Restaurant Law Blog

Tuesday, June 24, 2014

Top 10 Considerations When Buying a Restaurant or Bar

1.  Buying the Assets vs. Buying the Company

Buying a business can be structured as an asset sale or as the purchase of an ownership interest in the legal entity that owns the restaurant. There are critical differences between these two options which come into when dealing with the State Liquor Authority, Sales Tax Department and a myriad of vendors.  Generally speaking, if you only buy the assets of a restaurant you will not be responsible for the prior owner’s liabilities unless you specifically agree to assume them.  This is true with the exception of the prior owner’s sales tax liability, if any, for which you must obtain a waiver from the tax department.

Despite this, sometimes it is in your best interest to buy the company itself, even though the seller’s liabilities might remain. This is particularly true when you intend to apply for a liquor license in a difficult community in New York City.   Only by reviewing all of the facts can you best determine how to structure your deal.

2.  What Assets are Included

Every restaurant and bar has a myriad of assets, both tangible and intangible. Some assets are owned outright while others are frequently leased (e.g. dishwashers, soda machines, POS systems).  Be sure to identify each and every asset you are acquiring in the purchase and which assets the Seller has no right to transfer.  If the Seller is leasing equipment, does he/she expect you to assume his lease agreement and if so, what are the terms of the lease.  No buyer wants to close on a purchase only to discover that the many of the assets have been removed from the restaurant because the seller was under a different impression as to what was  being sold.

3.  Valuation

It is necessary to accurately value the assets or the company that you are buying. An unreasonably high purchase price lends itself to failure of your business.  Unfortunately, both parties are emotionally invested when it comes to the purchase price, and often buyers are distracted by the allure of owning you’re their first restaurant or bar, that they overvalue what they purchasing.   There are many formulas when valuing a business or its assets, but often that is skewed by the intangible mystic that comes with purchase of a restaurant or bar in New York City.  In short, carefully review and analyze all available financial data (e.g. profit and loss statements, tax records) and speak to a knowledgeable restaurant broker who can discuss comparable sales in the area.

4. Seller Financing

A buyer’s purchase price can be paid in many ways, including the transfer of cash at closing, waiver of debt, property exchange, and in many cases, seller’ financing.  The payment method can affect the total purchase price and have important tax consequences for you (and the seller).  It is surprising just how often seller financing is overlooked.  Seller financing can be as simple as an extension of credit to you through a promissory note or loan agreement, or as complex as an exchange of services in the continuing operation of the business (e.g. consulting services). In either scenario, the cash required to be paid by Buyer at closing is reduced.

5.  Monitoring Period

Buying a restaurant’s assets or an ownership interest in a restaurant (regardless of the percentage), without performing a due diligence review of the seller is a recipe for disaster.  How do you protect yourself?  Consider the inclusion of monitoring period in your purchase agreement that will give you free and transparent access to seller’s business, cash flow, accounts receivable and company debts.  

During this monitoring period you will be able to review the seller's books and records, inspect the restaurant and its assets, speak to key employees, speak with the local police precinct and community board about the seller’s license history, and generally, see what you can find out about the business from third parties.  While you are not guaranteed to find every problem with the business, a monitoring period is certainly a good start.

6. Seller’s Warranty

Even with the monitoring period, you cannot be sure that you are getting all of the necessary information? Have you missed something? Or, worse, has the seller misrepresented pertinent details of the business?   In New York, a seller has no legal obligation to tell you anything about its business.  You have all heard the expression “Buyer Beware," well so long as the seller hasn’t actually lied to you, it’s your problem, not his, once you close on the deal.   Once again, how do you protect yourself?  Simple, have the seller make written representations in the purchase agreement pertaining to the assets, ownership, debts, etc. of the company.  In doing so, you shift responsibility to the seller in that, if any representation or warranty is discovered to be false, you have a right to seek reimbursement from the seller for any damages you sustain.  If you fail to obtain these representations, in writing in the purchase agreement, you will have no claim after you close.

Determining which representations and warranties to include in the purchase agreement is not an easy task and is probably the one of the most negotiated points of a purchase agreement.  Without these representations and warranties, you are left to blindly trust the seller and hope that what you think you are buying, is what you will actually get. 

7.  Conditions to Closing

Many times things happen which warrant the cancelation of a purchase agreement.  For example, having one’s liquor license denied by the Community Board or the State Liquor Authority would spell disaster for a restaurant or bar.  In short, things happen between the execution of a purchase agreement and closing that make it problematic to close.  Other examples include:  (a) denial of loan application, (b) loss of critical investor, (c) landlord refusal to accept lease assignment, (d) rejection of building plans by Landmarks or the DOB, etc. 

If you fail to identify those conditions which permit you to cancel an agreement, you are liable to lose any down payment made under the terms of the agreement, but also you open yourself up to a lawsuit for damages or worse, being required to perform under the agreement.

8.  Shady Sellers

Between the time you sign the purchase agreement and the time you close, the seller has ample opportunity to harm your purchase if they are so inclined.  I frequently handle sales where the seller, in an effort to save money, reduces their customary inventory, fires key personnel, cuts utility services, refuses to pay suppliers and although infrequent, takes a loan out using the assets as collateral.   If you are purchasing a business which you intend to continue operating without change, reductions such as these will undoubtedly alienate your customers, suppliers and employees.  Moreover, if you haven’t identified what inventory or assets are being transferred, the loose definition of “all assets” is bound to be tested by the seller. 

Alternatively, if you are buying an ownership interest in seller’s business (say 40% for $100,000) take steps to ensure that the seller is restricted from issuing any additional stock or equity in the company to other people without your permission. This is common where the buyer is intended to be a “silent investor”.  If you are not careful, what you end up with may be very different from that which you thought you were buying. 

9.  Non-competition

If the seller has a good reputation in the community you might consider inserting a non-compete provision in your purchase agreement.  Most buyers do not include non-compete provisions into their purchase agreements and my experience tells me that this is because of a prevailing notion that non-competes are unenforceable, but that is not accurate.  Carefully constructed non-compete provisions are enforceable, especially when there is something unique to the skill, trade or business of the parties, or when a business is being purchased. Provided that the agreement is carefully tailored to confine the agreements terms (i.e. reasonable geographic limitations, duration, and independent value received for entering into the agreement), they are enforceable and may be the only thing standing in the way of seller challenging you on what is now your own turf.

10.  UCC Liens on Assets Purchased

The last think you want to discover is that the assets you are buying are not actually owned by the seller, or that there is a lien on the assets by a third-party.  Asset (UCC) liens are very common and can be verified by a simple background check at the State and Federal levels.   The purpose of filing a UCC lien is to place all potential buyers of the assets on notice of a debt owed by the seller and secured by the seller’s assets.  Failing to perform a UCC lien search is a great way to assume the seller’s debt up to the fair market value of the assets purchased. 

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