When you’re buying a business, you should make sure that the business’s assets aren’t encumbered by liens. As I mentioned in Don’t Let the Seller’s Liens and Taxes Stalk You, even if you structure a business acquisition as an asset sale, the seller’s liens are your problem.

A lien is a legal right or interest that a creditor has in another’s property. If you’re buying a business whose assets are encumbered by a lien, someone else will have an interest in your property. If that someone is the seller’s creditor, that’s bad news for you if the lien is still intact after closing.

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Everyone knows that business owners should form a limited liability company or a corporation. But just having a company isn’t enough to protect you from your business’s liabilities.

You’re responsible for your own actions when you harm someone else, even when you’re working for your corporation or LLC. So if you harm someone, they can sue you as an individual and go after your personal assets. Your business might still be liable under a concept known as vicarious liability, but you’ll be liable, also.

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A company’s key contracts represent a valuable business asset. Thus, it’s crucial that the contracts remain in force as a business changes hands from the seller to the buyer when the business is sold.

As I’ve written elsewhere on this blog, the sale of a small business is usually structured as either an equity sale or an asset sale. In an equity sale, the buyer purchases the equity from the owner(s) of the company being sold (commonly referred to as the target company) — stock in the case of a corporation and membership interests in the case of a limited liability company. The business is transferred to the new owners, corporate or limited liability company entity and all, and the target becomes a wholly-owned subsidiary of the buyer. There is no change in the status of the target entity itself, and its contracts, assets, and liabilities remain with the entity.

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“Leave the gun. Take the cannoli.” Fictional mobster Peter Clemenza delivers this famous line in The Godfather after a drive into the country with the godfather’s driver Pauli. The driver betrayed his boss and Clemenza has just meted out justice.

Take the good stuff. Leave the bad stuff. That’s the main idea behind buying a business via an asset purchase. Here are a few pointers so you won’t find yourself pursued by the Seller’s unpaid taxes and liens.

What’s an asset purchase?

There are innumerable ways to structure the purchase of a business, but most deals are either asset purchases or equity purchases. In an equity purchase, the buyer purchases the equity of a company (often referred to as the “target”) from its equity holders — stock in the case of a corporation and membership interests in the case of a limited liability company. The buyer ends up with the entire company, along with all of its assets and all of its liabilities. In a deal structured as an asset purchase, on the other hand, the buyer purchases the company’s assets but leaves the corporate entity behind, along with some or all of the company’s liabilities.

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Before you buy a business be sure you’ve done your due diligence. Even in the days of Carfax, you wouldn’t buy a used car without looking under the hood to make sure the car’s in good condition. You’d probably also take it to a mechanic to have it examined by an expert. If you’d do this for a car purchase, why would you making a life-changing investment without making sure the business you’re buying is in good condition?

If you’re smart, you won’t.

You’ve probably heard the phrase caveat emptor — “buyer beware.” It means that it’s the buyer’s responsibility — not the seller’s — to ferret out issues that could affect whether the buyer wants to go through with the deal. The onus is on the buyer to ask questions and challenge assumptions.

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Although deal lawyers generally describe their practice as involving “mergers and acquisitions,” the sale of a small or medium-sized business is usually structured as either an equity sale or an asset sale. Which structure is right for you depends on your circumstances. This post discusses some of the pros and cons of each deal structure.

Two ways of structuring a business acquisition

In an equity sale, the buyer purchases the equity from the owner or owners of the target company — stock in the case of a corporation and membership interests in the case of a limited liability company. The business is transferred to the new owners, corporate (or limited liability company) entity and all, and the target (i.e., the business being purchased) becomes a wholly-owned subsidiary of the purchaser. There is no change in the status of the target entity itself, and its contracts, assets, and liabilities remain with the entity.

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The final rule for the SBA 7(a) and 504 loan programs was published in the Federal Register today. One of the most significant changes is the elimination of the Personal Resource Test. The change is effective April 21, 2014.

The Personal Resource Test requires banks to certify that the borrower doesn’t have additional resources that should be used to support the business.

For commentary on why the SBA eliminated the rule, see Why SBA Wants to Eliminate the “Personal Resource Test” on the Coleman Report. According to Bob Coleman,

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Sole proprietorships pose unique issues when they are bought or sold. Sole proprietorships are businesses that are owned by a single individual rather than by an entity such as a corporation or limited liability company.

Most businesses are held and operated by companies rather than by an individual. Entities such as corporations and limited liability companies are created under state law by filing a document with the secretary of state and are treated under state law as a legal person separate from their owner(s). When the business is sold, the buyer’s focus is mostly on the entity: because the business assets and liabilities are contained within the entity, the buyer’s due diligence is focused on the entity’s assets, liabilities, and contractual relationships.

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SBA loans can be a great way to finance a small business acquisition. Like most government programs, SBA loan programs have plenty of rules. In this post, I summarize the highlights of the rules for SBA 7(a) business acquisition loans.

There are three key sources of information about SBA loan rules: the U.S. Code of Federal Regulations, the relevant SBA SOP, and the SBA website. The SBA’s authorization boilerplate is another source of information about SBA loans, and it supersedes the SOP if there’s a conflict. Some of the text below is taken directly from the government sources but not set off in quotes to enhance readability.
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