If you spend much time as an entrepreneur, you may find yourself with a business sale. This may be the opportunity to purchase another business or to sell your own. You may even begin your entrepreneurial journey with the purchase of an already-existing business. If that is the case, you should understand a few things about what that entails.
To begin, there are two different ways to purchase a business: an Equity Purchase and an Asset Purchase
As we have discussed before, owning a business is an asset in and of itself. Owning equity in a company is a valuable asset. As such, it can be bought and sold. Of course, purchasing the equity of a business is limited by the Buy-Sell Agreement among the owners of the business. For the sake of discussion today, let’s talk about purchasing all of the equity of a business. That means, all of the owners have signed off and are willing to sell you their interest in the business.
In an Equity Purchase, you buy the ownership in the business. That means that you take on all of the liabilities, debts, and obligations of the business. You typically will be required to transfer any personal guaranties of the former owners, but you come in to the business as a new owner. Nothing else changes.
The problem with an equity purchase of a business is that you take on all past liabilities. That means, if the business did something wrong or harmed a customer, contractor, or employee, you run the risk of being sued because of something that was done in the past. Though it is common for the seller to state that they are not aware of any potential claims and to agree to indemnify (or pay for) any such suit, that does not protect you from being sued. And, you are not in the business of litigation.
This is the option with the most liability exposure for you. Though there are reasons to take this approach, it is not very common.
The more common approach to purchasing a business is an Asset Purchase. That is where you buy the assets of the business. Understand this is more than the physical assets of the business. This is the: customers, trade secrets, trademarks, intellectual property, prospects, good will, employees etc. Anything that is a part of a business can be considered an asset of the business.
The important part of this type of purchase is that you are purchasing the assets and not the liabilities. That means you are taking everything out of that business and putting it into a different business. For this, you will need a company (we can discuss if Versa Vice should handle this, but it depends on what you are doing) to place the assets you purchase. Once the purchase is completed, the other company will shut down.
What Happens in a Business Sale
Depending on which of the options you choose for the purchase of a business, the documents, terms, and warranties will be varied, but ultimately the process is similar.
The transaction is handled on paper. In some cases, unlike the closing on a mortgage, the parties never come together for an official “closing”. There are several issues you should consider in the closing of a business sale.
Separation of Money and Liability
If at all possible, you want to make the purchase of a business and any resulting liability about nothing more than the money that changes hands. You do not want to be fighting over who did what in the business. This is one of the reasons an Asset Purchase is the go-to option for a business sale. That way, there are no issues over liability. You know you are only liable for any issues that come up after you start your new business.
The same is true for any kind of payment plan for the purchase price. If you plan to pay the purchase price of the business over time, you want to make sure that any issues related to the purchase of the business are related to the Promissory Note for the payment of the purchase price and not on the ownership of the business. Unless you are trying to limit your financial liability, you do not want the former owner to be able to reclaim any ownership of your business. You want to be the owner and for the former owner to be a creditor.
When the Business Sale Happens
If you are going to pay over time and the seller of the business is financing the purchase for you, that means you are not borrowing money, but you are making payments to the seller over time, the question comes up as to when the purchase actually takes place. Are you buying portions of the business over time? This is called an Installment Sale. Or, are you buying the full value of the business at the time of the closing. As you can tell from the section above, I would prefer to see you buy it once and finance the payments. Not to buy it over time. For one, this option limits the way you can structure the deal. Typically, an installment sale is going to be for equity. It is a lot more difficult to divide up assets in an installment sale.
If you finance the purchase of a business through the seller of the business, you need to make sure all of your documents are clear. You do not want any questions regarding the relationship. If at all possible, it is always better to borrow the money from another source and make the business purchase a cash purchase. Of course, in this economy that is not always possible.
If the seller of the business is going to continue to work in the business or provide consulting services, make sure that agreement is part of the business purchase documents signed at the closing. The relationships need to be clear before the business is sold. Otherwise, you may have a former business owner who can’t let go of the way they used to do things in the business. That can make the transition difficult.
Limit Your Liabilities
Make sure, if you are looking to buy or sell your business that you have considered all of the potential liabilities that come from a business sale. Limit your liability as much as possible by creating a new company and buying the assets of the other business. Or, of you re selling the business sell the assets and dissolve the business, which eliminates past liabilities from your time as owner.