Selecting the most appropriate attorney is important in any type of legal matter, but may be even more crucial in business transactions involving tens, if not hundreds of thousands of dollars, unique and often unclear circumstances and substantial risks to both Purchasers and Sellers. Retaining the most qualified and enthusiastic professionals is therefore essential and well worth the extra time and effort.

For the purposes of this article, "Due Diligence" is defined as the investigative research which both Purchasers and Sellers should undertake prior to buying or selling a business. The goal of this research is to uncover or "smoke-out" any and all apparent and not so apparent information as the circumstances permit and to avoid any post-closing surprises.

This article will explore some of the most essential business and legal issues facing both Purchasers and Sellers of convenience stores. While many of these issues require the review and consideration of your attorney, accountant and business consultant, because you are closest to the transaction and have the most to gain or lose, it is imperative that you, with the guidance of the professionals, conduct thorough and exhaustive research into the particular circumstances of your transaction. If you are curious as to just how much research you should conduct, just ask yourself: "Do I feel lucky today?"

It is important to interview a number of attorneys who have an established transactional expertise in the food industry--a non-legal background in this industry may help them to more fully recognize and appreciate the underlying business concerns and issues.

Determine whether they have written or lectured on this subject and whether they understand the core business issues which need to be recognized and addressed in the operative legal instruments (e.g. contract of sale, commercial lease, promissory note, security agreement, indemnification, escrow agreement, etc.);

Let the prospective attorney know that service and availability are crucial to you--remember you can lose a deal in a matter of hours, so be sure to have their commitment to give your matter a priority if and when necessary; and

Determine whether they have a "can-do" attitude and will not be stagnated by obstacles, but will be able to develop viable alternatives allowing the transaction to ultimately be consummated in an acceptable manner.

If you have assembled the right team of professionals and are working with them to conduct the thorough due diligence detailed below, you will become more familiar with the essence of the transaction and will be more able to carefully evaluate and weigh the risks inherent in the proposed transaction. Your attorney must be able to efficiently and effectively work together with you, your business consultant and your accountant to collectively formulate the best and most efficient strategy.

Accordingly, make sure that you trust your attorney. Not only is his expertise in this area of practice vital, but more importantly, is his willingness to work with you and your other professionals, under the requisite time-frames and in a manner that keeps his and the related professionals fees as low as possible. The contributions of the accountant and the business consultant are essential. Their input is needed up-front and ideally should be obtained prior to negotiating the contract.

A. Administrative Matters to Discuss With Prospective Attorneys:

Be sure to have a Retainer Agreement which clearly states the legal and non-legal fees to be incurred, the services to be performed and the hourly rate of the attorney and any of his staff, if applicable;

Billing (will it be hourly, fixed or "value billing"?);

Disbursements (which disbursements shall be charged to you?);

What is the billing structure if purchase is not consummated (does it revert to an hourly rate? Or, is there a set cap on fees?);

Have the attorney explain and define his role as attorney (determine whether he has consummated similar transactions; and define the role of the other professionals such as business consultants and accountants);

Have the attorney provide an explanation of the chronology of the transaction: from pre-contract through post-closing;

Discuss and define your responsibilities and duties (investigative and financial); and

Have the attorney explain what his strategy is beyond the "Battle of the Forms" (contractual protections cannot always replace advance and detailed due diligence).

B. General Background Information Which You Should Advise the Attorney of:

Your background: how long have you been engaged in this type of business? Have you ever purchased or sold a business before?

General description of business type (duration, sales volume and location);

How did you come to know of this transaction? Is there a business broker involved, and if so have any brokerage or binder agreements been executed?

Why is the business for sale? Is this the best time to buy or sell? Is the business seasonal in nature?

Proposed purchase/sale price: How was the price determined? What is included in the price? (e.g. restrictive covenant, equipment, goodwill, etc.) Breakdown of price: cash and notes (if any) and the term, security, guarantors (if any) and interest rate on such notes;

Are you considering alternatives?--Understand the significance in the negotiating process of having a viable alternative for both added perspective and bargaining leverage. Have you consulted with an accountant and/or a business consultant?

Have you already negotiated any of the terms?

I. Seller's Due Diligence:

Prospective purchasers are probably considering purchasing the subject business because they have decided against starting a new business. The lures of an existing business include: (i) less risk; (ii) Seller financing, which may be available; (iii) existing and proven "goodwill" (i.e. customer base); and (iv) market recognition. The Seller should establish to the Purchaser that his business meets these criteria and that there is little or no risk based on the viability and profitability of the business. Additionally, the Seller should, through his own investigative due diligence and with the assistance of his attorney, accountant and business consultant, determine whether the Purchaser will be able to perform all of his pre-closing through post-closing obligations.

Why are you selling the business? and why now? (Be prepared to address this question with prospective Purchasers);

Is this the best time to sell? (Is the business seasonal?) Do not wait until it is too late to sell (when the business is run-down or when the lease term is near expiration);

Why is the Purchaser buying? And what is his time frame?

Know the Purchaser: This is particularly essential when the Seller is willing to provide a purchase money mortgage. If the Purchaser does not have the necessary funds for closing, has silent partners or is merely setting up the store to be run by others (i.e. managers or family members), there is more reason for concern about the Purchaser's commitment to make good on such note payments. If you are willing to allow the Purchaser to conduct a trial run period, you should first be convinced of the Purchaser's sincerity and his ability to actually have the necessary closing funds (be sure to have the Purchaser substantiate this).

Further, consider the following:

Is the Purchaser experienced in this type of business? (preferably in the same community? And if so, what is his reputation?)

Will the Purchaser operate the business himself or through absentee management?

Will the Purchaser provide recent business references from: landlords, suppliers, venders, etc.?

Does the Purchaser currently have in place the capital required for the closing adjustments? (i.e. security for rent and utilities; inventory; working capital, etc.?)

Determine whether the Purchaser knows the industry in general and this business in particular. The earlier in the process that the Seller knows the Purchaser and his experience and reputation, the better. The earlier your attorney has all the necessary information from you, as well as from the other professionals, the better you will be able to negotiate the deal, know which issues, unique to this Purchaser, need to be adequately addressed in the contract and related documents, and most importantly, know at what point in the negotiations you should consider either pursuing the sale or consider an alternative Purchaser. Remember, to a large degree, your attorney's effectiveness is a function of his having complete and accurate early intelligence on the target Purchaser. Also, verify the Purchaser's identity (photo I.D., passport or driver's license). If he is not a US citizen, determine his immigration status and whether he had any INS or IRS problems?

The Lease: (Obtain landlord's release, and secure a right to immediately re-enter the premises in the event of Purchaser's default, and understand the distinction between assignment and subletting of the lease). Will there be a guarantor and if so, what precisely secures the obligation?

Contract of Seller: Negotiate assignments and assumptions and obtain adequate and meaningful security for same from Purchaser.

Judgment, lien and bankruptcy searches on Purchaser and Purchaser's other or prior business.

Equipment and Fixtures: Are they in any way encumbered (i.e. UCC filings)? Are they owned or leased (if leased when does the lease expire and is it assignable? What are the payments? Is service included? And what is the buyout price at the end of the lease term?).

Non-Competition by Seller: Be prepared to provide a non-competition agreement. Limit its geographical boundaries, its term and the types of businesses as much as possible. The Purchaser may require a such an agreement of key employees.

Note: If the value of the business is largely based upon "Goodwill" (the benefit or advantage of having established an ongoing customer base), using the business itself as the primary collateral for any notes taken at closing in lieu of the full sale price, may be problematic. The Purchaser could easily adversely effect the Goodwill in a way that it may never be redeemed. Personal guarantees may also be problematic because the Purchaser may be "judgment proof".

Remember, particularly if you are a first time Seller, that you cannot be too persistent in seeking to obtain complete and accurate knowledge of the Purchaser and his ability to go to closing and thereafter, to successfully operate the business. If the Purchaser resists, you should let him know that without such information you will not proceed. The ultimate goal is that there be no adverse surprises either before or after closing.

If possible, attempt to become more familiar with the Purchaser's background in this type of business and the Purchaser's business reputation by contacting the following sources (Purchaser's consent may be required):

Suppliers of Purchaser (assuming Purchaser is currently engaged in business)

Key Customers of (i) Purchaser (assuming Purchaser is currently engaged in business) and (ii) Seller (will they continue to deal with a new owner?)

Lawsuits, Violations, etc. (against Purchaser, Purchaser's current business or against Seller, which need to be addressed).

Licenses, Authorizations and Permits (are they transferable? And is there anything fact or circumstance concerning Purchaser or his prior conduct, which may effect Purchaser's ability to procure such permits?)

Financials and Tax Returns of Purchaser

Non-Competition by Seller (Geographic and Time limitations and conditions-if Purchaser breaches any agreements with Seller, the restriction against Seller competing with Purchaser becomes null and void)

Note: if the last business of the Purchaser is in trouble or is operated by absentee management, you may want to consider requiring the purchase price to be paid in full at closing.

BUYING A CONVENIENCE STORE

One of the most common mistakes Purchasers make when buying any type of retail business is being susceptible to the "Big Lie." The Big Lie is typically the Seller's over statement of the value of the business. Accordingly, beware of the Big Lie. For example, the Seller may represent to you that although the reported net income of the business is X, the actual net income (i.e. take home profits), is in fact X + Y. Sellers of retail/cash businesses know that Purchasers anticipate this and are predisposed to assume that there is additional income. The problems associated with this include: (i) if this is true, are you buying a potential tax liability?; (ii) how can you sufficiently confirm the truth and accuracy of these unsubstantiated representations? and (iii) will a trial run aimed at verifying the actual sales volume, expenses and bottom line take-home income suffice?(consider lengthening the trial run period). Be skeptical of paying for anything which cannot be substantiated to both you and your professionals full satisfaction.

Additionally, many Purchasers will assume that from day one they can increase the volume and profitability of the business. While many motivated and qualified Purchasers do ultimately succeed in improving the business, it usually takes longer than they anticipated. Thus, assuming that the business does not improve for an extended period of time or that the business never lives up to the Seller's representation (i.e the Big Lie): (i) can the business sustain itself?; (ii) is it still worth the price?; and (iii) do you have the capital reserves to get through this period without having to either default on any of his payment obligations or having to obtain additional financing?

Note: when valuing a business, at a minimum, you should consider: (i) the opportunity cost (the interest you would have earned on the capital used for the purchase price); (ii) the cost of the promissory note payments (the finance expenses); and (iii) whether you will, in addition to an acceptable salary, be able to generate sufficient profits. If you are uncertain that the business will cover the opportunity cost, the cost of the notes, an acceptable salary and profits, you may be overpaying for the business or subjecting yourself to a significant risk which may not be viable.

Do you know this industry in general and this business in particular? The earlier in the process that you know the business, the better. The earlier your attorney has all the necessary information from you as well as from the other professionals, the better he will know how to negotiate the deal, what issues unique to this industry and business need to be adequately addressed in the contract and related documents and most importantly, at what point in the negotiations, he should advise you either against pursuing the purchase or to consider an alternative purchaser. Remember to a large degree, your attorney's effectiveness is a function of his having complete and accurate early intelligence on the target business and the Seller's actual motivation for selling.

Remember, particularly if you are a first time purchaser, that you cannot be too persistent in seeking to obtain a complete and accurate knowledge of the business and the Seller's motivation for selling. If the Seller resists, you should let him know that without such information, you will not proceed. The ultimate goal is that there are no surprises after closing or even before closing when there is no way out.

Purchaser's background: have you been engaged in this type of business? If not, what is your strategy for success without experience? Have you ever purchased a business before? Are you familiar with the particular business being acquired? And do you have a qualified accountant and business consultant?

Why are you purchasing a business? And why this particular business? Are you aware of the enormous amount of time, effort and capital required initially and on an on-going basis--the Seller may have a good income because he works in the store full-time and accordingly, has a low payroll, and low shrinkage--if you are going to increase the payroll, how does that effect profitability?

General description of business-type (duration and location);

How did you come to know of the business?--Is there a business broker involved and if so have any brokerage agreements or "binders" been executed?;

What is the Seller's stated reason for selling the business?--This is one of the most significant issues to Purchasers. Typically the Seller will have an apparently viable reason for selling. But beware that the underlying reason may be based on certain detrimental factors which will only become apparent to you after closing.

The Lease: This instrument, together with the sales volume and actual expenses, is one of the most essential considerations in valuing a business. Remember, that while one of the reasons you purchase a business is for the anticipated stream of income, equally important reason is the potential resale price and the capital gain you anticipate realizing therefrom. If the lease is for a short term (i.e. less than 10 years) or contains, for example, provisions which make assignment or subletting difficult, (you do not want the landlord as a partner when you are attempting to sell), the value of the business may be adversely effected. Also, be wary of subordination provisions which could effect your rights as a tenant in the event, for example, that the landlord defaults on his mortgage obligations and the property is foreclosed upon by the landlord's lending institution.

Contracts of Seller: Some of these may be favorable and accordingly you will need to confirm their assignability and consider escrowing funds to be protected from the premature termination of such contracts. Some of these might not be favorable to you, in which event you will want to confirm that they will not be binding upon you. In some instances, these contracts provided the Seller with a front-loaded benefit (free inventory or use of equipment) that you should, in some way, be credited for if you choose to assume the contract. If you do choose to assume any contracts, estoppel certificates and assignments executed by the third party are necessary. The contract for sale should specifically address assumed and non-assumed contracts.

Contract for Sale and Related Agreements

Judgment and lien search, bankruptcy, zoning, building department and environmental type searches.

Note: Get involved in the due diligence process. This will serve to reduce your risks as well as your legal fees (for conducting this type of investigation) and reduce the chances of having a "bad" surprise.

Suppliers: obtain Seller's consent to contact suppliers to determine Sellers good standing. Obtain a list (verified by a Seller's affidavit) of all current and former suppliers, including their names, addresses, persons to contact, Seller's account identification number (if any) types of goods/services provided and whether any of these suppliers have liens secured against any of the assets of the business (if so, review all security documents and do not close without having obtained a satisfaction or UCC-3). Is the Seller locked into any one supplier? Consider negotiating concessions from distributors (loans; inventory or equipment);

Customers: Are there any primary customers upon which the business is relying or which constitutes a key component of the purchase price? If so, ensure that the customer will continue and escrow money to support this representation.

Trademarks, Servicemarks, Patents and Copyrights: Confirm that any of the above that apply will be included as an asset of the business. If there any trademarks or trade names, confirm that they have been duly filed with the appropriate federal and state agencies.

Key Employees: are they potential competitors?

Taxes: (review prior filings, obtain releases for prior periods and escrow money for same)

Equipment and Fixtures (are they owned or leased by Seller? If leased, verify the assignability, payments, term and buyback provision at close-out)

Lawsuits, Violations, etc.

Licenses, Authorizations and Permits (Confirm Seller's good standing, that there are no violations and no circumstances that would effect your ability to obtain such licenses)

Financials and Tax Returns

Non-Competition by Seller

Environmental

Trial run contingency: Be sure to conduct a trial run prior to closing and that the closing is conditioned upon your satisfaction with the trial run. Be wary of Seller's attempts to falsely inflate the sales volume.

Good luck and remember above all else to invest the requisite time and effort to: (i) recruit the best possible professionals who will assist you in uncovering, quantifying and hopefully, eliminating or reducing the risks unique to the proposed transaction; and (ii) personally and through your professionals, conduct thorough due diligence on the target Purchaser or Seller.

The information contained in this article is general in nature and does not constitute legal advice. Do not attempt to solve your individual problems, based upon the general information contained in this message.

Copyright © 2001 The Gulotta Law Group, PLLC