Owning a small business is a dream for aspiring entrepreneurs, and the chance to step into an existing successful business may be a quicker way to get there. However, before signing a purchase agreement, it’s critical to know what questions to ask and the red flags to look for.
This is especially true when entering into a new industry, as many entrepreneurs discovered in the emerging California cannabis market and internet-only businesses on Shopify, Amazon Marketplace and similar direct-to-consumer sites.
There are many unknowns related to regulations, consumer interest, market saturation and the like even in established industries, let alone more recent ones. In addition, the small and mid-sized business climate in California can change quickly.
So the most important decision you’ll make is buying the right company. This means knowing everything you can about the business before you make any binding decisions.
A business attorney can guide you through the negotiations, purchase and employment contracts, confidentiality agreements and other documentation, and perform the necessary due diligence to make sure that nothing’s been overlooked that may come back to bite you after the sale contract is signed.
“Due diligence” is the process of scrutinizing all the legal, business and financial records of the business. This includes any employment and vendor contracts, as well as tax returns and accounting records.
LawPLA specializes in business law and can help you avoid 5 common mistakes buyers make that endangers their future success. The good news is that all 5 can be successfully addressed if you know what to look for.
5 Dangers and Pitfalls When Buying a Business
You Don’t Confirm the Seller’s Claims.
This is all about due diligence and making sure the business is as represented by the seller. Are the taxes paid and up to date? Is there any current litigation against the company? Can the recordkeeping be trusted?
This is where professional guidance is most critical because you’ll be at risk of suffering higher losses if you miss a something the seller has tried to hide.
Business attorneys and consultants know exactly what to look for and where a seller may try to hide or bury information that may be damaging to a successful sale.
You Don’t Consider Buying the Company’s Assets.
An asset purchase rather than buying the entire business outright lets you choose which individual parts of the business you purchase. Building, equipment, vehicles and inventory are all assets you can purchase.
With an asset purchase, usually you, the buyer, won’t be held liable for the seller’s debts, liabilities and obligations — or you can use them to lower the purchase price for the assets.
Additionally, you also may benefit from a taxation perspective by spreading the purchase price over several years as depreciation.
However, without performing due diligence, it’s impossible to determine whether an asset purchase is the best way to buy the business — or is even possible for this particular business.
You Don’t Require an Indemnity Agreement.
An indemnity agreement covers any outstanding liability that may emerge after you purchase the business. Even with the most rigorous examination of documentation and records, the seller may still have acted — or failed to act — before the purchase in ways that you could be held liable for in the future.
An indemnity agreement holds the seller legally responsible for any liability that arises for a specific period of time after the sale. The seller may even offer this as a way to clinch the sale.
You Don’t Research the Company on Government Databases.
There are numerous filings and records published online that a business must complete when registering with California. All of these can help determine if the business follows state and local laws regarding small businesses — all contained in the California Business and Professional Code — along with confirming that the seller legal owns what he or she is selling and is not involved with any litigation.
You Don’t Involve Your Bank Early.
A mistake that some entrepreneurs make is approaching their bank for a business loan after the purchase price is settled rather than during or even before the negotiation process. The same holds true if you have private investors lined up: involve them early in the process.
If you wait too long, you’re putting the entire purchase at risk because there’s no guarantee that the bank will finance your purchase or provide loan terms that meet your needs.
Establishing a relationship with your financing partner(s) at the time you’re thinking of buying a business provides you important financial advice and information including how large a loan the business (and you) can afford to borrow.
Buying an existing business can be the start or continuation of a successful entrepreneurship but it can also bog you down in unexpected costs, liabilities and related issues that can mean the difference between failure and success.
For a free consultation with a Parag L. Amin attorney, just give us a call or use our easy online scheduling tool.