Three Ways to Screw Up a Business Purchase

Hundreds of thousands have asked me to weigh on the gun debate.  So here it is.  I understand the paranoia of gun owners when it comes to gun control legislation.  There is an idiot mayor in NYC, who is trying to ban 32 ounce soft drinks.  I have no doubt that he would ban hunting rifles, pea shooters, and metal cutlery.  Politicians never voluntarily restrict their own power.

On the other hand, most of the people, who want to own assault rifles, are precisely the type of people, who should be banned from having them.  Thirty years ago, many of these people were against stores opening on Sundays.  So just how much about freedom is this?  It's really about guaranteeing the right for everyone to think just like they do.

Here is my conclusion.  Assault rifles should be legal, but you should only be allowed to shoot politicians with them.  This would be handled the way deer season in Pennsylvania is handled.  Every registered voter gets a tag.  When you shoot a politician, you tag him, and then you are done for the year.  You only get one.  So choose well.

Here are three ways to screw up a business purchase.

First, buy the corporate stock of the seller.  When you do that you not only get the assets you want, such as customers, equipment, favorable lease, but you also get all of the liabilities, both known and unknown.  Two years from now when you find out the old owner didn't pay payroll taxes for a year, guess who gets to pay.  Sure, the purchase agreement states that he will pay any old liabilities that show up.  Try to find him after three years.  And if you do find him, what are the odds he has any money left.  Yes, you'll win in court, but you'll spend $50K in legal fees to collect nothing from him.

Second, let the seller continue to run the business.  Yes, you need a transition after the purchase to make certain the customers successfully transfer to you.  However, that is all you should need from the old owner after closing on the purchase.  If you need training in operations, get that before you close.  Once you own the business, own it for real.  There is little worse than a business with two conflicting owners.  Put in the agreement that the seller has no operational authority after the sale.

Recently, I saw a medical practice sale that went wrong when the new owner's decisions were overridden by the former owner.  The practice was the seller's baby for thirty years, and he just couldn't let go.  He let patients and staff alike know he didn't agree with any of the new owner's policies.

The old owner was to receive a monthly consulting payment from the buyer.  After two months of conflict the buyer quit paying to get the old owner to leave.  Four years of litigation follies ensued.

Finally, make the purchase formula as complex as possible.  Make certain a doctorate in mathematics is necessary to determine the price.  Here is a good example.  The purchase price shall be 50% of the lesser of the greater or the lesser of gross profit as derived under the assumption in subchapter A of part IV except when the moon is in the seventh house and Jupiter aligns with Mars.

Any formula based on profitability will cause litigation.  Yes, in theory profitability is a great measure, but profitability can be manipulated easily by massaging expenses.  For instance the buyer might decide his girlfriend's rent is a business expense.

Here's an example of a simple pricing formula that is in reality quite complex.  The buyer will pay the seller 20% of sales for five years.  This is how CPA's firms are commonly sold.  It is called an earn out.  Earn outs are great in theory, but complex in practice.

The problem is defining sales.  Are we talking about sales from customers of the business on the purchase date, or are we talking about sales from all customers before and after the purchase date?  You had better define that in the agreement.  The purchaser's lawyer will argue that only customers at the purchase date count.  The seller's lawyer will argue that all customers count.  Both will be billing at $400 per hour.  Budget $50K in round numbers to sort this one out, unless you go to court.  Then allow $100K.

There are a lot of other ways to screw up a business purchase, but these are three common ones.  I'm always amazed when I see a buyer rely on the seller's attorney to draft an agreement with no advice from his own attorney.  I am even more amazed when a buyer agrees to use the standard agreement from a business broker.  Many of these are fill in the blank agreements used for everything from gas stations to medical practices.  By fill in the blanks, I mean the blanks are filled in by hand.

When you buy a business, you need your own lawyer and CPA, both of whom should be experienced in business purchases.  Pay a few grand up front to avoid $100K later, not to mention a failed business.

As I write this, I'm watching the Baltimore versus New England playoff game.  I have tried rooting for the Patriots, but rooting for Bill Belichick is like rooting for Darth Vader.  I'd love to root for the Ravens, but they are stolen property - from Cleveland.  I grew up as a Baltimore Colts fan.  Then they packed up and moved to Indianapolis in the middle of the night.  So I'm sensitive to douche bag owners who move teams.  Also, I'm not that wild about middle linebackers who have been involved in murders.  I guess I'll just have a beer and wait for RGIII to come back next year.

As always, for real tax and accounting advice, visit www.skcpas.com or like the Stitely & Karstetter page on Facebook.  Connect with me on the How to Screw up Your Small Business Facebook page for daily advice on messing up your business.