Part Two of a Two-Part Series on Small Business Transactions
Buying a small business is exciting and legally complex. You are not just purchasing equipment and inventory. You are stepping into a web of existing contracts, lease obligations, regulatory requirements, and potential liabilities that the seller may not be aware of or fully disclose. The documents you sign at closing define the boundaries of what you own, what you owe, and what recourse you have if something goes wrong. An experienced attorney is an essential part of this process.
What You Are Actually Buying
In a typical asset purchase, you acquire specifically identified assets, such as equipment, intellectual property, inventory, leasehold interests, and assumed contracts, rather than the seller’s legal entity. This is generally favorable for buyers because it allows you to leave behind liabilities that are not expressly assumed.
However, the protection is only as strong as the asset and liability schedules in your purchase agreement. Assets not listed are not transferred. Liabilities not expressly assumed remain with the seller, but if the seller cannot satisfy them, creditors may attempt to reach the acquired assets under successor liability theories. Your attorney’s job is to make sure the purchase agreement and schedules are complete and that the assumed liabilities are clearly defined and limited.
The Documents You Will Sign
The closing package may include the following documents, each serving a distinct purpose:
- Purchase Agreement – The governing contract. In any conflict between the purchase agreement and any other closing document, the purchase agreement controls.
- Assignment and Assumption Agreement – You formally accept the seller’s rights and assume the seller’s obligations under the assumed liabilities, effective as of the closing date. Obligations arising before closing remain with the seller.
- Lease Assignments – You step into the seller’s shoes as tenant under any assigned leases. From the effective date forward, you are responsible for rent, maintenance, insurance requirements, and all other tenant covenants.
- Bill of Sale – Transfers title to the purchased assets to you, free and clear of liens (as warranted by the seller).
- Promissory Note – If the seller is financing part of the purchase price, you will sign a promissory note obligating you to make monthly payments over the note term, with the full balance due on the maturity date.
- Security Agreement – If seller financing is involved, the seller will likely require a security interest in assets of your business, a personal guarantee, or some other form of collateral for the note.
- Entity Authorization Documents — Your company must formally authorize the transaction so as to be legally bound by the terms of the purchase agreement.
Key Risks for Buyers
1. Inherited Lease Obligations
When you assume a lease, you take it as it exists, including any provisions that may be unfavorable. Review the lease carefully before closing for issues such as:
- Permitted use clauses that restrict the use of the property. If you intend to operate differently than the prior tenant, you may need landlord consent.
- Holdover provisions may impose increased rent (often 1.25x base rent) if you remain in the space after the lease term without a renewal.
- Common area maintenance (CAM) reconciliations mean your monthly operating expense payments are estimates; you may owe a true-up at year-end.
- Subletting and assignment restrictions may limit your flexibility if you later want to bring in a partner or exit the space.
What your attorney does here: Counsel reviews the full lease, including all amendments and addenda, before closing, flags unfavorable provisions, and negotiates landlord consent terms that protect your interests going forward.
2. Seller Financing Obligations and Default Risk
If the seller carries back a promissory note, the buyer needs to understand the terms, such as:
- Monthly payments begin shortly after closing and continue for the full amortization period. Missing even one payment could trigger default rights;
- Default rate interest applies automatically upon a missed payment – no notice required – at a rate significantly higher than the fixed rate;
- A confession of judgment provision may allow a creditor to seek judgment through a special court procedure without a conventional contested lawsuit. Its availability and enforcement depend on the provision and applicable procedural requirements. Buyers should understand the rights affected by the clause and discuss whether it can be removed or limited.
- Security agreement gives the seller a lien on collateral assets. Upon default, the seller can repossess and sell that collateral, notify your account debtors to pay the seller directly, and seek appointment of a receiver.
3. Representations and Warranties — Your Obligations
You make your own representations and warranties to the seller in the purchase agreement. These include certifications that your entity is validly organized, that the transaction has been properly authorized, and that you have the financial capacity to close. If any of these are false, the seller may have claims against you.
4. Successor Liability
An asset purchase can limit the liabilities a buyer agrees to assume, but it does not eliminate every potential exposure. Depending on the facts and applicable law, a buyer may face successor liability or other responsibility for pre-closing obligations. Counsel should evaluate the transaction structure and investigate potential tax, environmental, product-related, and other liabilities relevant to the business.
Tax Considerations for Buyers
The tax structure of your acquisition has long-term consequences for your business’s profitability.
- Asset purchase and stepped-up basis: In an asset purchase, you acquire each asset with a tax basis generally determined by the purchase price allocated to that asset which becomes your new tax basis. This is one of the most significant tax advantages of an asset purchase. Equipment and other depreciable assets can be depreciated from their new (higher) allocated values, generating depreciation deductions that reduce your taxable income in the years after closing.
- Goodwill amortization: Amounts allocated to goodwill and going-concern value are amortized over 15 years providing a steady annual deduction.
- Purchase price allocation: The allocation of the total purchase price among asset classes is negotiated between buyer and seller. Buyers generally prefer to allocate more value to depreciable assets (faster deductions) and less to goodwill (slower amortization). Sellers generally prefer the opposite. Your attorney and CPA must coordinate to reach an allocation that is both tax-efficient and defensible.
- Assumed liabilities: Liabilities you expressly assume as part of the purchase price increase your tax basis in the acquired assets, which can increase your depreciation deductions.
- Entity structure for the acquisition: Whether you acquire assets through an existing entity or a newly formed one affects how income and losses flow through to your personal return, your exposure to self-employment tax, and your ability to bring in future investors or partners.
What your attorney does here: Counsel works with your CPA to negotiate the purchase price allocation, structure the acquisition entity appropriately, and ensure that the closing documents reflect the agreed tax treatment.
How an Attorney Protects You as a Buyer
- Conducts due diligence on the seller’s assets, leases, contracts, and liabilities before you are bound to close.
- Negotiates the asset and liability schedules to ensure you receive everything you are paying for and assume only what you intend to assume.
- Reviews all leases and obtains landlord consents with terms that protect your right to occupy and, if needed, later assign or sublet the space.
- Explains and negotiates seller-financing terms, including the confession of judgment clause, default provisions, prepayment rights, and security agreement collateral, so you understand your obligations and have reasonable cure periods.
- Prepares and reviews entity authorization documents to confirm the transaction is validly approved and that the person signing on your behalf has actual authority.
- Coordinates the purchase price allocation with your tax advisors to maximize your post-closing depreciation and amortization deductions.
Discuss Your Business Purchase
Buying a small business in Pennsylvania involves more than agreeing on a purchase price. Careful due diligence, clearly defined assets and liabilities, and a thorough review of lease and financing terms can help you understand what you are taking on before closing. Before you sign, schedule a meeting with Attorney Joshua Shoemaker at Aevitas Law to discuss your proposed purchase, review the transaction documents, and identify legal issues that may affect your plans as a new owner.
Small Business Purchase FAQ
Before buying a small business, review the assets being transferred, financial and tax records, material contracts, leases, existing liens, pending disputes, and required permits or approvals. The scope of due diligence depends on the business and transaction structure. Your attorney and accountant can help identify issues that may affect the purchase terms or your decision to proceed.
In an asset purchase, the agreement should identify which liabilities you assume and which remain with the seller. However, that allocation does not eliminate every potential claim against the buyer. Successor liability and other legal requirements may create exposure in certain circumstances. An entity purchase presents different risks because the company generally continues to hold its existing obligations.
A lease may be transferable through an assignment, but the lease terms determine whether landlord consent is required and what conditions apply. Before closing, review the remaining term, renewal options, permitted use, rent, operating expenses, insurance requirements, and any guaranty. Confirm that the lease and assignment support your intended operation of the business.
Review the interest rate, payment schedule, maturity date, balloon payments, default provisions, cure periods, and prepayment rights. Understand which assets secure the debt and whether you must sign a personal guaranty. If the documents include a confession of judgment provision, ask your attorney to explain the rights it affects and whether it can be removed or limited.
This article is provided for general informational purposes only and is not intended as legal advice. Legal requirements vary depending on the facts and the applicable law.
