Look Before You Leap

I cringe in recalling numerous instances of business owners jumping into buying or selling a business, or entering into a significant business arrangement, without careful and appropriate prior diligence, negotiation and document preparation, only to wind up with one or more clearly avoidable surprises after the sale or transaction. The time to investigate is prior to closing – no exceptions.

Buyers. You must ask the right questions (especially the tough and less obvious ones) and uncover all of the warts before you sign on the dotted line. Look long and hard at each seller contract and arrangement with third parties to ascertain what it is, whether you can assume it, want to assume it, or can renegotiate it. Seek appropriate seller warranties by contract, and create an escrow to cover any post-closing problems if possible. It is not (necessarily) what you can see that will hurt you; it is what you cannot see. Successor liability for matters you fail to uncover is possible, and hidden liabilities abound. Regardless of the strength of your contract, it is always preferable to identify and deal with potential problems prior to closing, rather than seeking recourse after the money has changed hands.

Buyers should investigate and confirm revenues, relationships, payment/provision for all taxes, entity structure, equipment, and inventory. Dive as deeply into the operations as possible to get as comfortable as you can with what you are buying. A balance must be struck between sellers who want as little pre-closing disruption as possible – especially if knowledge of the pending closing is being withheld from some or all of the seller’s employees – and buyers who have a right to know what they are buying. I have seen several instances of sellers using this secrecy argument to withhold overstated revenues, significant liabilities, and other problems from buyers. And buyers, do not trust others, such as your lender (it must be okay because the bank is lending me money) or the seller, to do your diligence for you – it is your job and no one else’s. I have not seen a buyer over-investigate a purchase, but I have seen several fail to do their homework and pay dearly for it later.

Sellers. You must operationally prepare your business for sale, and sell it without the boomerang affect of having the buyer’s post-closing operational, regulatory, tax and/or other screw-ups landing right back in your lap. Do not fool yourself into thinking you can save money by simply signing the buyer’s purchase contract, collecting the purchase price, and hoping everything works out. You must investigate your buyer and document the transaction appropriately. It is not only important to contractually provide for the buyer’s assumption of agreed obligations, but also to ensure that third parties and the buyer follow through with these contract assumptions. The following situation can be a nightmare for sellers: Seller and buyer agree that the buyer will assume a seller contract; however, the parties do not investigate the mechanics of assumption, or whether the contract is even assumable, and the buyer never addresses the matter after closing. Months or years later, after the buyer runs up a huge deficiency on the contract and files for bankruptcy, the third party seeks recourse against the seller because the contract was not assumable and/or never properly assumed.

Think long and hard about seller-financing the purchase of your business. Regardless of contractual protections, as a practical matter, payment of your promissory note will be tied to the post-closing operational success of a buyer you cannot control. In my experience, unless the sell and buyer have a strong and successful pre-existing relationship, the success rate of seller-financed sales has not been good.

I cannot overemphasize the importance of looking before you leap – both with clients who wish they had, and clients that found, after proper diligence, that the best choice was to walk away from the deal. Sometimes the best deal is the one – after diligence and before closing – you decide not to do. The diligence and legal costs spent could be minor compared to the alternative.

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