By Craig P. Wagnild
(See full Japanese version of article condensed in “Hawaii ni Sumu” here.)

Purchasing an existing business in Hawaii can be an exciting and profitable venture, but careful planning and investigation is necessary to ensure a buyer avoids the many expensive and time-consuming traps for the unwary. Previously, attorney Go Kobayashi discussed the differences between a stock sale and an asset sale. In this article, I will discuss five common pitfalls to avoid when buying an on-going business.

1. Due Diligence. Typical purchase contracts provide buyers a period of time to conduct due diligence on the business. During this time, a buyer will have access to the financial and other records of the business before committing to the purchase. This inspection opportunity is critical and should be used by a buyer to carefully review everything about the business. Buyers often engage consultants to review the financial and tax records, inspect the physical premises and equipment, and investigate the background of the business and its principals. When the purchase involves real property, a buyer may order an appraisal, a survey, a title inspection, and an environmental survey. Having this information early will help a buyer negotiate additional terms to address unexpected problems, or provide an opportunity to terminate the purchase if the risk is unacceptable.
2. Approvals. Most business acquisitions will require the approval of some third parties. If the seller is leasing property, the parties will likely need to obtain the landlord’s approval to an assignment of the lease to the buyer, a process which may take some time. Purchase of a franchise business usually requires the franchisor’s approval. Restaurants often have liquor licenses and other approvals that are needed by the buyer to continue business operations. Depending on the type of business, other governmental approvals or new licenses may be required. A purchase contract should address these issues in a manner that will allow the buyer to immediately engage in and continue an ongoing business after the purchase.
3. Liabilities. Whether structured as an asset sale or a stock sale, one of the greatest concerns of any buyer is taking on “hidden” or contingent liabilities. The two greatest protections against this risk are conducting careful and thorough due diligence, and including sufficient representations, warranties, and indemnities by the seller in the purchase contract. A buyer needs an experienced business attorney to assist in identifying potential risks and concerns, mitigating liability exposure, and ensuring the legal requirements for an on-going business are fully addressed to avoid surprises and delays. Buyers should also strongly consider forming a Hawaii business entity to own and run the business, as that will provide liability protection for the individuals involved.
4. Employees. One of the greatest assets of any business is its employees. The employees can also be one of the greatest risks a buyer takes on with a new business. Employment concerns can include disgruntled employees, unknown employment-related claims (such as discrimination, sexual harassment, or unfair treatment), workers’ compensation claims, and violations of federal or state employment laws. A buyer should carefully investigate and consider which employees will continue or be rehired upon the purchase of a business, and make sure to have employment contracts, insurance coverage, and other employment-related protections in place before taking over the business. Seller indemnities for pre-closing employment-related claims are also important to protect a buyer from claims resulting from the seller’s employment practices, especially for claims which may be made by an employee after the buyer has purchased the business.
5. Tax Issues. Every buyer should have experienced, reliable tax counsel throughout the acquisition of a new business. Businesses are subject to various taxes at the federal, state, and local levels, and buyers may be able to structure an acquisition in a manner that will avoid detrimental tax treatment of the transaction.

These are only five of the common pitfalls unwary buyers may encounter in acquiring a Hawaii business. I highly recommend a buyer retain legal counsel early in the purchase process to assist them in structuring the agreements, ownership, and transition of a new business. Engaging counsel in early in the process will help protect the buyer’s interests and avoid these and other potential problems that can turn a dream business into a nightmare.