Top Ten 10 Issues When Self-financing a Small Business Purchase in Maryland, Virginia, and DC.
Purchasing a small business in Maryland, Virginia, or Washington, DC can be a complicated process fraught with anxiety. Since most large business purchases involve some degree of bank financing, the bank can dictate some of the trickier aspects of a business acquisition. For those not sufficiently large to involve financing from a bank, there are some addition concerns that a party should keep in mind when deciding to buy a business in Maryland, Virginia, and DC.
The purpose of this article is to address situations where a small business purchase is self-financed. Usually, in Maryland, Virginia, and DC, a self-financed transaction involves what is called a Purchase Money Security Interest (“PMSI”). In a self-financed transaction, usually the buyer puts a down payment on the purchase of the company, and, like the purchase of a home, the buyer agrees to pay the remainder over a period of time, subject to repossession of the company if the debt is not paid.
This type of PMSI transaction in Maryland, Virginia, and DC puts a higher burden of expectation on the parties involved. It means the buyer and seller are obligated to one another for the life of the debt, and their fortunes are tied together as well.
If you are contemplating a small business purchase in Maryland, Virginia, and DC, you need to be cautious about several matters involved in the purchase. Here are the top ten concerns you need to think about as a buyer involved in a self-financing purchase.
- Generate a very specific offer letter before going ahead with purchase
When contemplating a self-financed purchase in Maryland, Virginia, and DC, reducing the expenses involved in the transaction should be a high priority. In most cases, a very specific offer letter detailing every aspect of the transaction should be generated before the deal is drafted. If this offer letter is done between the parties, it can save a significant amount of money in legal fees because it reduces the time the drafting attorney spends seeking clarification on the terms of the deal, which can be time-consuming, and, therefore, expensive.
- Be sure to identify the proper parties to the transaction
In a self-financed transaction, the parties are legally obligated to each other for the lifetime of the debt in Maryland, Virginia, and DC. Given that this obligation is a reality in this type of sale, the buyer needs to be sure that the seller may be held properly accountable for the representations made to you in the sale of the company. The best way to do that is, whenever possible, include all parties involved — in some way — in the sale of the company. The buyer should ensure that the seller cannot hide behind any corporate entities that could immunize them from suit for any false statements made during the sale of the company.
- Decide on whether to make the purchase a Stock Purchase or an Asset Purchase
In most corporate sales in in Maryland, Virginia, and DC, there are a number of factors to evaluate in deciding whether to create a stock purchase or an asset purchase. In a self-financed transaction, it generally makes more sense to do a stock purchase rather than an asset purchase for a number of reasons. First, the transaction will most likely not be large enough to trigger any significant tax liability from a stock purchase. Secondly, purchasing a small company involves assets of the company that might not properly be in the company’s name if the company is a small business. The company’s bank accounts and its commercial space lease most likely will be in the owner’s personal name rather than the company’s (see below), as well as any potential intellectual property or company personal property, such as company cars. When doing a stock purchase, purchasing the total ownership of the company gives the buyer additional leverage in obtaining property reasonably believed to be owned by the company. It can also help the buyer obtain title to company assets more easily in situations where some of these assets may otherwise be accidentally omitted from the purchase agreement.
- Do some due diligence regarding the company’s reputation and the reputation of the selling parties.
When buying a small business in Maryland, Virginia, and DC, brand name reliability is almost always a major factor in the transaction. It is therefore incumbent on the buyer to ensure that the buyer has been thorough in evaluating the brand reputation of the company being bought. Thorough investigation on review sites such as Yelp can be helpful in evaluating the company’s reputation in the marketplace. Buyers can protect themselves further by including warranties in the purchase that the company has “conformed with the requirements of all of its contracts with its customers” and that there are “no threatened lawsuits against the company by its customers”. The Buyer may also wish to do a quick background check on the seller personally to see if he has been involved in any other business sales that raised red flags with other buyers.
- If there is a commercial lease involved, be sure to make the purchase contingent on the assignment of the lease
When a small business is leasing a commercial space, nearly every landlord will require that the owner of the business at least personally cosign the commercial leasing agreement, if not maintain it exclusively in the owner’s name rather than the company’s. As a result, it is necessary to make a transfer of the commercial lease space a contingency for buying the business.
- Be sure to assign company bank accounts as well
Banks will also generally require that the owner of the business personally cosign company bank accounts. Business loans occur at an interest rate significantly higher than personal loans, and banks may require assets to be titled personally to qualify for greater credit. Any personal back accounts containing company assets should also be retitled in the business’ name before going forward with the purchase of the company.
- Be sure to address the concept of right of redemption.
In a self-financed transaction, the parties are legally obligated to one another for as long as the debt remains outstanding between the parties. The parties should therefore plan specifically for what should happen if the buyer is unable to make payments to the seller during the life of the loan. In a real estate mortgage transaction, most banks give homeowners up to a year to pay back rent before the property is foreclosed upon. The buyer should think about what grace period should be given before the seller is able to lawfully repossess the company.
- Imagine the mortality of all the parties involved
The buyer may have to go against their instincts to avoid the subject of the death of the parties in a business purchase transaction. In the absence of any estate planning, a buyer may end up making payments and adhering to his/her obligations with a total stranger who inherits the business if the seller dies. The buyer should therefore inquire about life insurance policies, trusts and other contingencies should something happen to the seller.
- Whenever possible, reduce the number of parties involved to minimize the possibility of taxable transfers
In some cases, in Maryland, Virginia, and DC, the buyer might have a partial investor to assist in buying the company. It is important to avoid the creation of listed “Joint Buyers” of a company for both tax and liability reasons. If there are multiple parties contributing to the purchase of the company, the buyer might want to think about creating one holding company, rather than assigning different percentages of stock/membership ownership to different legal parties.
- Include a non-compete clause
As stated above, when buying a small business, brand name reliability is almost always a major factor in this type of transaction. Since small business owners buoy their reputation by maintaining close communications with their business clients, it is important to ensure that the seller not merely create another business in the same market space and then siphon off all the business’ customers to his new company. A non-compete clause in the purchase agreement should therefore be included in every transaction of this kind. Although the buyer may not believe the seller has nefarious intentions, it is important to keep the following things in mind: 1) people always gravitate towards doing things involving their skill set; 2) few people retire early; and 3) many business owners have personal relationships with their customers.
Longman & Van Grack’s business law attorneys regularly represent clients in many different business transactions and small business purchases in Maryland, Virginia, and DC. Our business law attorneys are also familiar with all of the tax related concerns involved in a business purchase or sale. Our business attorneys have assisted many clients through the process of buying and selling businesses and entities. If you would like to contact one of our business lawyers, you can reach us at (301) 291-5027.