Buying a Business During the COVID-19 Pandemic

Due Diligence Period in Purchase Agreements

A business purchase agreement, whether a stock purchase or asset purchase, should always include a provision allowing for due diligence. Merriam-Webster defines due diligence as: research and analysis of a company or organization done in preparation for a business transaction (such as a corporate merger or purchase of securities).
The due diligence period will usually start after a purchase agreement has been executed by all parties and the purchaser has transferred a good faith deposit to escrow. The due diligence period is the number of days a purchaser has to review and perform inspections on important items prior to the finalizing the purchase. The items considered important are dependent on the type of business and reason for purchasing the business. For example, is the business being acquired for the goodwill, lease location, equipment, etc. The time frame varies depending on the complexity of the business, but should be at least a couple of days. Considerations and due diligence include, for example, performing a lien search, reviewing the commercial lease, reviewing employment agreement, reviewing payroll records, reviewing merchant service records, and a thorough review of the company's financial history, including balance sheets, income statements, cash flow statements, and tax returns.

No Discounts or Promotions

A person selling a business in Sacramento might have offered promotional discount programs shortly before listing the business. In an effort to survive COVID-19 closures, many businesses have turned to Groupon, Living Social, and other third-party "deal" websites. The concept is simple: a consumer purchases a gift certificate with face value of $50 for the reduced cost of $30. The vouchers, or gift certificates, are handled differently depending on deal website. Most businesses do not receive any money until the gift certificate or voucher is actually redeemed at the business. However, some of these deal websites will give the business some or all of the money at the time the gift certificate is purchased by the consumer. This can cause tremendous issues for the person buying the business because they will be obligated to honor the deals. Hence, its a good idea to include a provision in the purchase agreement where the seller covenants that no discounts or promotional deals were offered in the last six months. Another good option is to search these deal websites for any evidence that these discounts may have been offered at any point in time.

Lien Search and Marketable Title

The California Secretary of State provides services for Uniform Commercial Code ("UCC")  inquiries. A UCC filing gives the public notice that a creditor has an interest in personal property of a debtor. A creditor accomplishes the notice by filing Form UCC-1. A person buying a business in Sacramento should consider performing a UCC search for any filings involving the seller or the seller's business. Meeting a surprise creditor shortly after purchasing a business would be terrible. Hence, its also good practice to search UCC Connect for UCC inquiries and filings.

A buyer can help protect themselves further by including a provision in the agreement that all tangible property is valid with marketable title free of liens and encumbrances. 

Commercial Lease

The lease agreement is one of the most important facets of buying a business. Buying a business that is currently on a month-to-month lease is not always the best idea because the buyer could be evicted at any time.

Questions to ask about the commercial lease before buying a business:
  • How many years are left on the lease?

  • Are there options to extend the lease?

  • Are there additional costs, such as common area maintenance ("CAM")?

  • Does the landlord pay for janitorial services?

  • Does the landlord pay for exterior problems, such as roof, foundation, exterior walls, graffiti, etc.?

  • Does the landlord pay for interior cosmetic problems?

  • Does the lease incorporate annual rent increases?

  • Did the seller take advantage of free rent that may need to be repaid in the event the lease is terminated?

Account Guarantees

Buying a business that consists of multiple customer accounts can be disastrous. A few example service based businesses with multiple customer accounts include, janitorial businesses, swimming pool cleaning routes, and certified public accountant financial services firms. These types of businesses can lose accounts during the transition period and individual accounts may choose to go with another business because their relationship was with the seller. With COVID-19, there is a higher possibility that these customer accounts will simply choose not to move on with the new business owners. A buyer can better protect their financial investment in buying the business by including a seller guarantee. For example, the parties agree to a particular value for each account and fifteen percent of the purchase price remains in escrow pending the full transition in ninety days. Any accounts lost during the transition period will be reimbursed to the buyer at the value agreed upon. A seller guarantee is a great option for the buyer to help finalize a potentially troublesome deal.

Financial History

The financial history of the business will provide insight into the operating costs and revenues of the business. Checking itemized bank statements can help the buyer to discovery any additional costs in the commercial lease, such as common area maintenance ("CAM"). Bank statements will also reveal more information than profit and loss statements, which can be tampered or altered.

Generally, a person buying a business in Sacramento should review all financial documents of the business including, but not limited to:
  • Bank Statements

  • Statements from Merchant Services

  • End-of-Day Receipts

  • Profit Loss Statements

  • Balance Sheets

  • Income Statements

  • Tax Returns

Sacramento Attorneys on Buying a Business in COVID19

Purchasing a business during an economic downturn requires careful consideration. It is highly recommended that you speak with a qualified business attorney to help with due diligence prior to finalizing a business purchase. Feel free to contact Sacramento Business attorneys to set up an initial consultation.

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Buying a Business in Sacramento with COVID-19
*The information provided in this post does not constitute legal advice or opinion. The information is for guidance purposes only. Individual situations vary and you should contact an attorney for legal advice. Rooted Legal PC includes attorneys who are well-versed in business law matters and are located in Sacramento California. This post is addressing some, but certainly not all, of the considerations in buying a business in COVID-19.