What You Should Look for When Examining a Business
DON'T BUY SURPRISES - You need to carefully assess the assets you are acquiring and the liabilities you are assuming if you buy the business. You should personally inspect the premises, looking for things like obsolete or unsalable inventory, out of date or rundown equipment, or furniture or fixtures you may soon have to repair or replace. Review the terms of any leases. One reason some businesses close or sell out is the imminent expiration of a favorable long-term lease, or if the landlord plans to raise the rent drastically or not renew the lease at all when the current term expires. Insist that all equipment be in good working order. Do a walk through of the facility and make up your own "punch list" of items not to your satisfaction, including any repairs and maintenance required on the building. Ask the owner what kind of allowance he will offer you against the purchase price if you perform the repairs and maintenance. If available, review the receivables (Accounts Receivable Ageing) with a fine-tooth comb, looking for over due accounts. If a significant amount of these receivables are over 90 days old, there could be trouble. You may even want to run credit checks on a few major customers, if they make up a large part of the receivables. The bankruptcy of one of those customers could also bankrupt you.
UNDISCLOSED LIABILITIES - Not all liabilities of a business show up on its accounting records. There may be any number of claims against the business, such as security agreements encumbering the accounts receivable, inventory or equipment, unpaid back taxes of various kinds, undisclosed lawsuits or potential lawsuits, or simply unpaid bills. Run a title and lien search in the local courthouse. This will disclose some of the problems. You may even insist on receiving a tax clearance certificate from the State Department of Revenue. If you are going to assume liabilities of the business, the written agreement of sale should specify exactly which liabilities are being assumed and the dollar amount of each. Watch out for any environmental issues. They can come back and haunt you. Many states now require an inspection by environmental engineers for ground contamination. If you are buying a dry cleaners, Laundromat, gasoline station, auto repair shop, salvage yard, fuel oil company, trucking company, or any similar business. You may have some environmental exposure.
BE WARY OF BUYING STOCK OF A CORPORATION. - If the business you are about to buy is incorporated, you will usually be well advised to buy the business assets from the corporation, rather than buy the stock of the corporation itself. The latter approach will subject the buyer to all hidden or contingent liabilities of the old corporation, whether or not you have agreed to pay for any liabilities of the corporation that pre-dated the sale. Also, you will frequently incur a tax disadvantage if you buy the stock, since you will not get a free step-up in the basis of the corporation's assets, unlike a direct purchase of the assets. (One exception would be where the corporation has unused tax losses or tax credit carry over that could be used to shelter some future income from tax. However, the '86 Tax Reform Act has severely restricted the use of such carry over where there is more than a 50% change of ownership of the stock of a corporation in a 3 year period.