You have given it some thought and you are ready to purchase an established business. In theory, assets are transferred and you are the new owner, easy! Unfortunately, there is a lot more involved with purchasing a company and that includes an extensive list of due diligence items. Annual financial statements, reconciliation of federal tax returns, list of annual sales by product category and marketing channels and employee due diligence to name a few. More common than not, most buyers forget one of the most important details – lien searches.
A lien is simply a legal right or interest in an individual or institutions’ property by a creditor. Liens guarantee an underlying obligation such as a repayment of a loan. Typical examples of liens involve home and auto loans. Individuals purchase vehicles and homes using funds from banks and the bank then grants a lien on the asset. If the loan is paid in full, the bank releases that lien and the individual owns the property free and clear. Alternatively, if that individual fails to repay the loan, then the lien holder can seize the asset in order to repay the loan.
For buyers purchasing a business, it is very crucial to search for liens (even if it is an asset sale) since any property that has a lien or debt owed to a creditor, even from the previous seller, may become your issue. Furniture, equipment, inventory, accounts receivable and goodwill of the business can all be pledged as collateral for lines of credit and loans. Therefore, the assets you recent purchased through the sale of a business could still owe money. While there are ways to protect yourself and incorporate specific language in LOIs and purchase agreements, nothing will ever be as definitive as searching public records for liens.
Uniform Commercial Code
The Uniform Commercial Code (UCC) is a series of legal rules that have been standardized among all 50 states as well as the District of Columbia, Puerto Rico, Guam and US Virgin Islands. First published in 1952, the UCC is a collection of rules governing how commercial transactions take place in the United States of America. Fact is that all businesses need cash and assets to grow, which can easily be done through bank financing or purchasing equipment and real estate. If a company has a UCC lien it does not mean it is an unhealthy business, it just means that they have assets or loans that are not fully repaid and still owe money. The UCC established these commercial rules so that all lenders are aware that particular assets from a certain company are borrowed and not owned, so that other creditors don’t loan money on those same assets.
For instance, a borrower gets multiple loans and guarantees collateral for the same property. Let’s say a farm in Illinois that has approximately 100 acres of land guarantees that land as collateral to different banks by taking out two loans. Which bank would be entitled to compensation when the farmer defaults on those payments, better yet four loans were taken out, which bank then? This is the primary reason the UCC exists and why the system has been simplified to conduct a public search for liens.
There is a big difference between tax liens and UCC liens. As stated above, a UCC lien means a company has borrowed money with collateral but a tax lien is filed by the IRS when taxes are due and not paid. A UCC lien is normally on a piece of equipment or real estate, whereas a tax lien is on all assets the company possesses. A tax lien is not only issued by the IRS but also any local or state establishments can place a lien for taxes unpaid as well.
Another important lien includes a judgement lien. When an individual or company loses a court case, a judgement lien is issued. This can be placed on any personal assets, property, automobiles and real estate.
How to Conduct a Lien Search
The most common way buyers conduct lien searches are through professionals or third-party services. You can conduct lien searches yourself but this can become a daunting task, especially since you are already buying a business and that is time consuming enough. Unless you know exactly what you are searching for, it would be best to hire a professional. When you hire a mergers and acquisitions firm, they will usually take care of this process for you.
If a lien search is conducted on a company and there happens to be a lien in the database, it is important to first determine whether the lien is active or if it has been terminated. Obviously, if the lien has been terminated, the debt has been repaid which means the assets are free and clear to purchase. Unfortunately, if the company has an active lien it will need to be addressed before you purchase the business. The seller can agree to pay off the lien before closing or the buyer can negotiate a reduced asking price. Otherwise, if the lien is not resolved before you purchase the company, any assets will still be subject to the creditors who are due repayment and will become your responsibility.
Businesses with UCC Filings
A UCC lien will reduce and may prevent your business from obtaining financing or qualifying for loans. Any filings will show up on the company’s credit report and will factor into lending decisions. It goes without saying, if your company has a lien on some or all of the assets, if you default, those assets can be seized in order to repay any outstanding balance due.
Buying an established business can be more complicated than originally anticipated. In addition to assessing the profitability of the company and examining due diligence documents, it is important to conduct lien searches. Hiring an experienced M&A advisor that has the knowledge and foresight through hundreds of successful closings can help a buyer prevent costly mistakes. The last thing any buyer wants is a creditor knocking on their new company’s door looking for debt repayment. This is a very crucial step not to be taken lightly and why every buyer should conduct a proper lien search before purchasing a business.
444 W Lake Street
Chicago, Illinois 60606
32 London Bridge Street
London SE1 9SG, UK
13155 Noel Road
Dallas, Texas 75240
1055 W. Georgia Street
Vancouver, BC V6E 3P3