Ten Things to Look at Before Buying a Business that Usually Overlooked and Can Cause Liability for the New Owner

It’s exciting! You have money to spend and want to purchase an ongoing business concern. Especially now, the present economy offers many delectable opportunities. Here are a few off the top of my head:

  • It is well known that we are in a recession that started several years ago. Recessions offer rare opportunities and typically create a buyer’s market where buying business are concerned.
  • If you have cash, or access to financing, that puts you in an enviable position. The decrease inavailability of easy credit has caused a slump in business transfers. In fact, SBA’s 2012 expected budget for lending is down 45% from2010.
  • Many businesses are being offered at lower prices due to recent drops in sales.
  • The impending retirement of the baby boomers; with the aging of the baby boomer population, millions of businesses are up for grabs. It is well known that a driving factor for many sellers is their impending retirement.

With all this opportunity must be added an extra degree of caution. With so many business opportunities to choose from, in your eagerness to buy, buy, buy and make money, money, money, you can easily overlook some factors or hidden liabilities that make the purchase of an ongoing concern your nightmare waiting to happen.

There are a few obvious things a buyer typically reviews when buying a business:

  • Tax returns
  • Cash flow
  • True Value of assets held in company
  • Salaries and perks to present owners
  • Present client base
  • Lease or rental agreements
  • Valuation of business
  • Licensing and permits needed
  • Present marketing strategies

This article hopes to shed light on things that are not necessarily scrutinized during this process, which may cause loss of time, energy money and unneeded stress on the new owner. So let’s get started.

  • Fiduciary issues with the company retirement plan. The business owner, referred to as the plan sponsor is legally responsible for the upkeep and results of the company sponsored retirement plan. That’s correct; the business owner, not the broker who sells and installs the plan, is responsible for keeping the plan in order according to the department of labor. A few of the things that the employer has to keep track of to keep the company retirement plan from becoming a large liability are:
    • The investments selected have been selected in accordance to the company’s stated Investment Policy Statement (IPS).
    • The investments are being monitored on a regular basis for performance that matched the criteria in the IPS.
    • The present investment selection offered is appropriately diversified
    • The Plan documents are up to date with current regulations
    • The fees being charged to the employees are transparent and reasonable
    • The employees have access to regular education to completely understand how to use the present plan and successfully retire
    • Are plan loans being monitored and have the loans that have been made been done in a satisfactory manner
    • Appropriate documentation of all above to ensure the safety of the plan sponsors
    • Have the present plan service providers been scrutinized for complaints internally in the company and externally with their broker dealers to insure the satisfaction of the employees.
  • Using free-lance Contractors (1099’s) instead of W-2 employees. There has been increased scrutiny on behalf of the IRS in reference to this employment practice. 1099’s are tempting because they save the business owner many traditional employee related expenses like health benefits , unemployment, workers comp, state disability and social security contributions. The use of free-lance employees also gives the business owner greater flexibility in expenses as business revenues fluctuate. Before entering into the buy sell dance with a business make sure to use the 20 part test as it applies to 1099 contractors that are part of the business to make sure you do not inherit this costly liability.
  • Employee handbooks are often overlooked when reviewing the human resources aspect of a business, and yet they are vital in protecting the small business owner from a host of issues. They are the first line of defense from issues with employees as they articulate the rules of engagement while operating as part of the business.
  • Trademarks, copyrights, patents and all claimed intellectual property need to be carefully examined to ensure they are legitimately gained, protected and used in the business. This is one of the rare areas that can pierce the corporate veil to reach the business owner.
  • Social Media. This exploding area of human communication needs to be reviewed on several fronts to protect the investment of the new potential business owner. How are the employees using social media as it relates to the company, its products or fellow employees? How is the company represented through its online reputation with its competitors? Lack of attention to either of these points may cause internal lawsuits in the company or abrupt changes in sales if the online reputation of the company is attacked. One can purchase business insurance for the latter if deemed appropriate.
  • Continued salary or benefits to disabled or injured company employees can create a substantial liability in a company. Unless a clear policy, correctly implemented, that addresses how workers will or will not be compensated in the event of a disability or injury is in place, and it is followed scrupulously in the event of an occurrence to someone in the company, the company may be liable the following consequences should an employee become disabled after a precedent has already been set.
    • All employees, regardless of their value to the company will have to be treated the same as the first employee who encountered this issue in the company.
    • The payments of “salary” and “benefits” can be construed as ad hoc payments and thus may not be tax deductible to the employer
  • Often in small business, business owners have to personally guarantee in order to get favorable loans, equipment or real estate leases or terms with wholesalers. It is important to review every contract and agreement for these clauses so as to not pass these promises on to the new owners
  • A small business usually has a few key employees, that without which, the business might meet a swift demise or serious setback in operation or cash flow. It is dearly important to meet, greet and solidify their continuance in the business to keep the goodwill of wholesalers, customers and employees to the business. One must also be concerned that a key employee leaving may try and set up a competitive business.
  • Although typically 5 years of tax returns are standard in the review process, even audits it is important to have a separate forensic evaluation of the tax returns. Taxes are an art! Each CPA is an artist that paints a picture of the business. There are many ways that a business can be portrayed in a more favorable light through the tax return. Depreciation perks to key employees or owners, insurance premiums that should or should not be paid through the business are just a few of the areas that can be interpreted to the seller’s advantage to make a business appear more favorable than it really is. This one step can save the new prospective buyer millions in the future from tax issues and waste in the company that affect profitability.
  • Many buyers go through a business broker to find that suitable business that fits their desire and need to buy a business. Most business brokers include a valuation of the prospective business for sale as part of their fee. I believe that there can be a conflict of interest in accepting this valuation. The broker is typically paid as a percentage of the business sale price, thus it is to their advantage to value the business favorably. I strongly urge the prospective buyer to get an independent valuation of the business form a third part not related to the sale, preferably from an independent firm that just does business valuation to avoid overpaying for a business. There are many firms that do this and the $10,000 or so spent in this process can help avoid a tragic mistake in this process.
  • This is a Bonus issue to consider. When buying a business that you hope will create income and stability for your future I would advise any of my clients to require the following of any person they are considering buying a business from: Personal credit scores,background checks and individual tax returns. Know who you are getting in bed with. Even though you may believe that once you buy the business, all dealings with the past owners are not your concern, the reputation of that previous owner can seriously harm your future business health. These three things will give you a flavor for the ethics and business savvy of the prospective seller that can help move the deal to completion or avoid a costly error.

Buying a business is a complex and exciting process. This article is not meant to be an exhaustive list of all the diligence that a prospective buyer should consider in the transaction, but a list of areas that are not usually addressed, thus can cause issues for the business in the years and decades to follow after the sale. For any questions about this article or comments, please email Jeanne at Jeanne@jeannebrutman.com.



Authored by: Jeanne Brutman

Jeanne Brutman is a fully independent Financial Planner in the New York area who advises people on how to grow their personal net worth through Easy, Step by Step Education and Decisions that build their wealth and security over the short and long term. Jeanne can be emailed at jeanne@jeannebrutman.com or visit her at her website www.askjeannebrutman.com for useful tools and tips.

Jeanne's Podcast Link: Setting financial goals (etc.) for the new year.

*All investment advice given by Jeanne Brutman is just opinion. Please consult with your financial professional for a more thorough discussion of what is appropriate for you

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