MIND YOUR BUSINESS COLUMN
Q: I am negotiating directly with the owner of a pizza restaurant that I want to purchase. How can I make sure I am not stuck with any unpaid bills to vendors or taxing agencies? The seller claims to be current with all bills, but I would like more assurance.
Seeking security in Dublin
A:It’s easy to picture the scenario you’re trying to avoid. You sign the deal, fork over a lot of money, start baking pizzas and serving happy customers, when wham! suddenly the mail arrives with a big bill for back taxes, unpaid purchases or maybe even notice of a lawsuit by former employees who were fired before you came on the scene.
Fortunately, there are some straightforward ways to protect yourself from such liabilities:
— Asset sale. If the business you’re purchasing is a corporation or limited liability company, there are two ways you can structure the deal. You can buy the entire entity. Or you can buy only its assets — equipment, inventory, name, reputation, lease, etc. (If the business you’re buying is a sole proprietorship, it will automatically be an asset sale.)
In an entity sale, the buyer typically assumes the liabilities of the business as well as its assets. But in an asset sale, the buyer is not responsible for liabilities incurred by the prior owner.
So structuring the deal as an asset sale can provide one initial layer of protection.
— Escrow. When you buy a home, the escrow process helps protect you from unexpected and costly surprises. Similarly, a business opportunity escrow can help protect you when buying this restaurant.
The buyer and seller typically split the costs of a business escrow, which vary based on the size of the deal. The escrow company takes out a newspaper ad announcing the sale and giving creditors 12 business days to come forward with their claims. It checks whether there are any liens on the business, and gets clearances from state and local tax agencies, ensuring that all tax bills have been paid.
The escrow agency won’t release your payment to the seller until all the specified conditions are met and escrow closes.
“By doing an escrow, you’re protected from any creditor, tax claim or lawsuit,” said Steve Zimmerman, a restaurant broker with Restaurant Realty Co. in Corte Madera.
“I absolutely won’t do any deal unless there’s an escrow involved,” Zimmerman said. “The charge is often about $1,200 to $1,500 per party, but it’s very reasonable considering the potential liability that you’re avoiding.”
— Contract terms. In addition to the escrow process, you can protect yourself through the terms of your purchase agreement.
For instance, you can include language in which the seller indemnifies you from any debts or claims that arose before you took ownership. (Similarly, the seller may want to be indemnified from any claims that arise after you buy the restaurant.)
You can also include language leaving some of your payment in escrow until enough time has passed — for instance, one year — for any stray debts to surface.
“Say this is a $150,000 purchase,” said John Marlow, an attorney with the Entrepreneurs Law Group in San Francisco. “You can hold back in escrow $20,000 or $50,000. If any liabilities come up after closing, the money that’s been held back can be used to pay the liability.”
You can do something similar in a seller-financed deal. Suppose you’ve agreed to make a $100,000 down payment, and then pay an additional $50,000 in one year. The contract could require that your $50,000 debt be reduced by the amount of any unanticipated liabilities.
“The agreement could have a provision where 90 or 120 days after closing, there is a recalculation of the purchase price based on (unforeseen) things that come up,” Marlow said.
Restaurant Realty Co.’s Web site includes several articles on the business escrow process. See restaurantrap.restaurantrealty.com/25.asp. And talk with an attorney to make sure you’re choosing the right structure and terms for this sale. Your restaurant may make a great half-baked pizza for takeout. But you don’t want a half-baked purchase agreement.