Introduction to Business Sales
Most business sales involve the sale of the assets of a business and the assumption of the lease for the space occupied by the business. Generally, the sales do not include the transfer of corporate stock or any interest in a business entity. The assets transferred may include inventory, a lease assignment, the assignment of a franchise agreement, fixtures, equipment, a non-competition agreement, an assignment of licenses, trademarks including the name of the business, accounts receivable, and goodwill. If real estate is involved, there is generally a separate concurrent transaction with two concurrent and contingent escrows. Other sales involve the transfer of stock. Sellers should consult with their tax advisor regarding the structure of a sale.
A business broker may be the agent exclusively for the buyer, the agent exclusively for the seller, or may be a dual agent.
An escrow company specializing in business sales should always be used. The escrow company will insure that the requirements of the Bulk Sales Law are met and, if applicable, the appropriate Commercial Code Sections for Secured Transactions. Buyers and sellers should be aware of the importance, in those transactions where the sale is being secured with the personal property of the business, of having a UCC-1 filed with the Secretary of State. Just as a Deed of Trust provides the security and collateral for a promissory note in a loan secured by real property; a UCC-1, when filed, gives notice to the world that there is an interest (lien) in personal property of the business. In order to fully protect the lender’s interest, a UCC-1, which is only a notice and not an agreement, must be accompanied by a promissory note and a security agreement covering all assets of the business.
While sellers have a duty to make a full disclosure and buyers are responsible for their own due diligence investigation, buyers should always consult with their attorney for legal advice and their accountant for tax advice.
Buyers and sellers are encouraged to use the standard California Association of Realtors Business Purchase Agreement and Joint Escrow Instructions when buying or selling a business. The contract forms are comprehensive and fair to both buyers and sellers.
Buyers and sellers of businesses must each independently determine the value of the business before a sale can take place. While there is no one perfect formula for determining value, generally the following three approaches are utilized:
- The net cash flow after all operating expenses, including a reasonable salary for the owner, is capitalized into value using a capitalization rate established by the market, or
- The fair market value of the fixed assets and inventory is determined, or
- The value is established by the market comparison approach.
We recommend that buyers and sellers consider all three approaches to value and compare the results. We also recommend that buyers and sellers consider obtaining a third party appraisal from an objective business appraiser before listing a property for sale or purchasing a business.
If you are purchasing a business, we recommend that your attorney review any commercial lease to be assumed. The terms of any lease to be assumed may be an asset or a liability. If you are selling a business, you should be aware that the lease being offered as part of the sale, may be an asset or a liability to the buyer and that the terms of the lease will have a bearing on the value of the business being sold.
Business goodwill may be substantial or nominal. It may even be a negative if the business has a poor reputation. Generally, goodwill is an asset that has value and consists of the expectation of continued public patronage. Placing a separate value on goodwill is extremely difficult, requiring an experienced business appraiser.