Crystal Utley
If you’ve built a business from the ground up, you’re already used to wearing a lot of hats. Founder, marketer, operator, customer service rep and yes, sometimes even your own “legal department”.
A recent Forbes article, “Why More Millennials Are Buying Businesses Instead of Starting Them,” caught my attention. The article explores why more millennials are choosing to purchase established companies instead of building businesses from the ground up.
That trend makes sense to me.
As a non-attorney who has built businesses and evaluated acquisition opportunities, I understand the appeal of buying something that already has customers, revenue, employees, and operating systems. Starting a business can be rewarding, but it also requires you to create nearly everything from scratch. An acquisition may give you a head start.
Still, a head start is not the same as a guaranteed outcome.
When you buy an existing business, you are not simply purchasing its revenue or customer list. You are stepping into decisions, relationships, commitments, and potential problems created before you arrived. Some of those things may add value. Others may not become visible until you know where to look.
That is why buying a business requires more than confirming that the numbers appear attractive. You need to understand exactly what you are purchasing, what you are assuming, and what will be required to operate the company successfully after the seller leaves.
You Are Buying More Than Revenue
When buyers first evaluate a business, the financials naturally receive a great deal of attention.
How much revenue does the company generate? Is it profitable? Is cash flow consistent? What will the loan payments look like? Can the business support the buyer’s salary?
Those questions matter, but financial performance is only part of what you are purchasing.
You may also be acquiring:
- Customer and vendor relationships
- Employee obligations
- Leases and equipment commitments
- Intellectual property
- Technology and operating systems
- Existing contracts
- Regulatory responsibilities
- Pending disputes or potential liabilities
- A reputation that you did not create
A business can look strong on a profit-and-loss statement while carrying serious operational or legal weaknesses beneath the surface.
Buyers need to understand not only what the business earns, but also how it earns that money and whether those arrangements are likely to continue after ownership changes.
Existing Customers Do Not Always Mean Guaranteed Revenue
An established customer base is one of the greatest advantages of buying a business. However, buyers should not assume that historical revenue will transfer seamlessly to new ownership.
Important questions include:
- Are customer relationships supported by written contracts?
- Can those contracts be assigned to a new owner?
- Can customers terminate on short notice?
- Is most of the revenue concentrated among one or two customers?
- Are customers loyal to the company or personally loyal to the seller?
- Does a change-of-control provision allow the other party to end the agreement?
If the company’s largest customer can leave immediately after closing, the revenue may be less secure than it appears. The same concern applies when the seller has maintained critical relationships through personal connections rather than written agreements.
Vendor and referral relationships deserve similar attention. A company’s performance may depend heavily on preferred pricing, supplier terms, or informal partnerships that are not guaranteed to continue after the sale.
The Purchase Structure Matters
One of the most important early decisions is whether the transaction will be structured as an asset purchase or an equity purchase.
In an asset purchase, the buyer generally acquires selected business assets and assumes specifically identified liabilities. In an equity purchase, the buyer acquires ownership of the existing legal entity, which may include its history and obligations.
Neither structure is automatically right for every transaction.
The appropriate choice can affect:
- Which liabilities the buyer assumes
- Whether contracts must be assigned
- How licenses and permits are handled
- Employee transitions
- Tax treatment
- Intellectual-property ownership
- What happens to accounts receivable and payable
- The buyer’s exposure to problems that occurred before closing
This decision should not be made simply because a seller, broker, or online template presents one structure as standard. The structure should reflect the actual business, its risks, and what the buyer intends to own after closing.
Due Diligence Is More Than Reviewing Financial Statements
Buyers often know they should review tax returns, bank statements, and financial reports. Meaningful due diligence goes much further.
The goal is to confirm that the business being presented is the business you will actually own.
Legal and operational due diligence may include reviewing:
- Organizational and ownership records
- Material customer and vendor contracts
- Employment and independent-contractor agreements
- Leases
- Loans, liens, and security interests
- Intellectual-property registrations and assignments
- Licenses and permits
- Insurance coverage and claims
- Pending or threatened disputes
- Privacy and data-security practices
- Regulatory and compliance requirements
- Prior owner distributions and related-party transactions
You also need to determine whether the seller has the right to transfer everything the business depends on.
For example, the company may use a logo that was never formally assigned to it. Essential software may be registered under the owner’s personal account. Contractors may have created valuable materials without signing agreements that clearly transfer ownership to the company.
These details can become your responsibility after closing if they are not identified and addressed beforehand.
The Seller’s Knowledge Has to Leave With You
In many small businesses, the owner is the system.
The seller may manage the most important customer relationships, approve every significant decision, or hold essential knowledge that has never been documented. The seller may also perform work that is not reflected in the organizational chart or financial statements.
If that owner disappears immediately after closing, the buyer may discover that the business is far less transferable than expected.
A transition plan can clarify:
- How long the seller will remain involved
- What training the seller will provide
- How customers, employees, and vendors will be introduced
- What information, documents, and credentials must be transferred
- Whether the seller will provide consulting services after closing
- What the seller may or may not do competitively after the sale
These expectations should be documented clearly. A general promise that the seller will help is not a sufficient transition plan.
The Deal Still Has to Work After Closing
It is easy to become so focused on completing the acquisition that you overlook what happens the following morning.
Who has authority to sign contracts? Are the bank accounts ready? Will key employees remain? Can payroll continue without interruption? Have customer and vendor communications been prepared? Who controls the email accounts, domain names, telephone numbers, social media profiles, and other digital assets?
Closing is not the end of the process. It is the point when the assumptions made during the transaction meet the reality of operating the business.
The strongest buyers plan for both the transaction and the transition.
Buying Can Be a Smart Path If You Buy With Clarity
Buying an established business can provide a meaningful head start. You may gain revenue, employees, customers, operating systems, and a recognized brand without experiencing every challenge of the startup stage.
But an existing business is not necessarily a stable one, and a profitable business is not necessarily well protected.
Ask questions. Verify the answers. Understand the obligations you are assuming. Make sure the agreements reflect the business you believe you are buying.
You do not need to become an attorney to purchase a business. However, experienced legal and financial professionals can help you evaluate the opportunity before you fully commit your time, money, and reputation.
Buying a business may allow you to begin with an existing foundation. Taking the time to understand that foundation can help you make a more informed decision about what you want to build from it.
This article was inspired by Melissa Houston’s Forbes article, “Why More Millennials Are Buying Businesses Instead of Starting Them.” The perspectives shared here are based on my own experience building businesses and evaluating acquisition opportunities.
This content is provided for general informational purposes and does not constitute legal advice. Reading it does not create an attorney-client relationship.