When deciding to purchase an existing business, the first decision a potential purchaser typically faces is how to structure the acquisition. The most typical types of transactions for smaller businesses involve acquisitions by either purchasing all of the seller's stock or purchasing all of the seller's assets.
(For ease of reference, this article will focus on corporate stock purchases, but the same principles apply if the selling entity is a limited liability company or a limited partnership and the purchaser is acquiring the membership or partnership interests of the LLC or LP. Mergers, which are less typical in transactions involving small businesses, have effects similar to those of stock purchases.)
Although both structures offer advantages, if the purchaser desires to limit exposure to the seller's existing (or not yet realized) liabilities, or if the purchaser only desires to acquire a portion of the seller's business, the asset purchase structure is usually the most practical. This article presents some of the key issues that potential purchasers should consider when contemplating (and documenting) the acquisition of an existing business by purchasing the business' assets. This article is not, however, a comprehensive list of all of the considerations that a potential purchaser should consider when negotiating (and documenting) an asset purchase, but rather of summary of important issues to keep in mind, some of which are relatively basic and some of which might seem slightly esoteric.
Due diligence
* Condition of assets: As an initial matter, a purchaser should insist that it has ample time to review the books and records of the seller. If the purchase agreement will be signed prior to closing, the agreement should provide for sufficient time to conduct a thorough review of the assets (often referred to as a "due diligence investigation"), including a provision that allows for the purchaser to walk away from the transaction if it is not satisfied with the results of the review.
* Ownership of assets, liens, UCC searches, etc. As part of the due diligence investigation, a purchaser should get comfortable that the seller actually owns the assets that it is purporting to sell. This can be accomplished by reviewing prior purchase agreements, contracts and title documents provided by the seller. A purchaser should also conduct Uniform Commercial Code ("UCC") lien searches of the seller/seller's entity to ensure that the assets are not encumbered by any liens. Financing statements (which document UCC liens) for entities are required to be filed with the Secretary of State's office of their home state. Additionally, if part of the assets include real property, the purchaser should obtain a preliminary title report from a title company, which will show any encumbrances of record that affect the real property. Obtaining a preliminary title report is often the first step taken by a purchaser before it obtains title insurance for real property included in the purchase.
* Contracts. Purchasers should review of all of the seller's contracts to decide which contracts, if any, they would like to have assigned as part of the purchase (and which contracts they would like the seller to terminate). Purchasers should keep in mind, however, that some contracts may not be assignable (pursuant to their terms).
* Environmental issues. If part of the assets include real property, the purchaser should investigate any potential environmental liabilities related to the property. Obtaining a Phase I environmental assessment should provide a purchaser with an idea of the likelihood of environmental problems on the property and may provide some protection against successor liability under applicable environmental laws related to the condition of the property.
Excluded assets/contracts
As briefly highlighted above, a purchaser should make sure that any assets that it does not want to acquire are specifically excluded from the purchase agreement, including any existing contracts of the seller (again, the burden should be on seller to terminate existing contracts prior to closing that the purchaser does not intend to assume).
Licenses
Purchasers should be mindful of the need to obtain all of the necessary permits and licenses needed to conduct the business prior to closing, which may include state and local business licenses, fictitious name filings/registrations (often referred to as "DBAs"), and privilege licenses for alcohol, gaming, and other businesses specifically regulated by the state. Privilege licenses typically require background checks and other administrative due diligence and thus often require significantly more lead time than standard business licenses and permits.
Organizational approvals
If the seller is an entity, a purchaser should review its constituent documents (articles of incorporation or articles organization, and the bylaws or operating agreement) to ensure that the seller has obtained all of the requisite approvals necessary to sell the assets (e.g. from other owners of the business).
Successor liability
Nevada law imposes liabilities on asset purchasers for various liabilities of the seller, including, among other things, accrued taxes (e.g., sales tax, room tax, employment taxes). Although indemnification provisions included in the purchase agreement may limit some of the purchaser's exposure, there are additional measures that a purchaser may take to provide further protection (e.g., obtain clearance forms from the Nevada Department of Taxation).
Indemnification
As mentioned above, a purchaser should insist that any purchase agreement contains comprehensive indemnification provisions that provide that the seller will indemnify the purchaser (i.e., defend and hold harmless) from any liabilities incurred prior to the closing date of the transaction.
Existing employee issues
Purchasers should be mindful of how they intend to address existing employees of the seller, including accrued vacation and other benefits. If the seller has a significant number of employees, a purchaser may be required to comply certain federal requirements (e.g., the Worker Adjustment and Retraining Notification Act, which requires that certain notices be sent to employees of the seller).
Non-compete, non-solicitationand non-disparagement
A purchaser should consider asking the seller (and key employees of the seller) to execute an agreement prohibiting them from competing with the purchaser, soliciting former customers/business contacts, or making disparaging comments about the purchaser.
Intellectual property
If trademarks and patents make up a significant portion of the purchased assets, be aware of the necessity to obtain the proper assignments and registrations for such intellectual property. A purchaser should also consider assignment of other non-tangible assets, such as trade names, DBAs, phone numbers, web addresses, and social media outlets (e.g., Facebook and Twitter accounts).
Gift certificates
In Nevada, a business is required to escheat to the state treasury 60 percent of the remaining balance due on expired gift certificates. A purchaser should investigate the gift certificate policies of the seller to ensure that it will not inherit any liabilities associated with expired gift cards when it purchases a business. Surprisingly, this issue can create significant liabilities for purchasers and is often overlooked during the due diligence investigation.
Purchasing a business obviously requires careful consideration of numerous factors, and those factors will vary greatly depending on many variables, including the type of business and the potential purchaser's familiarity with the particular assets that it intends to purchase. This article is meant to provide a cursory overview of some key issues to consider, but is by no means a comprehensive list of all of the important considerations a potential purchaser should investigate when considering acquisition of a new business. Although some transactions may seem too small to justify engaging an attorney experienced in negotiating and documenting commercial transactions, doing so will often allow a purchaser to better protect its legal interests while at the same time provide a more comprehensive understanding of the assets and liabilities it will be acquiring. Moreover, the initial investment in an attorney may save a purchaser tens (even hundreds) of thousands of dollars of litigation expense in the future.
Colleen Dolan is a shareholder and Brian Schusterman is an associate in the business law department of Lionel Sawyer & Collins in Reno. Both practice primarily in the areas of commercial transactions, real estate and business organizations. Contact them through www.lionelsawyer.com.
