What is involved with a purchase of an existing small business? This blog post will discuss some basic points to consider.

Structure of the Purchase: Most small business purchases are actually what are known as asset purchases.  In an asset purchase, the buyer purchases certain tangible assets, which are physical assets such as inventory, furnishings, equipment, vehicles, etc. and intangible assets, usually called goodwill, which represents the value of the business in excess of value of the physical assets.  The other option is to actually purchase the seller’s entity and take over the existing business structure.  However, in this scenario, the buyer is also taking on all known (and unknown) liabilities that the seller may have incurred.  So if for instance the seller entity has a product that it sold prior to the purchase and that product fails, that would be a liability the new purchaser unknowingly assumed.  In an asset purchase, in most circumstances the seller would still be responsible for any such liabilities while the buyer would have a clean slate.  The buyer should also form an entity, such as a Limited Liability Company, as the purchasing party.  Formation of business entities is discussed in a prior blog post here How Do I Start My Own Business (Part 2 of 3).

Letter of Intent: Frequently the parties to a business purchase will start with a Letter of Intent (LOI).  The LOI sets forth just the basics of the transaction such as purchase price and what is being sold.  It is important that the LOI is non-binding to prevent you from unknowingly entering into a contract without all the terms spelled out.  An LOI is often used to allow a purchaser to review confidential business information to perform the initial due diligence.  Then, if the buyer is satisfied with the initial due diligence, the LOI can be used by the seller’s attorney to draft the full purchase and sale agreement.

Purchase and Sale Agreement/Asset Purchase Agreement (APA): The purchase and sale agreement, frequently called an asset purchase agreement when structured as an asset purchase, sets forth the terms of the sale. The APA would include items such as sale price, deposit, and closing date, and would also list the specific assets being included and excluded.  If the seller is providing any financing for the purchase this also would be included in the APA.  The APA also frequently includes provisions for the buyer’s due diligence or inspection rights, representations and warranties, and if necessary contingency provisions for the buyer to obtain financing as well as to make an agreement with the seller’s landlord regarding the lease for the business location.  The APA may also include provisions regarding the post-sale obligations of the seller, such as to provide training to the buyer, and may limit the seller from competing with the business the seller has just sold (a non-compete).

Lien Searches: One of the items your attorney will obtain prior to the closing on the purchase is a lien search to verify if any creditors have liens against the business assets or if any tax liens have been filed against the seller.  Depending on the business the buyer may also want to obtain a litigation search to be sure that the seller is not being sued for anything in relation to the business.  Also necessary in Connecticut is verification from the Connecticut Department of Revenue Services (DRS) that the seller has paid all of its sales and use taxes and withholding taxes.  If this tax clearance process is not followed, the DRS can claim a lien against the purchaser.  Tax clearance is obtained by the buyer making application to the DRS for a tax clearance certificate.  The DRS usually requires that some of the funds be held in escrow to insure all sales taxes up to the date of closing are paid by the seller.

Use an attorney: The buyer and seller should each consult with their own attorney, to review the terms of the LOI, to draft the APA and to prepare the closing paperwork.  The attorneys of Gesmonde, Pietrosimone & Sgrignari are experienced with all aspects of the purchase and sale of a small business in Connecticut.

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