Buyers are often shocked to find out that after the closing of the business sale, they assume all of the risk of the business they purchased. This is often a first-time buyer reaction, because seasoned entrepreneurs know that risk is a part of being a business owner. When you go to a car dealership and buy a car, you complete the purchase and drive off the lot with the car. From that point, you are responsible for all of the expenses and upkeep of the car, and you are also responsible for all aspects of that vehicle. The same concept applies when you purchase a business, although there are safeguards and processes, like Due Diligence, put into place to mitigate risk to the buyer.
Limiting Risk
There are certain things in place to make sure that the new owner doesn’t inherit any of the previous owners’ liabilities or debts, which are built into our standard Asset Purchase Agreement, and also the closing agent will do a search to make sure that there are no outstanding equipment liens, etc. In many transactions, there is also an agreed-upon amount of funds held back from the seller’s proceeds of the sale (known as an 'escrow hold-back') in an escrow account for a short period of time (usually 30-90 days). This would be a buyer’s security blanket in essence, because if any outstanding debts arise from when the previous owner was running the business, and the seller refused to satisfy the liability, then the new owner could seek out funds from the escrow hold-back to pay for any surprises that did come up. Buyers would need to communicate with the closing attorney handling their sale to get details regarding the process for claiming on the escrow hold-back.
Asset Sales
Another way to limit buyer liability in small business sales is almost built into the process, just by the nature of our transactions. The majority of small business sales are what’s known as an “asset sale.” That means that the buyer is purchasing the business assets of the seller, but not the business entity itself. That way, the new owner does not take on all of the liabilities of the previous business entity, like they would if they were purchasing the business in a stock sale. In essence, the buyer to start fresh by creating a new business entity or purchasing the business assets under their own existing entity, leaving the old business entity behind.
Buyer’s Due Diligence
As a buyer, once you are under contract, you have the chance and the responsibility during Due Diligence to ask any and all questions you may have to find out everything you want to know about the business. The whole point of Due Diligence is to prove that what the seller is advertising regarding the business’s financial performance and operations is true. If the buyer uncovers something that they aren’t happy with or are uncomfortable with, then they have the right to cancel the sales contract and get their deposit back. As always, if the buyer would like professional assistance during Due Diligence, they are encouraged to engage the services of an attorney and or CPA.
After performing Due Diligence, if you are not 100% sure that you are ready to take on the risk of buying this business, then you probably shouldn’t move forward. Being a small business owner is not always easy, and yes, the risk of this business failing or thriving is completely on the new owner’s shoulders. Not everyone is cut out to be an entrepreneur, so make sure you are ready to take the risk on the right business before you start shopping.
If a buyer has specific questions about the risks involved with their business purchase, they are encouraged to speak with their attorney. We are business brokers, and can only offer our experience and observations, based on business sale transaction history. For legal advice, buyers and sellers should always seek counsel from their attorney.