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Purchasing an Existing Business

Some people interested in going into business for themselves start their own business from scratch.  Many others, however, have the opportunity to purchase an existing business.  The potential upside to purchasing an existing business is that you're buying into a business which already has a track record, existing customer base, and trained employees.  If the opportunity presents itself to purchase an existing business, this article is intended to describe the two main ways in which that purchase transaction may be structured.  

Consider the case of the purchase of an existing restaurant business owned and operated by ABC Corporation, which is a corporation that is solely owned by John Smith.  You, as the buyer of the business, can structure the deal as an "asset purchase" or a "stock purchase."  In an asset purchase, the Seller is ABC Corporation, the Buyer is a new company formed and owned by you, and what's being bought and sold is all of the assets owned by ABC Corporation in connection with the restaurant operations, including but not limited to:  the tables and chairs, silverware and plates, food/liquor on the shelves, stoves and refrigerators, signage on the side of the building, and the rights to take over the lease of the building.  In a stock purchase deal, the Seller is John Smith, the Buyer is you (personally), and what's being bought and sold are all the shares of stock in ABC Corporation.  In this stock purchase, you're not directly buying the assets, but you're buying the corporation which owns the assets [a quick side note - if the business is being operated by an LLC instead of a corporation, then in this second scenario the Buyer would be purchasing "membership interests" instead of shares of stock].  

The biggest danger to consider in a stock purchase deal is that the Buyer, when buying the corporation, is not just getting everything that the corporation owns, but he/she is also taking over everything that the corporation owes.  In other words, taking over the corporation means you're taking over all of its assets and its debts and liabilities.  If ABC Corporation has just lost a lawsuit for $200,000, and then you purchase all of the stock of that corporation, it is now on your shoulders to settle that debt, because the debt follows the corporation.

Because a stock sale involves the assumption of all corporate debt, most transactions for the sale of a business are structured as asset purchases and not stock purchases (at least that is the case if the Buyer is getting advice from an attorney who is doing his/her job).  That way, you don't have to worry about buying a dog with fleas, because you're setting up your own company and just buying the assets.  

In certain circumstances, however, it may be appropriate to structure a deal as a stock sale.  For example, in the case of the restaurant described above, the liquor license issued to that restaurant may be specific only to ABC Corporation.  If the Buyer is going to create his/her own company to own and operate the restaurant, then that new company will have to apply for its own separate liquor license, which could take weeks, during which time alcohol cannot be sold to customers (which could threaten to kill the business).  In such a scenario, the deal may be strucured as a stock sale so that the corporate entity operating the restaurant (in this case, ABC Corporation) is not changing, and thus a new liquor license does not have to be obtained, and the new owner can hit the ground running and continue selling alcohol on day 1 after the purchase.  

There may also be tax reasons why the deal would be structured as a stock sale instead of an asset sale.  Depending on the specific tax circumstances of Seller and Buyer, there may be significant tax savings if the deal is strucured one way or the other, and you should always consult with a CPA to determine the tax consequences before finalizing the deal structure.  It is also a good idea to consult with a CPA ahead of time to get an outside opinion on whether or not you're paying a fair price, which the CPA can determine after being provided with the business tax returns and financials for previous years of operation.  

After reading the potential dangers described above, do not make the mistake of assuming that a stock purchase is dangerous and an asset purchase is safe.  In an asset purchase, there is the danger of purchasing assets that have liens on them.  Going back to the restaurant example, suppose ABC Corporation took out a $200,000 loan from XYZ Bank three years ago, which was used to purchase all of the restaurant equipment.  There is a very good chance that XYZ Bank placed a lien on all of that equipment, meaning that the equipment was pledged as collateral for that loan.  Thus, if the loan has not been repaid, and you purchase that equipment, you are taking possession of that equipment subject to the Bank's lien, meaning that the Bank can seize the equipment and sell it at auction to pay off the debt owed by ABC Corporation.  Perhaps your purchase agreement will then give you the right to sue ABC Corporation, but that will provide little consolation to you if ABC Corporation has no money, or if you are required to shut down for 3 months while you go out and spend money on all new equipment.  

The way you protect yourself against that horrible scenario is by having an attorney perform a lien search on all of the assets that you are going to purchase.  That way, you know ahead of time if anyone else has any claims on what you're buying, and you can arrange to have the purchase money paid to the Bank and have the lien released, so that you own the equipment free and clear of any encumbrances.  

There are dozens of other issues that must be investigated and negotiated before the complete details of any purchase agreement are finalized:  how to handle accounts receivable/payable?  will the Landlord allow the lease to be transferred?  how to handle gift certificates?  will the employees stay on?  can the Buyer obtain any loans needed to buy the business?  how much inventory will be left behind?  The scope of this article is not intended to cover all of these topics, but is instead meant to explain the major conceptual differences between an asset purchase and a stock purchase, so that you do not rush into committing to one or the other until after you have consulted with a business attorney and an accountant.  

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