Managing Risks Associated with the Purchase of a Business

You have decided that it is time to expand or that there is an area where your business needs to grow. There are many options available. A number of risks need to be reviewed in order to decide on the method of handling the acquisition. This article is intended to point out a few of these. Complete discussions of risks and decisions need to be undertaken with professionals including counsel.

shutterstock_250912225Expansion can be a beneficial thing. However the risks associated with the method of the purchase need tobe examined. There is a need to understand and determine the goals of the acquisition and then a discussion regarding the risks can ensue. Certain types of acquisitions may have risks of inheriting the obligations of the target or add to the obligations of the purchaser as just being a substitute entity. A purchase might be solely to acquire assets or it could also other assets of the target including tax benefits.

At the outset, a determination of the status of the target and its creditors is conducted by a factual investigation of the target. This is commonly referred to as conducting one’s “due diligence”. The scope of the diligence is a combination of risks that are deemed acceptable to the acquirer including costs and speed. However, it is fair to say that the more thorough the diligence conducted, the lesser are the risk of surprises arising at a later time.

Some decisions regarding a target are based upon a determination of whether the target company is in financial distress. When the target is in this situation more constituencies than the members or shareholders of the target enter into the picture. These interests can affect the sale situation and strategy. Also, the types of creditors need to be determined. These can be determined through a search of UCC filings, tax and judgment lien searches. Determination of the types of collateral possessed as well as the consideration that they will receive. From the target’s perspective, consideration of any claims of shareholders as well as any guarantees needs to be factored in as that will affect the value that is sought and types of indemnities sought as well.

The simplest type of acquisition is a purchase of the assets of the business. Several methods of this type of purchase are available and need to be considered. Depending upon the number of creditors and potential claims, it might be in the best interests of the acquirer to attempt to “wash” the assets of any adverse claims to clear title to the acquiring party. This can be done through a bankruptcy proceeding or a non-judicial proceeding, in Illinois, an assignment for the benefit of the creditors. In either situation, it is possible to clear title to the assets through a bidding process held by a third party. The acquiring party might want to set an opening bid to start the process and weed out any kicking of tires.

The risk of any acquisition is that the creditors of the target attempt to follow to the new entity. This is commonly referred to as “Successor Liability”. Several theories are possible for these to occur. Examples include that the target had not received “reasonably equivalent value” for the business or the target failed to maintain proper books and records for the business. So a complete analysis of the target needs to be conducted as part of the diligence process in determining how to proceed. Risks multiply when a decision is made to acquire more than simply the assets of the business and additional diligence is in order. Likewise, an understanding of the target is needed to avoid liability as being just a continuation of the target entity. If there is too much similarity in the target and the acquirer this could result in the liabilities of the target being acquired by the purchaser even without this being considered. Some of the answers to avoiding successor liability involve the use of appraisers and parties experienced in valuation of businesses.

As you can see there are numerous issues that will need decisions in processing an acquisition. Consultation with your professionals is the best way to avoid any unintended issues from arising.

This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.