desire of the seller to sell and the desire of a buyer to buy are powerful factors in the equation and in the end price determination is a matter of judgment. A lender can take the assets of a business as security for a loan. Also the seller is often willing to finance part of the price and this is really the only way most sellers can get the top price for their business. A seller who finances part of the purchase usually retains liens on the business to secure payment. However, if the purchaser is also getting a bank loan or other financing the seller will have to expect to take a second position in the assets. To get bank financing you will have to put up collateral well in excess of the amount of the loan. Collateral consists of assets which the bank can put a lien on and take if the loan is not paid according to its terms. In addition the bank usually will want to see a stable earnings history for the business. The buyers of the business will also have to guaranty repayment of the loan personally. That is, they will have to pledge all their non-business assets and income to support repayment. Above all, no matter what the collateral, a bank will want to know that it will be repaid on time with interest. Banks are interested only in loans where every payment will be made in full and on time, no matter what. A good loan application shows the bank collateral, earnings history and an experienced and able management and anything else which will enable the bank to draw the conclusion that it will be repaid in full and on time. Bank loans are sometimes easier to get with Small Business Administration guaranties. The SBA does not make loans. Banks make the loans and the SBA guarantees repayment of all or part. There are also finance companies which often make loans which banks will not. They require collateral and personal guarantees also. They generally charge higher rates of interest, but they usually are more willing to make loans. Here a word about loan brokers is in order. These are people who are in the business of getting loans for other people. The customer usually pays the broker a front fee. At this time the broker gives the customer a contract specifying the loans terms the customer must agree to or lose the deposit. The customer usually signs this without consulting a lawyer or any negotiation at all. Then when the time comes to negotiate the loan with the lender the customer has no negotiating leverage at all. All such documents should be reviewed by your lawyer before you sign a thing. Also keep in mind that because it is customary for the customer to pay up front, the business attracts scam artists. You should never do business with a loan broker without thoroughly checking it out. Most brokers can withstand investigation and will not mind it. If a franchise is involved, the franchisor may give financing. You should also look into financing from suppliers who may want to insure a source of sales. Finally, do not overlook the possibility of leasing assets instead of buying them. The costs of leasing and buying on credit may be roughly the same, but sometimes it is possible to lease when it would be possible to buy only for cash. Venture capital and sales of stock are not feasible for most small businesses. Venture capital companies are interested only in fairly large investments. And they are interested in only the most promising of those. They also usually invest in purchasing a business only if management is staying and they do not finance other buyers. Stock sales, if the securities laws are complied with, are very expensive. Stock is also almost impossible to sell. Most investors with substantial funds have a lot better and less risky investments available to them. And just finding investors with substantial funds is hard. How many people do you know with a spare $10,000 or $100,000 which they would like to put in your business. If sales of stock are contemplated and realistic, you should bear in mind that stock cannot be sold unless it is registered with the S.E.C. and in the states where it is to be sold, unless exemptions from the registration requirements can be found. Even if an exemption is available, all material facts about the business must be disclosed. This includes all the bad points and possible risks involved. The result is that substantial (and expensive) disclosure packages are required. And remember that any time stock is issued to anyone, even your spouse, the securities law apply. You should also know that the securities laws apply to interests other than stock. Partnership and limited liability company interests, for instance, are sometimes considered securities, at least where the buyer will not take an active part in managing the business. If you do plan to obtain outside financing it is a good idea to have a document called a business plan. You show this to potential sources of funds to explain the business to them and interest them. This document describes the business and your plans for it in succinct, plain English. It should avoid the use of jargon and code phrases. It should contain facts and information, not promises and descriptions long on adjectives and adverbs, but short on nouns, verbs and numbers. Among other things the plan should describe the problems facing the business and the problems which could arise. It should describe how you plan to deal with these problems. Of course all favorable facts about the business are also disclosed. The plan should set forth the buyer's background and experience and abilities. It should show how you plan to produce and sell the business' products and services. It should state what funds are available and what funds will be needed and when. It should provide complete financial information and projections as well as all other facts relevant to the business. All assumptions should be identified and substantiated. The purpose of the plan is to interest a lender in the business. It should show the lender a good business under good management. It should show management is aware of all potential problems and has realistic plans for dealing with them. Above all, it should show how the lender will be repaid. There are numerous books and internet sites which describe how to produce a business plan. They are available on the web and in most book stores with business sections. However, if possible, expert help should be obtained in preparing these documents. Many accounting firms have departments for this and many law firms have the expertise as well. Buying a business is complicated and involves numerous legal judgments if a buyer is to be adequately protected. Therefore, you should get a lawyer to represent you. Do not sign anything until your lawyer approves it. One major function of a lawyer is to keep you from signing anything you should not. It is a waste of money to sign a document and then take it to a lawyer to have him explain to you what you have signed. Take your time. Do not be rushed. Let your lawyer review it. Then you can sign if everything seems all right. If you are told that someone else is about to make an offer, let them. Better they should get stung than you. Remember, there is always a better deal out there somewhere. Also remember that if you cannot wait to get the business, you will really get the business. When business sales get down to the final stage the parties discuss price and certain of the other basic terms and reach a basic understanding. But you should understand that a handshake is not a deal for most business purchases. Only a contract in writing is and one which covers all essential elements of the deal. Most written contracts also cover much more than the basic deal outlines which the parties agree to at first. Once a basic understanding is reached a lawyer for one of the parties draws up a contract. However, the lawyer often prepares something called a letter of intent first. This merely sets forth the major terms of the deal without a lot of detail. The purpose is to get it in writing so both parties see the same thing and there is no mistake about the basic understanding. However, such a document rarely covers everything a contract should. Therefore, it contains language to the effect that it is not a binding contract. Without this language such documents have been held binding by the courts which means that one of the parties has an agreement enforced against him or her which does not contain provisions which he or she would have wanted in it. As you can see, it is important to have your lawyer prepare any such document or review it if it has been prepared by the other side. Contracts for the sale of a business cover certain basic subject areas. Within each area there is much variation from contract to contract depending on the type of business involved and what is important to the parties. Some contracts also contain unusual provisions required to deal with the specific business involved. The common subject areas are: - Corporate stock, partnership interest, limited liability company interest or assets? - Sometimes, when assets are being sold, this is allocated among the assets being sold. - When is the price to be paid. - If the buyer will pay some of the price over time the seller will want security for payment. The seller usually takes an interest in the assets of the business to secure payment. - If a corporation is being purchased the buyer gets all its debts unless the seller specifically agrees to assume any of them. Even then the creditors can still elect to collect directly from the corporation leaving it to collect from the seller. - Many states have laws saying that a buyer of substantially all the assets of a business is responsible for the seller's debts to the extent of the value of the assets acquired unless the seller gives the buyer a list of creditors and the buyer gives them notice of the sale a specified period before the sale. Notice to Tax and Unemployment Compensation Authorities - In Illinois in most asset sales the buyer must notify the Department of Revenue and Labor of the sale and withhold the amount of any taxes, unemployment compensation contributions, penalties and interest owed by the seller until the seller produces proof of payment. - The sale is often made contingent on the buyer getting financing. - The price is usually adjusted at closing for certain items the buyer is getting which are paid for in advance (added to the price) or which have not been paid for (deducted). Examples are real estate taxes, prepaid expenses and deposits, rent, service contracts and advertising costs. Documents and Other Items to Be Delivered at Closing - Deeds, assignments, approvals, etc. Schedules and Attachments Describing the Business - Financial statements. Representations and Warranties - The seller has good title to the assets free and clear of all claims except those shown in the contract. - Between signing the contract and closing the seller agrees to certain limits on the conduct of the business. Collection of Accounts Receivable - Whether or not these are being sold, some provision needs to be made for their collection since the customers may continue to pay the buyer and not all the receivables will be collected. Non-competition by Seller and Its Key Employees Who Are Leaving - Consider requiring arbitration of any disputes instead of litigation. It can be faster and cheaper. Also more arbitrary.- You cannot require arbitration without a contract provision to that effect. There are many ways in which a business can be sold. For instance, if the business is conducted by a corporation, the stock of the corporation can be sold. Or the corporation can sell its assets to the buyer. Or only part of the assets can be sold. Or the corporation may put the assets to be sold in a subsidiary and sell the stock of the subsidiary to the buyer. The buyer may set up a corporation to take title to the assets or stock being sold. The buyer may pay cash. Or the buyer may pay part cash and part in deferred installments. Or the buyer may pay by issuing stock in its corporation. The possibilities are endless. The particular form the sale takes may be dictated by tax considerations of the buyer and seller which often conflict. These considerations and the other elements which can influence the form a sale takes are sometimes very complex and technical. You should consult your attorney and accountant about them before agreeing to any particular form of the transaction. The buyer should use some form of organization which limits liability. As a practical matter this means a corporation. Limited liability companies (LLCs) and entities called limited partnerships also limit liability, but are not always suitable. Limited liability means the owners of the business are not personally liable for its debts unless they agree to be. To limit your liability it is not enough to form the corporation or LLC some time. You must form the entity before you sign anything. Then you must use the entity. You must sign for the entity as its agent. Merely signing your own name makes you personally liable. Business owners cannot escape all liabilities. Some lenders require the owners to agree to personal liability as a condition of making a loan. The same is often true of lessors. The owner may also be personally liable to someone he or she injures while conducting business, although there should be insurance coverage for this. If there are to be several owners there should be an agreement among them to cover certain eventualities. One thing that should be covered is how to resolve differences when the owners cannot agree and there is a deadlock. The agreement should also cover what to do if one owner wants to sell to an outsider or dies or becomes disabled. These agreements often provide for a buyout in these cases. Competition by an owner should also be covered. It may also be wise to have employment agreements where there are several owners. The tax consequences of any form of organization should also be considered. With sole proprietorships and partnerships there is only one tax at the owner level. Limited liability companies are taxed the same way. On the other hand, regular corporations (called C corporations) pay a tax on their profits before any dividends are distributed to the owners. The owners then pay a second tax on any dividends. There are many other less important tax considerations, but for most small businesses, the double tax means no one wants a C corporation. However, owners do want a corporation to limit liability. There is a type of corporation which does not pay tax itself. This is an S corporation. All of its income is put on the owners' tax returns and they pay the tax. Most small businesses find this the preferable form of doing business. S corporations are merely regular corporations which file an election with the Internal Revenue Service to be taxed as S corporations, provided they meet the eligibility standards. This election must be made by the fifteenth day of the third month of the taxable year for which the election is to be effective. This is about 75 days, but the standard is the 15th day of the third month which is not always 75 days. No extensions or excuses are allowed. Since S corporation status will usually be desirable from the start this means that an S corporation election must be made soon after incorporating. The subject of how a business should be organized is very complex and S corporation status is not always desirable. What is appropriate depends on the particular business and the needs of its owners. If you have set up a new entity to buy a business, you will need to get a federal employer identification number (FEIN) and a state sales tax number, if you will be making taxable sales. You may also be required to get a license if conducting a licensed occupation. The state usually does the licensing. In addition some municipalities require business licenses as well.
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Donald M.
Thompson * Illinois Business Lawyer - 55 W. Monroe #3950;
Chicago, IL 60603 © Copyright 2005 * Chicago Business Attorney at Law Donald M. Thompson |
