By Socrates Xanthopoulos
So, you’re looking to buy a business in New York? That’s likely one of, if not the greatest, financial decisions that you will make in your life; as a result, there are lots of issues that you should consider before committing to partake in such a transaction – and certainly before signing, or otherwise entering into, any sort of formal agreement or contract. Generally speaking, the approach you take in pursuing, and your goals in consummating, such a deal should be focused on maximizing your upside (cashflow and ROI) while minimizing risk (liabilities), including the avoidance of any costly errors. How do you achieve those goals? For starters, you want to align yourself with the right professionals that can help structure and negotiate the financial and legal terms of your business purchase, protect your interests, and otherwise guide you through the process. Of paramount importance is the need to consult with an experienced attorney as early in the process as possible. Additionally, you should consult with an accountant to determine or confirm the deal’s financial viability, your current and future income needs and expectations, and any potential tax consequences relative to the transaction. I would also be helpful to utilize a broker to negotiate the initial terms on your behalf. Even with such trusted professionals by your side, however, you should nevertheless be aware and mindful of certain things that can impact your decision to buy a business, some of which are discussed below.
(a) The Negotiation and Pre-Contract Stage
Once you settle on a particular target business to acquire, you will want to initiate negotiations by submitting your offer in writing. This is generally done by setting forth the proposed deal terms in a letter of intent (known as an LOI) or term sheet and submitting to the business owner for their review. The LOI is a preliminary document that serves as a roadmap for the more formal written purchase and sale contract that will ultimately be executed if the parties reach a final agreement on the deal terms; however, it is important to ensure the LOI makes clear that it is not legally binding (unless that is what you want) so that you can preserve your ability to walk away from the negotiation and otherwise not be bound to perform any particular obligation. Of course, if you’ve retained an experienced attorney as recommended above, the LOI should be reviewed and negotiated by them. If you’re submitting an offer prior to engaging an experienced attorney, you should make clear in the LOI that your offer is being made subject to attorney review, the full execution and delivery of a separate, definitive written purchase and sale agreement, and your performance of satisfactory due diligence.
(b) Due Diligence
One of the most important aspects of pursuing a business transaction is the due diligence process;you need to be able to understand the ins and outs of the business you are looking to acquire, the people that manage and operate it, and become intimately familiar with all financial and tax information relating to the company. If you haven’t performed the proper due diligence, you’d be hard-pressed to argue that your decision to buy the business was an informed one; and, if you nevertheless go through with your purchase and the transaction closes, you may very well wind up with the proverbial egg on your face as a result. To avoid that, it is imperative that you (and your counsel) carefully review and analyze information which includes, but is not limited to:
- Customer information, operational processes, and goodwill of the business
- Employee base and retention
- Bank statements, debt and financial statements (I&E/ P&L/ projections), and tax returns
- Employment contracts and non-compete agreements
- Business licenses (e.g., liquor license) and the transferability of same
- Real estate and commercial agreements, including: leases, service contracts, vendor agreements, client account agreements and more
- Inventory lists and asset schedules
- Lien, judgment, bankruptcy, and pending litigation searches
- Corporate and organizational documents of the seller
(c) Structuring the purchase – what exactly are you buying?
So, you’ve made a decision to buy a business… that’s great! But what are you really buying? What are you getting in exchange for the price you’ve agreed to pay? In “buying a business,” you’re buying either the assets of the business (i.e., asset purchase) or the ownership interests of the entity that owns the business (i.e., stock sale). Generally speaking, a buyer will prefer to utilize the asset purchase structure (as opposed to a stock sale) for various financial and legal reasons.
When purchasing assets, you must allocate the total price you are paying to acquire the assets to the specific assets that are acquired – this purchase price allocation strategy (which is unavailable to a stock purchaser) offers several tax advantages to the buyer, including amortization (e.g., spreading the cost of a business’ “goodwill” over 15 years to reduce the buyer’s tax liability) and depreciation of business assets (even if the seller has fully depreciated an asset for its own tax purposes).
In addition, an asset purchase structure allows a buyer to cherry-pick which assets it will be acquiring at closing, whereas in a stock sale, the purchaser doesn’t have that option (since they’re directly acquiring all the equity interests in the entity owning the business, and by virtue of that, they’re indirectly acquiring all the assets of the entity/ business). Take accounts receivable, for example – this is an asset, but if the seller hasn’t been able to collect those receivables, despite its diligent efforts, you may find little to no value in paying to acquire such accounts receivable; with an asset purchase, you can choose to not acquire them, but you don’t have that option in a stock sale.
An asset purchase structure also allows a buyer to cherry-pick which liabilities it will be assuming at closing – in turn, this minimizes your exposure to undisclosed and unknown debts and liabilities of the business. Had you structured the deal as a stock purchase, on the contrary, you’d be assuming all the business’ liabilities (all of which transfer to the buyer at closing along with the ownership interests in the entity that owns the business) – even those you do not know about when you acquire the business! In New York, this is especially important because individual owners of a business (or of the equity interest of an entity that owns a business) are personally liable to the business’ employees in the wage and hour context. Remember, while making lots of money is certainly important, minimizing your risk and exposure to liabilities is just as important of a goal/objective when buying a business.
(d) Bulk Sales Tax Considerations
Most business acquisitions/sales in New York are subject to “bulk sale” requirements – under New York tax law, a bulk sale is defined as “any sale, transfer or assignment in bulk of any part or the whole of business assets, other than in the ordinary course of business, by a person required to collect tax and pay the same over to the Department of Taxation and Finance.” If you are unsure if your business purchase qualifies as a bulk sale, assume that it is, but ask your attorney to confirm and of course explain why (or why not).
As the purchaser of business assets, you are required to comply with Section 1141(c) of Article 28 of the NYS Sales and Use Tax Law, which requires you to notify the NYS Commissioner of Taxation and Finance of the pending purchase/sale of business assets, by submitting to them a completed Form AU-196.10 (Notification of Sale, Transfer, or Assignment in Bulk) at least ten (10) days prior to your closing (i.e., paying for or taking possession of such assets). The primary purpose of doing this is to allow the NYS taxing authorities the chance to determine if the selling party owes any sales tax to NYS or if it is under audit for same – if the seller does not owe any unpaid sales taxes, and if an additional review or audit is not necessary, NYS will send you a sales tax release letter (on Form AU-197.1, Purchaser’s and/or Escrow Agent’s Release — Bulk Sale), in which case you can go ahead and proceed to arrange for the closing of your business purchase. If you close on your business purchase, pay for the assets, or take over control of the business without having received such bulk sales tax release letter from NYS, and it turns out that the seller does in fact owe unpaid sales and use taxes, you can be held personally liable for the seller’s unpaid sales and use taxes.
(e) Third Party Consent/Approval Rights
The business you decide to purchase will usually operate from a particular location (or locations) pursuant to a commercial lease agreement with the owner of the real estate. If your business purchase is structured as an asset purchase, you will be acquiring the business in a name that is different than that of the tenant under the commercial lease; for the purchaser to continue operating the business from that particular location, the tenant under the lease (i.e., the seller of the business) must assign you (or your entity), as the purchaser, its rights under the commercial lease. The need for such a lease assignment is obviated if your business purchase is structured as a stock sale because you are acquiring the ownership interests in the selling entity (i.e., the tenant under the lease) that owns the business, so the name of the tenant would remain unchanged.
Why does any of this matter? Well, it matters, because commercial leases typically prohibit a tenant from assigning its rights and interest under the lease without obtaining the landlord’s prior written consent. Thus, if your business purchase is structured as an asset purchase, you will need to have the lease assigned to you, which can’t be done unless the seller’s landlord consents to it in writing. If the landlord doesn’t issue its consent to the requested lease assignment, you will not be able to operate the business from that location, even if you’ve paid the seller and done everything else required of you – your attorney should ensure that the formal purchase and sale agreement conditions your obligation to close on (amongst other things) the receipt of the landlord’s prior written consent to the assignment of the lease to the buyer.
If your business purchase is structured as a stock sale, it is not recommended that you assume that either an assignment of the commercial lease to you or landlord’s prior written consent will not be needed – this is because many commercial leases contain language that deems a transfer of the ownership interests in the tenant entity to a third party (e.g., you, as purchaser of the stock) to be the equivalent of an assignment of the tenant’s rights under the lease – if the lease contains such language, landlord’s prior written consent to your purchase of the ownership interests in the selling/tenant entity must be obtained in order for you to be able to continue operating the business from that location.
Regardless of how your business purchase is structured (i.e., asset purchase vs. stock sale), your attorney should carefully review the commercial lease agreement (in addition to any other relevant documents) during your transaction’s due diligence period to determine whether the landlord’s (or any other third party’s) consent, approval or authorization will need to be obtained, as well as whether its provisions otherwise apply or are desirable to you, as the buyer. For example, if the permitted use clause of the lease permits the sale of only women’s clothing and you, as the buyer, intend to operate a restaurant in the location, the lease (and the building’s certificate of occupancy) will need to be modified to allow for same – of course, such a need may drastically alter (for the worse) the parties’ financial, legal, and timing expectations with respect to the transaction, and the deal may no longer make sense for the parties. Likewise, if the lease expires in two years, you, as the buyer, will need a lease modification extending the lease for another ten (10) years (or whatever other time period you’d be looking for) so that its business does not need to renegotiate another lease or relocate to an entirely new space in a short timeframe. In such case, the landlord (and you, as the soon-to- be tenant) may prefer that the tenant sign a new lease and will deliver it to your attorney for negotiation on your behalf. Alternatively, the business may be operated from a property that’s actually owned by the seller – in such a case, you will potentially be negotiating a new lease with the seller (as landlord) from the onset of the transaction, or, depending on how you negotiate and structure the transaction, arrangements can also be made for you to purchase the property (and the business). The information contained in this article is by no means exhaustive, but hopefully provides helpful insight into things to consider before buying a business in New York. For more information on buying a business in New York, or on any other related matters, please contact Socrates Xanthopoulos at socrates@kilegal.com.
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