Characteristics (and Red Flags) to Look for When Buying a Business

According to Merriam-Webster, an entrepreneur is “one who organizes, manages, and assumes the risks of a business or enterprise.” Being an entrepreneur means taking financial risk for economic profit, it doesn’t mean building a completely new business. For those with an entrepreneurial spirit who don’t have the latest and greatest idea for an app or new technology, acquiring and improving an existing business is just as entrepreneurial as starting a new company. When buying a business, there are several characteristics that you need to look for, as well as a few red flags.

  1. Asset vs Stock Acquisition. For the majority of entrepreneurs, an asset acquisition is the ideal method of buying a company as it provides tax benefits and shields you from existing corporate liability, such as a pending lawsuit or one yet to be brought. When looking to buy a business, openness to an asset acquisition is a preferred characteristic. A seller only offering a stock sale should be a red flag. By limiting the sale to a stock sale, the seller is transferring legal liability to you – the red flag. However, for certain opportunities, a stock acquisition may be preferable to an asset acquisition.
  2. Seller Indemnity. Regardless of whether you choose to conduct an asset or stock acquisition, receiving a seller indemnity shields you from legal liability going forward. If a seller refuses to grant an indemnity, they are refusing to take responsibility for any illegal conduct they engaged in while owner of the business, which should be a red flag.
  3. Orderly Books and Recordkeeping. An often-overlooked characteristic of a business, even one in dire need of saving, is a clear history of recordkeeping. The business should be able to show cash flows into and out of accounts, current accounts receivables, etc. Without clear records, you could be acquiring a business that has failed to properly account for its debts – a liability you could be taking on.
  4. Proof of Tax Payments. Similar to orderly books and recordkeeping, the seller should be able to prove that all sales tax, payroll taxes, and any other outstanding taxes have been properly paid. Failure of the business to pay these required taxes could mean liability for you. Even in an asset acquisition, outstanding tax owed for those assets can become your problem.

In the end, entrepreneurial ventures may be risky, but they also offer the potential of significant profit.