Friday, April 22, 2011

Purchasing a Business: Legal Due Diligence

Purchasing an existing business can be a complicated process with several stages. Perhaps the most important stage is the completion of the “due diligence” study by the purchaser. Oftentimes, the due diligence study reveals areas of concern and areas of seller mismanagement that the purchaser is unaware of during the “courting” stage of the process. Thus, regardless of the structure of the purchase transaction (asset purchase, stock purchase, membership interest purchase, merger, etc.), it is imperative that the purchaser conducts a thorough review of the business, both from a financial perspective and from a legal perspective. While an experienced attorney can provide guidance for the financial review, engagement of a CPA is the better course of action. Hiring an experienced attorney is critical, however, for the legal review. The attorney will investigate the various legal issues that most purchasers overlook or do not even consider while focusing on the big picture deal. Based upon the findings of the due diligence review, the attorney will make recommendations to the purchaser and will attempt to structure the deal to protect the purchaser’s best interests. Some of the issues that are most commonly overlooked by purchasers include, but are not limited to, the following:

1. Formal business organization.

What type of entity is the business? LLC, Corporation or other type? Who are the owners? What agreements exist between the owners? Who are the managing members, directors or officers? What approvals are required for the sale to take place?

2. Registration, permits and licenses.

Where is the business registered? Is the business in good standing in all places where it is registered? Does the business need to be registered elsewhere? What permits and licenses are required to operate the business? Are the existing permits and licenses transferable?

3. Asset review.

What assets are owned by the business? What assets does the business finance or lease? Where are the assets located? Are there recorded and/or unrecorded liens on the assets? Which assets are going to transfer in the deal? Which assets are not going to transfer? Are the assets transferable?

4. Contract review.

What existing contracts is the business a party to? Are the contracts transferable? How must the contracts be transferred? Does the business sale result in a breach of any contract? What contractual obligations will the purchaser be bound to following the sale?

5. Employee issues.

Who are the existing employees and independent contractors? Will they remain with the company after the sale? Are there existing employment contracts? Will the purchaser want employees and independent contractors to execute new agreements? Is there an employee handbook? Are there employee benefit plans in place? Are there any disclosed or undisclosed employment disputes or potential violations of employment laws?

6. Existing Lawsuits and Judgments.

Are there existing lawsuits against the business? Are there outstanding claims against the business or its owners? Are there existing judgments against the business that have not been satisfied and released? Are there potential lawsuits or administrative claims?

7. Taxes.

What types of tax is the business required to pay? Have all prior taxes been paid? Are there any outstanding tax liens or assessments? Have all employee taxes been properly paid? Is there some contingent liability such as employees being improperly classified as exempt or non-exempt?

8. Creditor Issues.

Who are the creditors of the business? How much debt exists? Is the debt going to be assumed? Are creditors going to be paid out of the purchase price?

9. Other Issues

Insurance coverage; Franchise considerations; Environmental concerns; Customer relations; Intellectual property matters; etc.

The information learned from a thorough due diligence review will be critical to the purchaser’s decision of whether or not to go forward with the purchase. In some cases, the anticipated structure of the deal will change based on the information that the attorney discovers, as the purchase agreement must be designed to protect the purchaser from expected and unexpected legal problems following the sale.

Some ambitious (and imprudent) business purchasers believe that hiring an attorney to conduct legal due diligence will only “throw cold water” on the deal that the parties want to consummate. However, some of the most commonly litigated issues that arise following a business sale (including fraud and breach of contract) can often be eliminated by having an attorney complete a legal due diligence review prior to the closing of the deal. Thus, a small investment prior to closing the sale may eliminate substantial legal expenses (and perhaps worse) after completion of the sale.

The attorneys at Gross & Romanick, P.C. have substantial experience representing clients throughout the process of acquiring a business. They understand the issues that the purchaser must investigate and consider, and know how to structure the deal to protect the purchaser’s best interests. Gross & Romanick, P.C. also represents sellers, who have other issues to consider in the course of a business sale (which issues will be the subject of another article).