San Diego Business Lawyer Blog

Ownership of investment property in San Diego can be a rewarding venture.  However, as with all investments, a return is never guaranteed.  It's important to evaluate the property's value up front factoring in: the property's relative worth compared to alternatives; the market value of rental income in the geographic area for similar properties; the property's potential for appreciation; management costs; and potential liability and tax implications.  This article focuses on the choice of business entity that best protects investors from liability and negative tax implications.  Whether or not you already own investment property or are considering purchasing investment property, choosing how to structure your ownership is crucial.  Consultation with an experienced San Diego business lawyer and a real estate professional are the best ways to maximize your personal protection.  

There is a reason the prevailing wisdom favors the Limited Liability Company ("LLC") as the best form of ownership in California for investment properties.  California LLCs are relatively flexible business entities that have proven particularly beneficial when it comes to ownership of investment properties.  First, LLCs allow for pass through taxation avoiding the double taxation associated with C-Corporations (C-Corporations are taxed first on their profits and taxed again on the profits shareholders receive as dividends).  Second, like most formal business entities, LLCs provide personal protection from the liabilities associated with an investment property.  A member's personal assets are protected from claims against the LLC.  Personal ownership in an investment property or ownership as a partnership leaves the owners vulnerable to liability for accidents that occur on the property.  Liabilities are often extensive and can exceed insurance policy limits, particularly where permanent injury or death is involved.  

S-Corporations are a tempting alternative to the LLC, and in some business contexts the S-Corporation may make sense.  In addition to liability protection, qualifying corporations that make an S-Corporation election with the Internal Revenue Service also benefit from pass-through taxation.  However, S-Corporations lack the flexibility that LLCs offer.  To maintain S-Corporation status, corporations must be domestic, have only one class of stock, distribute profits and losses in proportion to each shareholder's ownership interest and cannot have more than 100 shareholders who are natural persons and U.S. citizens.  LLCs, on the other hand, allow for unequal allocation of income, deductions and losses.  Members can choose how profits are allocated regardless of each member's contribution or level of management responsibility.  This is especially convenient for family owned investment properties or where one owner will be more actively involved in the management of the property.  Members of an LLC can also be a corporation or other LLC.  In addition, if an S-Corporation transfers property to another entity or sells a property to another entity in exchange for another property, it immediately incurs a capital gains tax.  These transactions, if done properly, can be tax free for LLCs.

Continue reading "Why the California Limited Liability Company Is Right for Investment Properties" »

Continued from "Choosing the Right Business Entity for Your New Business".

Now that you have a business plan and the capital to get started, the next step is to secure necessary raw materials, wholesale goods, manufacturing equipment, vendors, licensing, contracts and other necessary procurements all of which will be unique to your business. Securing a commercial lease on the other hand is common for virtually all businesses and, unless you plan to operate out of a home office, will have a critical impact a business' success. First, by entering into negotiations for any commercial lease, you are making a fundamental choice about the location of the business. The location chosen can make or break any new venture. Second, the particular terms of the lease impact the bottom line. Rental payments, annual rental increases, inducements, common area maintenance expenses (CAMs), the term of the lease, options to renew and other rights and obligations set forth in the lease directly impact profits. Lowering monthly rents is obvious, but there are other less obvious costs that new tenants must concern themselves with many of which are intertwined with CAMs. For instance, most commercial leases require tenants to cover property taxes as part of the annual CAMs. Tenants are often shocked to learn later that the property was sold and a lump sum property tax was due sometimes tens of thousands of dollars or more per tenant.

Often, entrepreneurs fall in love with a particular location and begin to negotiate for a lease from a weak position. If prospective tenants have no other options, they are typically willing to accept almost anything from the landlord so long as the rental payments seem reasonable. This is a mistake. The better approach is to choose among multiple locations all of which have positive features. Of course, there is almost always a "better" location for the entrepreneur, and there's nothing inherently wrong with pursuing choice one first. However, knowing that other options exist better equips the entrepreneur to walk away from really bad deals. On the other hand, unrealistic expectations about lease terms can be just as detrimental to a new business. It remains important to understand relative bargaining power and make reasonable determinations about acceptable lease terms. Landlords also have other options, and are generally savvy real estate professionals. They understand what the market will bear and work from there. The negotiation requires tact and subtlety, and most importantly a hierarchy of priorities.

Because the commercial lease is of critical importance to any business, it is best to consult with an experienced San Diego Lease Lawyer before signing any lease. If hiring an attorney is not practical, take the time to review your proposed lease and diligently research all of the issues you are unclear about. There is a wealth of information available on the web.

A California Close Corporation is a corporation designed to give its shareholders more control over the operation of their business.  Instead of sitting back and letting others run the company, the owners of a Close Corporation typically act as the company's managers.  By complying with specific statutory requirements, Close Corporations can forego many of the corporate formalities other corporations are required to comply with.  This in turn reduces the risk that others will be able to pierce the corporate veil and reach the owners' personal assets.  Section 300 of the California Corporations Code states: "The failure of a close corporation to observe corporate formalities relating to meetings of directors and shareholders in connection with the management of its affairs, pursuant to an agreement authorized by sudivision (b), shall not be considered a factor tending to establish that the shareholders have personal liability for corporate obligations".  However, shareholders who manage the Close Corporation are subject to the same fiduciary duties any director of officer of a corporation has.  

The California Corporations Code imposes the following requirements for qualification as a Statutory Close Corporation:  

1.    The Corporation cannot have more than 35 shareholders.  However, for the purposes of satisfying this requirement, spouses are considered to be a single shareholder as are corporations, trusts, partnerships or other business associations unless the primary purpose of the entity was to acquire the close corporation's shares.  

2.    The Articles of Incorporation must include a provision that the corporation cannot have more than 35 shareholders and specifically state that the corporation is a close corporation.

3.    The corporation's share certificates must contain a conspicuous legend stating: "This corporation is a close corporation. The number of holders of record of its shares of all classes cannot exceed 35. Any attempted voluntary inter vivos transfer which would violate this requirement is void. Refer to the articles, bylaws and any agreements on file with the secretary of the corporation for further restrictions."

4.    The Shareholders must enter into a written agreement setting forth the matters upon which the shareholders, rather than the board, will exercise control.  The shareholders' agreement must be lodged with the Secretary of the Corporation and available for inspection by prospective purchasers.  It is common for Shareholders' agreements to include buy-sell provisions limiting transferability of shares providing existing shareholders with a right of first refusal.  Moreover, close corporations may provide for greater control by minority shareholders and disproportionate distributions of profit.  

In addition to these statutory requirements, Close Corporations cannot go public.

Continue reading "What is a California Close Corporation?" »

Continued from How to Fund Your New San Diego Business.

Choosing the right business entity for your new San Diego venture is a critical step that should be made early in the process.  It's important to diligently examine the pros and cons of each choice before deciding on what business entity to go with.  In some cases, opting for a sole proprietorship or general partnership remains a practical option.  In other cases, the owner or owners desire the creation of a more formal entity such as a corporation, limited liability company (LLC), limited liability partnership or professional corporation.  The ultimate choice will depend on the nature of the business, the number of owners and the capital investments being made.  The goal is to minimize potential liabilities including taxes.  The correct business entity choice for any particular company will depend on the individual characteristics of that company.  Your accountant and business attorney can provide guidance.  Nonetheless, there are some general issues to keep in mind:  

Limiting Liability:  One of the main reasons people opt for a formal business entity is to insulate owners from company liabilities.  Limiting the liability of owners encourages investment offering a distinct advantage over operating as a sole proprietorship or general partnership.  However in most cases, the owners of new businesses are required to give personal guarantees for commercial leases, loans and contractor agreements.  If so, the benefits of the formal business entity become less relevant, particularly if the business is adequately insured and intends to form an LLC or S-Corporation resulting in pass-through taxation.  If the owners have to personally guarantee loans and commercial leases, have insurance to cover civil liabilities and are going to elect pass through taxation so that they are taxed as individuals, there is little incentive to go through the expense of forming a formal entity.  

The Limited Liability Company (LLC) or S Corporation:  Most people forming new businesses end up narrowing the choice of business entity to an LLC or S-Corporation.  This is because they want pass through taxation to avoid the prospects of double taxation associated with C-Corporations.  If you are forming a new business and your main goal is to limit owner liability, the LLC is generally a good choice.  It offers more flexibility than the S-Corporation, and allows for unequal allocation of income, deductions and losses to the owners.  On the other hand, the S Corporation may offer some advantages to those concerned with self employment and FICA taxes.  If there is any doubt between these two forms of business entities, it's best to consult with your accountant (preferably a CPA) or tax advisor for input.

Continue reading "Choosing the Right Business Entity for Your New Business" »

Continued from Be Prepared Before Undertaking a New Business Venture.

Marshalling the resources necessary to fund a new San Diego business can be intimidating. In fact, it's probably the biggest reason many decide against a new venture. How in the world will I come up with the capital necessary to: purchase an inventory; purchase equipment; lease commercial space; hire employees; pay an accountant and/or a business attorney; and/or pay for insurance? And even if I come up with the necessary funding to open my doors, will I be able to continue paying the company's expenses? What about my personal expenses? These are important questions and they require a funding plan that takes into account start up requirements as well as the company's short term and long term financial needs.

To properly evaluate a business' capital needs, it's important to have a strong business plan that clearly defines the company's strategy for success and sets forth detailed projections of the company's short term and long term finances. It will also define how an infusion of capital will be spent (whether on operating expenses or capital expenditures necessary for real estate and equipment). A critical analysis of the financial landscape aids in determining just what level of funding is needed and whether additional funding will be needed down the road. The more detailed and well reasoned your business plan, the more likely lenders and investors will provide needed capital. They will want to know how the money will be spent.

There are numerous ways to finance a new business' operations. In most cases, new businesses are funded via a combination of resources. Personal assets, credit cards, bank loans, third party loans, 2nd mortgages, loans from friends and family, partners' capital, sale of a corporation's shares or a limited liability company's membership interest, venture capital, sale of personal assets such as stocks, automobiles and boats are all common and legitimate means of raising capital. The first step is to inventory your personal resources. Whether via the sale of assets, withdrawal of cash from checking and savings accounts or via a second mortgage on your home, tally the dollar amount of the investment you are able to make. In deciding the amount of personal assets to invest in your new business venture, be sure to consider the need to meet personal expenses over time (preferably two years). Under your business plan, will you be paid a salary? Will you have enough money set aside as a cushion should the business prove unable to pay your salary or worse fail? These are important questions. Remember that you can opt to keep some reserves and make up the difference in needed capital via other means.

Continue reading "How to Fund Your New San Diego Business" »

Continued from Starting Your Own Business - Be Willing to Commit.

Before starting up a new business, it's important to have a plan.  This may seem obvious, but all too often young entrepreneurs incorrectly believe that the idea itself is good enough.  They are hungry for success and anxious to get started.  In many cases, an important facet of the new business is in place providing a false sense of security.  For instance, it may be that a head chef discovers an ideal restaurant space is for lease.  He or she knows the broker and learns that excellent commercial lease terms are being offered.  Rather than diligently examining the business' prospects, the excited chef dives in taking out loans with unfavorable terms, entering into oral partnerships, engaging the services of the first vendors that come along and/or exposing his or her personal assets without the benefit of adequate insurance or the formation of a corporation or limited liability company.  

If the head chef's plans for a successful restaurant are sound, they won't depend solely on the restaurant's location.  It is best to first diligently analyze all aspects of the business and develop a business plan before starting any business venture. Consult with trusted advisors such as your business attorney, accountant, banker and insurance agent to ensure that you are prepared for all of the professional requirements of business ownership.   In the above case, this is true even if it means losing out on the favorable lease terms being offered.  The development of a sound business plan includes: identifying the target market for the goods and services being offered; developing a marketing strategy that includes an examination of the prospects for capturing and maintaining a profitable share of that market; strategies for growth; securing funding and capitalization; consideration of employment and management structures; personal income needs; analysis of potential risks; and consideration of alternatives such as purchasing an existing business or franchise.  This is not an exhaustive list and an in-depth analysis of the development of a business plan is beyond the scope of this article.  See Writing an Effective Business Plan.  

When starting a new business, consider the competition.  Successful competitors have well developed plans and proven systems in place.  They remain acutely aware that entrepreneurs are poised to challenge their market share at every turn.  They are ready for any contingency because they understand that even "the best laid plans of mice and men often go astray".  Diligent preparation and thoughtful consideration are necessary if one plans to seize market share from these dedicated capitalists.  Consider contacting a San Diego Business Attorney for assistance with your initial planning.

Part Three of this series "How to Fund Your New San Diego Business" examines funding options. 

Starting your own San Diego business is as scary as it is rewarding.  It requires an entrepreneurial spirit, common sense, commitment, organization and resources.  This series looks generally at the process in order to focus the young San Diego entrepreneur on the task at hand beginning with the opening move.  The series is not for those with unlimited resources.  For most of these folks, business opportunities abound whether expanding on already successful business models or selecting among numerous business ventures proposed by others, those with unlimited resources can afford to risk their capital.  They simply choose among the most lucrative options, if they choose at all. For most of the rest of us, we pour everything into a new business and each decision is life affecting.  

In this writer's opinion, the single most important factor in the success of a business venture is the owner's steadfast commitment.  While the phrase is perhaps an overused cliché, "No Fear" should be the guiding light for the young entrepreneur.  A timid part-time attempt at developing and nurturing a new business idea rarely pays off.  This is not to suggest that the young business owner should ignore reality and dive head first into an empty pool.  What it does mean is that after carefully surveying the territory, taking inventory of his or her resources, doing the leg work necessary to evaluate the business venture's potential (due diligence), determining the income necessary to maintain a living wage (including that necessary to support his or her family) and evaluating worse case scenarios and exit strategies, the entrepreneur can make an informed decision, and upon making that decision should commit to it.   

The prevailing wisdom is that one should have two years worth of living expenses set aside before starting a new business.  This is of course hard to argue against.  Nonetheless, putting aside that much money is not always practical for every entrepreneur and the ultimate decision depends on one's individual risk profile.  Someone with a family of five will be far more concerned with risk than the unmarried graduate just out of college.  Whatever one's risk profile, there are other ways to marshal resources including business loans, investment capital, selling and collateralizing existing assets, revolving credit and the assistance of friends and family.  While the topic of marshaling resources will be dealt with later in this series, it is illustrative here as one of the advance considerations one makes before committing to the business venture.

Continue reading "Starting Your Own Business - Be Willing to Commit" »

The question of where to form a Corporation or Limited Liability Company, like everything else in law and business, depends on your particular circumstances.  For most small and medium size San Diego businesses, incorporating in California makes the most sense.  Incorporating in another state requires additional resources in time, paperwork and expense, and access to court and government services is geographically inconvenient.  In addition, there's the possible inconvenience of having to prosecute or defend lawsuits in a foreign state.  There is a common misconception that forming a Nevada Corporation is worth the additional cost and inconvenience because businesses can avoid California's higher tax rates.  However, companies doing business in California, no matter where incorporated, are required to register in California as a foreign corporation and are required to pay taxes on their corporate profits.  Unless you plan on moving your business to Nevada, there are no real tax advantages for companies that do business solely or primarily in San Diego.  

The question becomes more complex if your company is doing business nationally or in multiple states.  Every state in which a business operates will tax at least some portion of that business' profits based on a standard apportionment formula used to determine each state's share of the business profit it taxes.  Your accountant can help you better analyze your tax liabilities in these circumstances.  There are additional legal considerations that tend to favor incorporation in Delaware and Nevada that typically benefit larger publicly held corporations.  Delaware has one of the most advanced and flexible corporation statutes in the country.  Delaware courts have a great deal of experience handling business disputes, and large corporations count on the courts' consistency and experience.  Consult with a San Diego Business Lawyer if you are uncertain about the effect incorporation in Delaware or Nevada will have on your business.

Continued from Due Diligence When Purchasing a Business - Part One.

It's also important to be certain about the extent of the company's additional obligations.  Is there a lease?  What is the rent?  Are there common area maintenance expenses?  What is the term of the lease and are there options to renew?  Must the landlord consent to an assignment?  Be sure to review all existing leases including any addendums and amendments.  Confirm with the landlord that the rent is up to date.  Equipment leases should get the same scrutiny.  Ask the seller whether there are pending or threatened lawsuits or governmental proceedings against the company.  You'll want the seller to retain such liabilities where possible.  A business attorney can assist with negotiations and ensure that the purchase agreement reflects the seller's retention of liabilities.  

An important operational component of any business is the existing staff.  Talk to key personnel such as officers, managers and supervisors to get a sense of their commitment and to get a feel for the employees' level of productivity.  Is there a risk of mass exodus with the departure of the current ownership?  Do the employees seem content in their positions?  Or does there appear to be a widespread discontent with working conditions and pay?  If there is an employee manual, review it carefully.  Does the company appear to follow its own policies?  Does it comply with Federal and State employment laws?  

If purchasing the business entity as opposed to the business' assets (see Considerations When Purchasing a San Diego Business, Part One), be sure to review the company's books in detail including articles, bylaws, resolutions, minutes, and/or operating agreements.  Confirm that the books are up to date, that the business is in good standing with the State, and that the seller has the actual authority to sell.  Whether or not you are purchasing the business entity or the business assets, ensure that all licensing is current and that business taxes are up to date.  

Before closing any deal, ask the seller to personally guarantee that all of the information provided is complete and accurate.  Your San Diego Business Attorney should insist on a "Representations and Warranties" clause to accomplish this goal.  Once all the information is in, compare what you have learned about the particular business with the industry overall.  What is its market share?  Can it remain profitable under the current conditions?  
A "due diligent" investigation ensures that the buyer has the clearest possible estimation of the company's worth.  It may seem a bit daunting but it is a worthwhile investment. See Purchasing an Existing Business Offers Benefits Often Overlooked.

The process of investigating a business for sale is commonly referred to as "due diligence".  In layman's terms, "due diligence" is essentially the exercise of common sense, and it is the difference between the beginning of a successful venture and a complete disaster.  Proper due diligence requires a thorough evaluation of the company's business, its history and its finances, and it is best conducted with the assistance of a team of professionals including a lender (or lenders), an appraiser, an accountant (preferably a CPA) and a lawyer.  

"Due diligence" starts with an understanding of the industry.  It's important to learn as much as possible about the industry's fundamentals including operations, manufacturing processes, suppliers, current and historical markets, customer preferences, local and national competitors, marketing methods and anything else relevant to the industry.  Wise purchasers look for businesses where they have an aligned interest or expertise.  Once you have a clear picture of the industry you can better evaluate the specifics of the prospective purchase.  

The next step is to examine the business for sale, starting with its financials.  This is best done with the assistance of an accountant.  The review should include an in depth analysis of the company's records including but not limited to its current balance sheets, profit and loss statements, financial audits, accounts payable and receivable, debts (secured and unsecured) and information pertaining to any liens on debt, and the company's tax returns for the past five years.  Check, or have your attorney check, with the County Recorder's office for undisclosed liens and UCC-1 filings (filings made by creditors with loans secured by the company's assets).  Ask the following important questions:  What does the revenue stream look like?  How has it changed over time?  How about expenses?   

In addition, inspect the company's physical assets including equipment and inventory.  If uncertain about the condition of equipment, consider inspection by an expert.  For instance, it's probably a good idea to have a certified mechanic inspect a fleet of delivery trucks.  Ensure that the inventory is in good shape, current and marketable.  Include an inspection of the office furniture, equipment and supplies.  It's best to know in advance if you are investing in obsolete printers, copiers, software or other leading technology.  Moreover, you can tell a lot about a company based on the condition of its office or offices.  Consider the companies intangible assets including copyrights, patents, trademarks and trade secrets.  Talk with the company's customers, vendors, suppliers and even its competitors about its reputation, and contact the Better Business Bureau and other industry associations.  Finally, conduct an internet search for reviews.  Sites like Yelp.com offer insight into the business' goodwill in the community.  

Continued in The Necessity of Due Diligence When Buying a Business - Part Two.

In this writer's experience, the most common cause of business failure is the lack of a written agreement between partners. No one ever enters into business with a friend or trusted associate thinking that the deal will collapse around them. Yet, business relationships routinely run into difficulties, and without a written contract defining the contours of the relationship, the difficulties are often destructive. Even minor disputes result in financial ruin for unwary partners who had vastly different expectations regarding the minutia of the business relationship. Moreover, partners expose themselves to substantial liability for the debts incurred by their partners on behalf of the partnership and for the conduct of their partners.

Partnerships are complex and demand serious commitment much like any business relationship, whether a corporation, limited liability company or other formal business entity. Along with the financial resources necessary to start up the partnership, partners invest their time and energy. In most cases, they make a personal and emotional commitment to the venture hoping for significant financial reward. This personal investment makes it all the more difficult to deal with the inevitable conflicts. The key to success is planning and this starts with a well drafted partnership agreement.

People often start out in business together with nothing more than a hand shake, but they rarely anticipate the number and variety of decisions they will have to make moving forward. It is common for young partners to exhibit flexibility in the beginning but as businesses grow or struggle, the decisions become more complex and more important and partner flexibility starts to wane. If the partners cannot agree on key decisions, the partnership falls apart. Without a well drafted written agreement, the partners have no mechanism for operational continuity or for winding up the company's affairs. Will one partner be bought out? If so, for how much? How should the business be valued? If both partners wish to continue, who will retain the company's assets, including the company's name, website, location and customer lists? If both partners have personally guaranteed a lease, how will the exiting partner be relieved of his obligations? What other continuing debt obligations will the exiting partner retain? If the partners decide to dissolve the partnership, how will the company's debt be paid? How will the remaining assets be divided? Who will be responsible for winding up the company's affairs? What if one partner abandons a failing business entirely and disappears? What recourse does the remaining partner have to recover losses? A well drafted partnership agreement will set forth mechanisms to deal with such contingencies.

Continue reading "Why Oral Partnerships Are a Bad Idea" »

Continued from Considerations When Purchasing a San Diego Business, Part One.

The Valuation: Add your own critical assessment to the appraiser's valuation by personally reviewing the company's records. For small businesses, the valuation can be done without the assistance of an appraiser if necessary. The process of conducting a thorough valuation will be discussed in a follow up article. Either way, think about the intangibles. Will there be a future market for the goods or services provided? Will the company maintain the same goodwill with existing customers that the current ownership enjoys? Is there a likelihood that competitors will open up in the same geographic area? Is there a potential for a shock to costs such as a shortage of a key ingredient or an anticipated new law that will increase licensing fees and/or taxes? The fact that a business enjoys a positive revenue stream today doesn't guarantee a future revenue stream.

Compare Other Options: It is common for prospective purchasers to fall in love with a particular business (much like first time home buyers). Recognize that the temptation is there, and look for other options, or if you are working with a broker ask that they provide several options. You may ultimately decide to go with the first business, but at least you have done so after comparing its value with other companies. Where possible, try and perform your own valuation before paying a professional appraiser. Narrow the field first, and then pay a professional to be sure you have chosen wisely. In addition, there's no reason not to consider starting a brand new business if you have the expertise in a particular area. Put a lot of time and thought into your initial decision before committing your time and resources to a new venture.

Know the business: It's a good idea to know something about the business you are investing in. If you have been in the restaurant business for twenty years, buying a manufacturing business may not be the best choice. Consider you personal expertise.

Escrow: Purchasers are often tempted to bypass escrow believing it an unnecessary complication. This is not a good idea. Escrow protects both the seller and the buyer. Sellers are reassured that deposits and purchase funds have cleared before closing. Buyers retain the ability to take deposits back upon discovering deficiencies in the seller's representations during the due diligence period. Escrow also performs a UCC search to ensure that the seller doesn't have other liens or encumbrances against the assets of the business, and that a "Notice to Creditors of Bulk Sale" is published putting other creditors on notice of the transaction so that they can file claims they may have against the business prior to closing.

Deal Killers: While it may seem counterproductive for this attorney to call lawyers potential "deal killers", it is in fact a common occurrence. However, lawyers are a necessary part of the contract negotiation. Sellers will almost always have a good business lawyer on their side negotiating the best possible deal. Buyers should do the same. To avoid problems, prospective purchasers should work closely with an attorney they feel comfortable with, and clearly define their objectives. Clearly defined objectives let the attorney know where the client wants the line drawn, and facilitates the decision making process when the attorney has concern about a particular contract clause. Your attorney should understand the art of the deal and relative bargaining power. If the seller has all the bargaining power, it's a deal killer to insist on every conceivable contract advantage. A reasoned and tempered approach works best.

As with any new venture, the purchase of an existing business is fraught with risk. Is the business viable? Does it have growth potential? What are its hidden weaknesses? Is the purchaser experienced enough in the company's business? Is current goodwill and reputation dependent on existing ownership? Is the revenue stream consistent? The list of questions is endless. Ultimately, the decision rests on the purchaser's due diligent efforts at valuing the business. This article briefly addresses some important considerations:

The Seller is the Seller: Whatever the business and whoever you deal with, whether directly with the seller or a broker, the seller is determined to get the most value for their business. Aside from their financial investment, most sellers have poured their hearts and souls into the business. Either way, you can be sure that the product is going to be pitched in the light most favorable to the seller. Avoid being lured in by "pie in the sky" stories of marketing genius, unlimited revenue and unreported incomes. Take everything at face value and let the professionals (an appraiser and/or a CPA) give you a frank assessment of the stream of earnings you will be purchasing. Even then, it's wise to assume there are skeletons in the closet. Look for clues. If you have uncovered a minor misrepresentation, it might be a clue that they are hiding bigger secrets. Rely on your common sense and gut feeling about the seller and his or her representatives.

Funding: Marshaling the resources needed to purchase a business is not as prohibitive as many imagine. In fact, it is possible for some, especially those with good credit, to purchase an existing business entirely through seller financing. While the chances of obtaining 100% seller financing might be slim, seller financing of a portion of the sales price is common. Sources of funding include personal savings, asset backed loans, business loans and seller financing. Prospective buyers can expect to pay a 20% to 30% down payment on a business loan and sometimes a higher percentage for seller financing. However, a large cash layout isn't always necessary. The Small Business Administration (SBA) can assist with loans of all sizes with as little as 10% down, and sellers are often more flexible than expected. Diligently investigate options and shop around for the right deal for you. You might be surprised at how low the sales price is for many businesses. The key is to think creatively about funding the purchase. Explore all options and combine the most attractive and practical sources.

Entity v. Asset Purchase: There are two ways to structure the purchase of an existing business: an entity purchase (purchasing the Corporation, LLC or other formal business entity) or an asset purchase. Purchasing an entity involves taking on the company "as is" and absorbing all of its financial, contractual and legal obligations. Asset purchases are typically the better option for the buyer. With an asset purchase, you buy all of the company's assets, tangible and intangible including inventory, real estate, equipment, copyrights, patents, trademarks and trade secrets without absorbing any of the company's liabilities. In some cases, sellers may insist that the buyer in an asset purchase agree to take on some liability such as accounts payable, but this is all part of the negotiation. Prospective buyers should also talk with their CPA or tax attorney regarding the tax consequences of either approach.

Line up Professionals: Prospective purchasers of an existing business benefit from experienced advisors. In addition to diligently investigating the business, buyers should consult with experienced professionals: an appraiser to ensure the business is adequately valued; an accountant to ensure continued economic viability; a broker to expand your options; and a business attorney to protect your interests. Don't rely on your broker to value the business. His interest is in making the deal.

Continued in Purchasing Existing Businesses In San Diego, Part Two.

San Diego has seen a steady stream of young entrepreneurs starting up their own businesses over the last few years.  This is in large part attributed to the collapse of the financial markets and the ensuing recession.  Professionals in transition and the recently unemployed see starting their own business as an alternative to the continued disappointment they face in a tight job market.  An often overlooked alternative is to purchase an already proven business.  The idea perhaps gets little consideration.  In reality, purchasing an existing business is not that far out of the reach.  The option should at least be on the table for anyone thinking about starting a new business.  With numerous financing options available, many businesses can be purchased with the same up front capital typically necessary to start a new one.

In general, purchasing an existing business is less risky.  It doesn't matter whether one is purchasing a contracting business or a law firm.  An existing business has a proven track record.  It has developed a strong customer base and good will in the community; has invaluable systems in place for operations, accounting and employee management; and has reliable and trusted vendors, suppliers and professional advisors.  The purchaser takes over an operation that is already generating profits.  Of course, the quality of the existing business can vary widely.  Ensuring that the business is viable requires an in depth analysis of the company's history and finances, or what attorneys call "due diligence".  The importance of a "due diligent" examination of a prospective business cannot be overstated, and will be discussed in more detail in a follow up article.  

The point of this article is to highlight the benefits of purchasing an existing business and to inform prospective entrepreneurs that the alternative is feasible.  It seems that the biggest barrier to entry is an erroneous belief that purchasing a business is too costly.  People tend to see the buying and selling of businesses as a game played by large investors.  It is not.  Individuals motivated to go into business for themselves can and do buy existing companies.  They do so by marshalling personal resources, securing investment, securing seller financing, taking out business loans, and/or resorting to other creative financing.  In some cases, the purchase of an existing business is entirely financed by the seller.   

Purchasing an existing business may not be right for everyone, but it is a viable option for most people who have already chosen to go into business for themselves.  Barriers include lack of resources, bad credit ratings and inexperience in the particular business being considered.  However, these are the same barriers to starting a new business.  Where the motivation exists, entrepreneurs choose to make it happen.  If they have limited resources, they turn to specialized lenders like the Small Business Administration.  They solve credit problems by seeking investment partners and/or seller financing.  They substitute hard work and commitment for lack of experience.  If opting to purchase an existing business, be sure to consult with trusted advisers such as your accountant or business attorney before making the leap.  In addition, consider working with a broker but be careful about relying on his or her opinion about the valuation of the proposed purchase.  In the end, there is no substitute for due diligence.  See Considerations When Purchasing a San Diego Business, Part One and Part Two for further information.

As with the purchase of any business, purchasing a franchise in San Diego requires careful consideration of the company, its operations and profitability and the economic climate.  Franchise opportunities abound and they offer purchasers the unique ability to operate a business using an existing and successful business model.  With proven systems already in place, it is generally easier to operate a franchise than to start a new business.  However, the franchise model does not guarantee success.  Different markets, unfamiliarity with the business type, economic swings, geographic differences and other factors can combine to ensure failure in one locality where another thrives.   This article briefly addresses some of the more important considerations prospective purchasers should look at before making the decision to buy a franchise.  

Most importantly, the prospective purchaser should learn as much about the franchise as possible.  It is important to analyze the franchise disclosure carefully, to contact existing franchise owners and to visit the franchise headquarters.  Ask the following questions: How many individual franchises are there?  What type of training is offered?  What is the company's reputation?  What are the typical profit margins?  What are the company's plans for growth?  The answers to these questions help to inform the ultimate decision.  In addition, the prospective purchaser should perform its own a market analysis.  An independent evaluation will look at the uniqueness of the product or service, the vulnerability of the business to market fluctuations and the franchise's historical profitability.  If a thorough independent evaluation isn't practical, at least take a look at the differences and similarities between the proposed location and other successful locations.  If the demographics are completely different, it could be a red flag requiring heightened scrutiny.  

Armed with an in-depth understanding of the business model, the prospective purchases can next consider whether the purchase of the particular proposed franchise makes sense for them individually.  What level of expertise do they have in the particular business?  What kind of start-up capital is required and how might they raise it?  What are the franchise fees and will the profit margins be high enough to cover them?  How long will it take to recoup the initial franchise fees?  What is the term of the franchise agreement?  What are the franchise's operational requirements?  What about leasing obligations?  It isn't wise to take short cuts when answering these questions.  Where possible, enlist the services of an accountant, business attorney and/or financial advisor with experience in assisting clients with franchise businesses.

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