“Anyone who thinks it is expensive to conduct a legal examination before a transaction, probably has not yet paid for a legal review after the transaction.”
A Good Deal
Smart entrepreneurs know how to find business opportunities, invest at the right time and place, and maximize their profits. One of the most effective ways to do this is to purchase an active, running business. This way you can significantly shorten the period that passes from the moment of investment to the moment of generating income.
In other words, instead of investing, building and establishing a new business from scratch, many entrepreneurs would prefer to purchase an already working business at an attractive price. So, instead of building a business from the ground up, their investment focuses on the development, marketing, improvement and more efficient management of the existing business.
Furthermore, it is a safer bet since you have existing data for income and expenses. And many times buying an active business not only includes the purchase of assets but things that may have taken years to build; like a good reputation, active customers, suppliers, employees and professional knowledge. Sounds like a fantastic entrepreneurial move right? But wait………
Not So Fast
Before you take out your pen and sign, it is advisable to place some emphasis on carrying out preliminary tests to confirm the feasibility of the transaction.
Recently, we were contacted by a client who purchased a restaurant. He was delighted by his ” great deal.” The price was very attractive. In exchange for an amount that reflected a revenue cycle of only one month, he purchased an entire restaurant, with all the equipment, CRM systems, reputation, regular customers, and a fully equipped kitchen. He knew he could change the menu, market widely and significantly increase the revenue cycle. But within a few months of the purchase he received a legal order instructing him to close the restaurant. It turned out that the municipal plan didn’t allow for a restaurant in that location at all.
Luckily for him, we knew how to drop the criminal charge against him and prevent him from paying fines. (At the same time as suing for the return of the money he paid to the seller). But it would have been much better if he had contacted us before he made the deal. Then we could have prevented him from suffering in the first place.
What Exactly Is Due Diligence?
So what is the due diligence we are talking about? Before purchasing a live business, insist on the selling party allowing you to check out every aspect of the business. There is no reason to avoid allowing such an inspection to be conducted. Many times it is even possible to actually sign a purchase agreement for the business, that is conditional on the results of the inspection. This comprehensive examination shows a picture of the business from a legal, business and accounting point of view.
These are the main things that need checking from a legal point of view.
- What are the legal rights you are acquiring – is it the purchase of a business activity or the purchase of shares in the company?
- Does the business operate according to the law? Does the business have the licenses required for its legal activity? There are many businesses whose activity is illegal if they do not have a license or a certain permit, such as: restaurants, dental clinics, cosmetic institutes, and more.
- Are there legal proceedings underway against the business? For example, if it is a matter of purchasing a company due to intellectual property that it owns, it is advisable to make sure that there is no other claim to ownership of that intellectual property. If the main payment is for goods in the warehouse, it is advisable to check that it is not foreclosed, etc.
- What are the contractual rights and obligations in the business? Take for example, a deal involving renewing the lease agreement. If we find out that it is just about to end, we will make sure that the business is not contractually bound to order goods from a certain supplier, or to work with a specific service provider. Will examine if the business is dependent on one central supplier, or on one central customer?
- Is the intellectual property of the business protected? So, when the entrepreneur acquires a business with a reputation built on the name of the business, it is advisable to make sure that the same name is protected by a registered trademark, and that the purchase includes the rights in that intellectual property.
- What are the rights of employees in the business? It is advisable to examine whether there will be a need for a change in the personnel (layoffs / recruitments) in the business, and whether the salaries and benefits of employees have been paid in full. Are there employees with unfulfilled rights? (The labor courts have already recognized the right of employees to receive compensation and social benefits retroactively from the period of their employment by ‘the previous owner of the business’).
- Is the business profitable at the moment? And of course, it’s necessary to examine the reliability and authenticity of the business and the accounting information presented to the buyer. (I’ll address this in another article.)
Buying a Business? Protect Yourself
There are many additional details that should be examined. It all depends on the nature of the transaction, the industry, type of business and the extent of its activities. Therefore, it is always advisable to consult with a commercial attorney before making any purchase.