Buying a Business or Franchise & Relevant Legal Concerns
Many people believe that buying an existing business or franchise is more worthwhile than starting a new business. If you are buying an existing business or franchise, you are getting an established customer base as well as other established elements. Although there are certainly advantages to buying an existing business, there can also be pitfalls.
People buying an existing business or franchise need to do their due diligence and find out as much as possible about the entity they want to acquire. Due diligence requires a buyer to look at everything about the existing business or franchise that could trigger liability once the buyer becomes the owner. These are areas that should be addressed in the purchase agreement. For example, the buyer may negotiate with the seller to remove certain liabilities as a condition that must be met for closing, or ask that the seller indemnify the buyer for specific liabilities after closing.
Basic Due Diligence
1Review all business records, such as financial statements
2Check public records, including liens
3Hire experts to evaluate the business and its assets
Proper due diligence can entail a review of cash flow statements, accounts payable and receivable, personnel files, major contracts and leases, litigation history, and certified financial records. A buyer or their lawyer should check with the county clerk or other applicable public office in the jurisdiction where the business is located to see if any liens have been filed against it. A bank or other creditor may file a UCC lien when providing credit to a business to inform the public of its interest in the collateral securing the loan. It is critical to research whether any such liens have been taken out against a business you are interested in buying, as the lienholder can potentially seize and sell any secured assets even after a new owner acquires the business. Buyers may need to hire experts to make sure that equipment and other assets being purchased as part of the business acquisition are in good working order and not obsolete. Done well, due diligence will alert a buyer to potential problems down the road. For example, it could reveal that litigation is still pending against the company and is likely to prove costly.
Negotiating and Structuring the Purchase
After due diligence is complete, a prospective buyer and the business owner need to negotiate the terms of the purchase, including the assets and debts that will be assumed, and determine the purchase price. In some cases, it is necessary for each side to retain an appraiser or to agree upon an appraiser, investment banker, or accountant to determine the value of the business.
A business acquisition can be structured as a merger, an asset purchase, or a stock purchase. It can be critical for the buyer to retain an experienced attorney to determine how the purchase should be structured for the purposes of taxes and liability. Often, business purchases are subject to an installment payment plan in which a substantial down payment is made and a promissory note is signed, obligating the buyer to pay the balance in installments over a period of years. The promissory note usually includes agreements about the down payment, the interest rate that the buyer will be charged, the payment schedule, and the final payment date. However, in other cases, buyers pay a lump sum at closing.
Once the purchase price, the terms of the deal, and the structure of the deal are determined, the buyer and the seller enter into a good-faith letter of intent, which describes the basic deal, the price, the parties’ expectations, when closing will occur, and other crucial details. The buyer determines everything that must occur for closing to happen, including any required consent that should be sought, and the document should be shared with the seller to ensure that both parties are on the same page.
Some buyers include an earnest money deposit along with their letter of intent to show their commitment to the deal. However, a buyer might also include a clause in the letter of intent that the earnest money is refundable if the deal falls through and that the letter of intent is not binding.
Finalizing the Sale
The buyer's attorney drafts the purchase agreement in most cases, since the buyer is typically the party with the greater risk. Both parties may need to complete certain tasks for closing to occur. Usually, closing occurs when the parties exchange consideration, and ownership is transferred to the buyer. At closing, the seller delivers instruments and stock certificates that cause the transfer of ownership.
Special Issues Involving Franchises
There are unique legal issues that may come up for people buying an existing franchise. Often, the franchisor provides only limited information to the buyer prior to the sale. Royalty payments may need to be paid on a monthly basis. There may be significant restrictions on the franchisee even after the sale. A franchisor may be able to terminate the agreement based on minor infractions. Franchisees often do not have legal recourse if they are treated improperly by a franchisor, since most franchisors require them to sign agreements waiving their federal and state rights.