PURCHASING

I am often consulted by buyers of businesses who have gotten “burnt” by the experience. Either they signed a lease that they did not understand, or did not conduct the proper searches against either the property or the owner of the business they bought. Maybe they did not obtain the proper tax releases from the tax authorities having jurisdiction over the business. Perhaps they did not obtain the proper permits for the type of business they wanted to run. The “maybes” are many and you should be careful with what you do, if you’re considering purchasing a business or commencing one.

The commencement or the purchase of a business is difficult to consider in the abstract, as each business is different and the variables involved in each depend on many factors that must be examined individually. However, here are some pointers.

The most important consideration is the type of business you want to get into, and what are your qualifications and/or experience in that type of business. Once you have determined that you have the know-how, determine the viability of that business. For example: you had lots of experience working in a video store. Is opening a video store a viable business because it will be the only one from here to the Pacific?

Let’s assume that you have the know-how and that your business idea is a viable one. What’s next?

1. FORM OF BUSINESS OWNERSHIP:

Should you form an entity to run the business or should you run it in your own name? If you have partners or investors, the most advisable is to form an entity. Even if you are the only owner, you should create an entity to run the business, such as a business corporation or a limited liability company. It may be the best tax vehicle for you and it will protect you from personal liability.

You can easily form a limited liability company or a business corporation. Which one is best suited for you should be discussed with an accountant and your attorney.

If you have partners, you should make sure that you have a clear, well drafted operating agreement, in the case of an LLC, or a shareholders’ agreement, in the case of a business corporation.

2. LEASING

Unless you are purchasing or commencing a business in a location that you either already own or will purchase as part of the business venture, you will have to rent space. Most businesses are operated from rented locations and not from owned real estate.

One of the most important steps is the negotiating of the lease. Here is a checklist of terms to negotiate and understand:

– Rent: most likely the “base rent” which does not include a series of other expenses referred to as “additional rent.”

– Number of years for a lease.

– Hours of operation.

– The different additional charges that will become the “additional rent.” Among these: water, utilities and services.

– Repairs and maintenance: what will be the responsibility of the landlord and what will be the tenant’s obligation.

– Real estate taxes: a percentage payment of real estate taxes will probably become part of the “additional rent.” The issue to negotiate is the percentage that the tenant will pay and whether it will be a percentage of the total real estate taxes, or a percentage of the increase over the “base year.”

The percentage is generally calculated on the basis of the square footage occupied by the tenant in proportion to the total square footage of the entire building, a tricky calculation when the building is mixed residential and commercial. As to whether you should pay a percentage of the total tax bill, or a percentage of the increase in taxes over the “base year” is a subject of negotiation.

The “base year” is generally the fiscal year in which the lease is signed. New York City has a fiscal year from July 1st to June 30th. If you were signing a lease before June 30th, you would be paying a percentage of the increase in taxes if the taxes increase on July 1st.

Before you willy nilly accept terms in the payment of taxes, whether you’re a landlord or a tenant, you should analyze the property tax bills for a number of years and try to project how the taxes might rise in the future. Even then, you will probably be wrong on your prediction.

– Insurance: both sides should make sure that they are both adequately protected. The landlord will want the tenant to obtain the highest insurance protection for the property at tenant’s expense. The cost of the premiums could be substantial, depending on the type of business, the property location and the rating of the tenant.

– Sublet: most leases provide that the tenant does not have the right to sublet without the permission of the landlord, which permission will not be “unreasonably” denied. This is fair. Subletting, in a commercial setting, is usually applicable to a situation where the tenant brings in another business to share the rent or apportions a separate space within the rented space to another business.

– Assignment: most leases provide that the tenant does not have the right to assign (transfer) the lease to someone else without the consent of the landlord, which consent will not be “unreasonably” denied. The right to assign is very important to a tenant, especially the longer the lease term. It is one of the most important considerations in purchasing a business. The tenant is going to want to make sure that s/he will be able to transfer the lease without much restriction. This transfer may be necessary in case that the tenant’s business is not going well and that someone else is interested in the space to run a different type of business. It is very valuable to a tenant when the tenant opens a business, does really well and suddenly can sell the business for a lot of money.

– Legality of the space being rented. Make sure that the space rented has a certificate of occupancy for the use intended.

– Licenses: there are always licenses that you must obtain from different municipal or state agencies depending on the type of business you plan to operate.

– Guarantee: this is usually one of the most vexing issues in negotiating a lease. When you enter a lease in the name of a newly created entity, the landlord will want a personal guarantee for the performance of the lease from the individual(s) the landlord has met and negotiated with. But, what if you sign a lease for ten years and after three years the business is not doing well? You’re still obligated to pay rent, unless you find a suitable tenant willing to assume all the responsibilities under your lease. And, what if you can’t? You will want to terminate the lease and cut your losses. For the parties, the way out in a way that does not completely hurt one or the other side, is the “good guy” clause. In its simplest term, the “good guy” clause provides that the guarantee will be terminated upon the payment of rent and additional rent up to the time of the delivery of the space vacant and clean to the landlord. There are many variations of the “good guy” clause, but guarantors should always insist on obtaining it and clearly understanding what their financial exposure is under the negotiated guarantee.

3. Selling and purchasing a business

Here is a list of items to consider:

– Price and how it should be paid: deposit on contract signing, the balance to be paid in cash or financed, whether by a financial institution or the seller.

– If part of the price is to be financed by the seller, the terms of payments, such as interest rate, monthly payments, self-liquidating loan or balloon payment loan, or a hybrid of both.

– What is included in the sale: equipment, furniture, furnishings, inventory, telephone number, client lists, accounts receivables, etc.

– Are any employees of the existing business being transferred with the purchase? Have you the option to meet and negotiate directly with them?

– Are there any suppliers that you need to establish relationships with?

– Are there any debts that you must assume?

– Is any inventory not yet paid for?

– Is the personal property included in the sale (equipment, furniture, furnishings) subject to a loan?

– Will you be spending any time in the business before closing on the purchase to assess how the business is running?

– Taxes: generally the one item to be the most careful about. Make sure that you have conducted a thorough investigation of the business and that all taxes are paid to date of transfer. In most cases you must apply and obtain a bulk sales tax release from the State of New York. Make sure that this is handled properly and that, if the transfer of the business takes place before the receipt of the release from the State, an attorney involved in the transaction holds sufficient money in escrow until the release is obtained. A purchaser is responsible for any taxes owed by the seller up to the price paid for the business.

– Search of public records, not only for outstanding taxes, but also for any loans pending against the business or the equipment, furniture or furnishings included in the sale.

– Searches of different municipal agencies having jurisdiction over the property where the business is located to determine violations or liens and/or judgments pending against the property.

– Agreement not to compete, or open a similar business within a given area for a certain period of time.

SELLING

If you are selling a business, read the above and it will give you an idea of how you should prepare to sell your business. Following is a list of what you should be ready to provide at the outset:

1. A copy of your lease;
2. Access to tax information. Maybe copies of different tax returns and books of the business;
3. Information about the entity that owns the business, such as an LLC or a business corporation;
4. Copies of all licenses that you have to operate the business;
5. Negotiate for a time frame for the prospective purchaser to spend in the business for the purpose of assessing how the business operates.

The above information is by no means complete, but it may give you an idea of the importance of understanding that buying or selling a business is not a simple process and should not be taken lightly. Thorough, thoughtful due diligence may save you a lot of money, anxiety, legal problems and sleepless nights.