This article first appeared on Forbes.
Buying a business is similar to buying a home. If done correctly, it can have a daily positive impact on your life and increase your net worth. But just as you wouldn’t purchase a lemon for a home, if you purchase the wrong business, it can be a damaging drain on your financial and emotional resources.
I have helped with the purchase and sale of dozens of businesses, and I find that the same pitfalls come up over and over again. By knowing what they are and avoiding them, you’ll be happy with your business purchase not only on the day you take the keys but for many years to come.
1. Have a narrowly defined non-compete provision
The last thing you want is to provide the jet fuel for the seller to open a competing business next door. To protect yourself, you should include a non-compete provision that prohibits the seller from participating in a competing business.
The provision should narrowly define the type of similar businesses the seller is prohibited from not only owning but also working in. In addition, the provision should include a set amount of time that the seller is prohibited from operating a similar business within a specific geographic scope. For example, if you are buying a restaurant, you would specify that the seller cannot invest or work in the restaurant industry for five years within 30 miles of the restaurant you are purchasing.
2. Run a lien search
A lien is an interest or a legal right that a creditor has on another person’s property. It’s important to make sure that there are no liens attached to the assets you are purchasing. By running a lien search, you can ensure that the assets are not encumbered by a lien, and you’ll know that a third party does not have any interest in the assets you are purchasing.
Have the escrow agent for the business purchase run the lien search, or if you are not using an escrow agent, hire a filing company to do so.
Investing a few hundred dollars in a lien search can pay enormous dividends as it ensures that any problems the seller has with creditors don’t become your problems with creditors.
3. Research the company’s financial history
Have a CPA “kick the financial tires” of the business to make sure the purchase price is supported by the company’s revenue and expenses. A solid CPA can not only help you determine whether the asking price for the business is fair but will look under the financial hood of the business to see if the numbers the seller is providing you are actually accurate.
4. Carefully review the commercial lease
Often, one of the biggest assets of a business is its commercial lease. It is worthwhile to hire an attorney who specializes in commercial leases to highlight the key terms and negotiate fixes for any “gotcha!” clauses. Often sprinkled throughout a commercial lease are additional expenses you should be aware of to determine the true rental price of the property and not just the sticker price.
5. Hold the seller accountable
Ideally, the seller will sign the purchase agreement not only on behalf of the company but also as an individual. Here’s why this helps you as the buyer: If the seller only signs the purchase agreement on behalf of the seller’s legal entity, that company could be dissolved and you would have no way to hold the seller accountable for the promises made in the agreement.
In contrast, if the agreement is also signed by the seller as an individual, you can still hold the seller accountable even if the seller’s legal entity is dissolved. By requiring not only the legal entity but also the seller to be personally accountable for the promises made in the purchase agreement, you can help make sure that the promises made in the agreement are fulfilled.
6. Have a dynamic purchase price
If possible, you should consolidate a dynamic purchase price into the purchase agreement. For instance, instead of paying the full purchase price at closing, you can pay a portion of the purchase price then the rest of the balance after agreed-upon metrics have been hit or the seller’s obligations have been fulfilled. This way, you help make sure that the ultimate purchase price matches the value you get from the business.
Navigating the waters of buying a business can be tricky. There can be a variety of pitfalls that vary from deal to deal. But by following the above tips and working with an attorney and a CPA, you ensure that you’re buying a business that’s right for you. When you turn the key on the first day, you’ll have the returns you initially forecasted for many years to come.
Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.