Structuring the sale correctly will give you peace of mind and potentially save you thousands.
Attorney Don Kochersberger weighs in on what to do when existing debt was not handled appropriately during the sale of a business.
My boyfriend and I recently bought a business. It is a gym that my boyfriend has been a trainer at for several years. I came up with the down payment, $235,000, which I withdrew from my IRA. We are both listed as borrowers on the loan for the rest of the purchase price and we are both listed as 50/50 owners of the gym. The former owner had been my boyfriend’s boss and friend for many years. He provided all the documents for the sale and we were pleased everything went smoothly. 60 days into owning our gym we have learned that the former owner owed on a loan more than half of the equipment. The loan is delinquent and the finance company is threatening to seize the equipment. We have tried to reach out to the former owner about this but he is avoiding us and not returning our calls. We paid for all of the equipment when we bought the business. It says so in the documents. So, this finance company can’t just come take our equipment, right? I mean, we have a huge loan balance to prove that we paid for it.
Sorry to hear the purchase of your new gym came with some unpleasent surprises. There are a lot of potential issues to cover so let’s jump in.
First, when purchasing a business, there are myriad considerations about how the transaction should be structured. One of the main considerations is whether, or not, to purchase the prior owner’s business entity, or simply the assets of the business itself. In the former situation, generally, the new owner takes over whatever assets and liabilities the old owner had at the time of the sale. In essence, the business itself never changes form, the owner simply changes. This type of transaction may make sense, depending upon the unique characteristics of the business in question. But, if this is how your gym transaction was structured, it is likely that the business owes the finance company, and the finance company may be able to retrieve the equipment for non-payment. If, however, the transaction was structured as an asset sale, the situation is less clearly in favor of the finance company. This is because the equipment will actually have been sold to a new owner, who paid for it. Depending on how the financing company structured the sale of the equipment (see the next paragraph), its only recourse may be against the old owner. This decision of how to structure the transaction is one in which the assistance of an experienced business attorney can be greatly beneficial. And, as you can see, the consequences of that decision may include something as important and basic as whether the new owner is responsible for the old owner’s debts.
Next, as you see in the prior paragraph, there is more to the situation than simply how you and the old owner structured the transaction. That may provide you some guidance on dealing with the old owner (i.e. whether you can obtain money from the old owner to offset having to pay for the equipment). Another, and quite separate, issue is whether the finance company is able to seize the equipment at all. This depends to a great extent on whether the finance company has a “security interest” in the equipment. When purchasing expensive equipment, such as professional gym equipment, the company financing the transaction will typically “take a security interest” in that equipment. The security interest is a legal device that allows the finance company to “secure” their loan of money to purchase the equipment, with the right to repossess the equipment for non-payment. This is very much like the mortgage that people have on their homes: if you do not pay the bank, they can take the home for payment. The law of security interests can be quite technical, and is largely beyond the scope of a brief response like this, but one requirement is that the finance company must record that security interest with the appropriate government body. The reason for the recording (i.e. filing a document that memorializes the security interest) is to allow others to search and discover whether property they are purchasing is subject to a security interest before they purchase it. Again, this is where an attorney can be handy on the front-end. The attorney would have been able to identify this issue before the sale, and it could have been resolved at that point. However, now that you are already in this predicament, you (or your attorney) will need to check into the finance company’s efforts to record that security interest prior to your purchase. If they did, you are presumed to have known about it, and there is a decent chance that the finance company may simply be able to take the equipment, unless you pay them for what is owed.
Finally, regardless of how things turn out with the finance company, you will need to consider whether you can obtain some relief from the old owner. Largely your success will be determined by the documents that accompanied your transaction. Often, these documents will dictate which party is responsible for the existing debts of the company. Your attorney will need to review the transaction and provide advice on your potential recourse against the old owner, if any.
In the end, this entire dilemma is illustrative of the adage “an ounce of prevention is worth a pound of cure”. In other words, hiring an attorney to prevent things like this from happening in the first place is precisely the best action you can take to avoid issues like this. Unfortunately, the problems we avoid are often not apparent to us at the time, so the cost of hiring an attorney to prevent them, particularly when you are excited about your new business adventures, is difficult to value. Nonetheless, building a solid foundation for your new business, is almost always less expensive than cleaning up after it falls apart.
Best of luck in the new business.
Are you considering purchasing a business? Even if the transaction is taking place among “friends”, it is vital to use a qualified, Business Attorney. Business Law Southwest can help ensure the purchase of your new business does not come with surprises. . Contact us today.