In a prior article, we outlined some of the more common corporate documentation and record-keeping items that prospective business owners should review and address prior to marketing a business for sale.
This article tackles another important pre-sale due diligence exercise: ensuring the business is current and in good standing, and that it has obtained all required governmental authorizations, licenses, and permits.
When a business client engages me in connection with a business purchase or sale, one of the first things I do is visit the applicable state government’s website to check whether the entity is in good standing. I’ve lost track of how many times that quick exercise has resulted in an outright sprint on the part of the seller to fix a host of corporate registration or qualification issues to save a deal from falling apart.
In counseling business sellers, I usually begin the engagement by asking them some form of the following questions:
Is the entity you do business under in good standing?
It never ceases to amaze me how often business owners let an entity fall out of good standing with state authorities where the business is domiciled or, worse still, allow the business entity’s legal status to be revoked entirely.
Aside from the very real risk that a business owner might lose some or all liability protection offered by an LLC or corporation whose entity status has been revoked, so-called corporate “good standing” issues often signal to a potential buyer that the target business has been playing fast and loose with legal compliance obligations and corporate formalities.
This can result in increased due diligence costs, delays in completing diligence, and more intense and unfavorable negotiations for buyer liability protections in the transaction documents.
The good news is that such good-standing issues (even corporate forfeiture or revocation) can typically be remedied in as little as a few weeks or less with the filing of any delinquent reports, fees, or tax returns and the payment of relatively modest penalties. However, a deal with a buyer on a tight closing timeline can go off the rails quickly if these issues aren’t addressed well in advance.
Are you doing business in more than one state?
As far as I am aware, all fifty states and the District of Columbia require that an enterprise “doing business in” that jurisdiction be duly qualified and registered with one or more of that jurisdiction’s agencies.
While the definition of what constitutes “doing business,” as well as what registrations may be required, varies from state to state, the implications of NOT registering are typically equally serious.
The types of activities that can trigger registration requirements and/or tax obligations can include (without limitation) having one or more remote employees working from that jurisdiction or physically sending any employee into that jurisdiction on business (whether for potential client solicitation or actual client servicing).
This is ultimately a facts and circumstances inquiry; however, if it is clear that a business has continually operated in a jurisdiction without having properly registered, it can drastically affect negotiations with a potential buyer who may not want to take on the associated audit and penalty risk or headache without financial compensation or other protections.
Do you have the legal rights to all names under which you do business?
Very often, enterprises will do business under a shortened name or “trade” name. For example, “Aunt Martha’s Baked Goods, LLC” might be referred to simply as “Aunt Martha’s” or “Aunt M’s” on menus, business cards, and business signage.
However, business owners are often surprised to learn that using a shortened or alternative name that differs from the exact, registered legal name of the business usually requires state (and even local city/county) registration as a “trade” or “fictitious” name.
Worse still, a business owner who has firmly established a trade name in a community or industry may come to learn that someone else has registered the rights to use the same name in that jurisdiction. I once saw a potential buyer register the selling entity’s trade name in multiple jurisdictions before the parties even signed a letter of intent.
Why does this matter?
Buyers will often require representations and warranties that the sellers own all rights to the business name and other intellectual property, and then require the seller to indemnify and cover all legal costs for any breach of such representations and warranties.
What permits and licenses are used in connection with the business?
This question usually requires some in-depth discussion with the business owner.
Depending on the industry, the business owner may hold the key license permitting the business to operate in her or her individual name, as is typically the case with a master electrician license, master plumber license, or general contractor license.
A restaurant or other hospitality business may hold a liquor license or an outdoor “streatery” seating license, with particular restrictions and conditions on its use.
Potential buyers will want to ensure that all such licenses can be transferred to them upon a sale, which often requires timely advance cooperation on the part of the selling business owner. They will also want to know any restrictions on their intended use of such licenses and permits which might affect their expected revenue — and therefore the deal price.
Some business owners discover for the first time during a buyer’s due diligence investigation that the business has operated for years without a required business license or permit.
On several occasions, I have seen buyers walk away from a deal over a missing business license – almost always because the buyer knew that obtaining that particular license would likely take many months and that the license application itself would likely trigger an audit or investigation for the existing business.
It is therefore advisable for business owners to research and tackle any licensing or permitting issues well in advance of any potential sale.
Are you ready to sell your business? Contact Tim Canney, chair of the business and tax practice at Bulman Dunie, at tcanney@bulmandunie.com or (301) 656-1177 for help navigating your sale!
