Five issues to address when acquiring a business

Numerous legal and operational issues can arise when acquiring a business. Proper preparation by assembling the right group of professionals and conducting due diligence will save time and costs and ensure that the purchaser’s risk is reduced and interests are protected. 

1. Ownership of assets or equity

If a purchaser is acquiring the stock in a corporation or interests in a limited liability company, it is imperative to confirm that the sellers of which stock or interests are, in fact, the owners. 

If the business is a corporation, the sellers should provide the bylaws of the business with any amendments, articles of incorporation with any amendments, original stock certificates and stock ledger. If the business is a limited liability company, the sellers should provide the operating agreement of the business with any amendments, articles of organization with any amendments and assignments of membership interests.

The purchaser should review these documents to confirm the number of shares or interests owned by each seller and how such shares or interests are held, as some owners prefer to hold their shares individually, in a trust or another entity. If the shares or interests were distributed in accordance with a probate matter, the probate order and related documentation should be reviewed as well. 

2. Existing liens and debts

Uniform Commercial Code (UCC), litigation and tax lien searches should be ordered on the seller(s) at the onset of every transaction. In an asset purchase, the searches should be conducted on the company selling the assets. In a stock purchase, the searches should be conducted on the company and the owners/members selling their respective shares/interests. 

If the seller(s) have existing liens, it should be a condition precedent to closing that those liens are paid off and evidence of the release of such liens is provided to the purchaser. For example, if the seller has a bank loan and a UCC-1 was filed by such bank, the purchaser should require the seller to pay off the loan and provide the purchaser with evidence of the release and a UCC-3 termination. Similarly, if there are tax liens, those should be paid off and released prior to closing. The parties should also consider requesting a tax clearance certificate for the company from the applicable state Department of Revenue, if available. 

3. Employees and consultants

When a business being acquired has workers, a purchaser should promptly find out how many employees and consultants the business has and request any employment or consulting agreements that the business has entered into with such individuals.

It is important to determine the number of individuals employed by the business to analyze whether the WARN Act applies to the transaction. The purchaser should conduct diligence to attempt to find out if the seller misclassified any of its workers. The two major types of misclassification are (a) misclassification of employees as “exempt” from overtime and minimum wage requirements under the law; and (b) misclassification of employees as independent contractors. The purchaser should also ask for evidence that the seller has properly completed Form I-9s for all current and former employees and has complied with E-verify requirements. 

4. Real estate

If the business being acquired includes leased real estate, a purchaser should immediately ask for a copy of the lease and all amendments. In a stock sale, the parties should review the lease to identify any “change of control” language, which may require the seller to give notice to the landlord of the change of ownership or require the landlord’s prior written consent. 

In an asset sale, the parties should identify any “assignability” language in the lease, which may require notice to the landlord or require landlord’s prior written consent to the assignment. The purchaser should also confirm the term expiration date of the lease and any renewal options.

If the business being acquired includes owned real estate, the purchaser should first confirm if the entity it is buying is the same entity that owns the real estate. Real estate diligence should be commenced at this point, as well, such as an environmental report, survey or appraisal.

5. Contracts

It is imperative to review all of the contracts and agreements the business is a party to prior to the purchase. If the purchaser is acquiring the stock or interests of a business, the purchaser will essentially step into the shoes of the prior owners, so all existing contracts and agreement will remain.

In this situation, the purchaser should review all contracts and agreements to identify any change of control language that would prohibit the change of control, or trigger notification to or consent from the third party to the contact.

If the purchaser is acquiring the assets of a business, it should identify the existing contracts and agreements in order to determine which contracts and agreement the purchaser desires to assume, particularly those that are imperative to the business operations. In this situation, the purchaser should review all contracts and agreements to identify any assignment language that would prohibit assignment or trigger notification to or written consent from the third party to the contract.  Further, if there are any contracts that the purchaser does not want to assume, those contracts should be reviewed for termination provisions, such as when the contract can be termination, if notice is required and if there are termination fees.

Client alert authored by Margaret M. Salinas (312.855.6126), principal.

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.