RICHMOND, Va. — When you buy an existing drycleaning business, you’re not just buying the equipment you can see. You may be buying the debt attached to it.
That was one of the messages of a recent National Federation of Independent Business (NFIB) webinar titled “Buying, Selling, or Expanding Your Business,” presented by Jim Wilson, an attorney with Wilson Law Group, PLC, who has spent more than 30 years working on startups, acquisitions and business transactions.
In Part 1 of this series, we looked at the foundational decisions that shape a business, including entity structure, intellectual property, the “think like a franchisor” mindset and the retirement advantages of separating operating and real estate companies. Today, we’ll examine the steps necessary when buying an existing operation, where Wilson believes the biggest mistakes tend to come from what buyers don’t look for.
What You Think You Own
The equipment inside a drycleaning plant — the presses, finishing equipment, boilers and point-of-sale systems — represents a significant portion of a company’s value. But Wilson cautions buyers against assuming that value transfers cleanly.
Business owners frequently use their equipment as collateral for loans, and those loans are recorded through UCC (Uniform Commercial Code) filings. If a buyer purchases a business without checking those records, they may be acquiring a lien along with the asset.
“If you acquire that business and there’s a lien on it, you’re acquiring the lien,” Wilson says. “That loan may be owed by the seller, and he may stop paying. And if he stops paying, the person who lent that money to him will come and get that equipment, even though you think you own it.”
UCC searches can be run online in most states for little or no cost, and Wilson treats them as non-negotiable. When liens do exist, the fix is straightforward: get payoff letters from the lenders and route a portion of the closing funds directly to clearing the debt.
“Even if it’s been around here for years, it doesn’t matter,” Wilson says. “Check on it. Find out what the real ownership situation is.”
Other Surprises to Look For
Liens are one problem. Wilson flags several others that routinely catch buyers off guard.
Balloon notes are a common one. A business loan might carry monthly payments calculated over 25 years, making them seem manageable — but with the full balance due in 10. If you buy a business in year eight and assume the seller’s debt, you’ve just inherited a large payment due in two years.
Equipment leases deserve similar scrutiny. If leased equipment is nearing the end of its term, the leasing company may be coming to reclaim it shortly. New owners shouldn’t assume the machines they walked past during a site visit are part of what they’re actually buying.
Supplier and vendor contracts also need to be read carefully, particularly for change-of-control provisions. Certain clauses might allow the other party to renegotiate if ownership changes hands.
“It is not uncommon to have a supplier agreement that says if an excess of 30% of the equity or assets of the business are sold to a new owner, we reserve the right to renegotiate,” Wilson says. “Well, that’s what you’re trying to do, because you’re buying the business. You'd better find out whether they’re going to exercise that or not.”
Beyond contract terms, Wilson recommends verifying actual performance. If a supplier has been routinely falling short of what their agreement requires, and the current owner has never pushed back, that’s a problem the new owner will inherit.
Asset Deals vs. Equity Deals
Two basic structures exist for buying a business, and Wilson says the distinction between them matters.
In an asset purchase, the buyer selects specific items owned by the business — equipment, customer accounts, goodwill and whatever else the parties agree to include. In an equity purchase, the buyer acquires ownership of the entity itself. Everything comes along: assets, contracts and liabilities.
Both approaches have legitimate uses, but liabilities are the key variable. When liability exposure might extend past the closing date — a pending workers’ comp claim, a disputed vendor invoice or anything with a statute of limitations still running — Wilson recommends using an escrow or holdback to keep funds available until the risk period passes.
He’s also clear about the optimism that tends to surround a business acquisition.
“If you think you’re good friends with a seller up until closing, and that he’s going to remain your best friend in the world after closing and come to your rescue anytime you need, you’re probably going to find he likes fishing a lot more than you after closing happens,” Wilson says. “So, use an escrow as a holdback.”
The protections aren’t about distrust. They’re about the fact that leverage — the ability to address a problem and get someone to act on it — disappears the moment the documents are signed.
“It’s personal exposure to liabilities that you really want to limit as much as you can before closing,” Wilson says, “so that it doesn’t come up and surprise you after.”
Come back Thursday for the conclusion to this series, where we’ll look at expanding to multiple locations, managing the employee issues that come with growth and what to watch for when it eventually comes time to sell. For Part 1 of this series, click HERE.
Have a question or comment? E-mail our editor Dave Davis at [email protected].
