This article was contributed by Mike Young, an international business lawyer who helps clients buy and sell companies. This is part one of a two part series on legal considerations and tips when buying an e-commerce business.
Why a Qualified Internet Business Lawyer is Important
Before buying an online business you should retain an experienced internet business transactional lawyer to help you. Why? There are many legal considerations when buying any business assets and it’s your responsibility to ensure you are adequately protected. Some basic considerations include the type of business entity you should use to acquire the assets, legal due diligence matters, and how to reduce your risk of loss before and after executing the deal.
So what characteristics should your lawyer possess? The right lawyer will understand e-commerce, won’t try to reinvent the wheel and works with you and the other parties to make the deal come together.
Understands e-commerce
There are many business lawyers that have limited or no experience representing clients in e-commerce matters. If you retain one of them to represent your interests, you’ll be overpaying for the lawyer to learn the basics of e-commerce law. Your lawyer should be able to understand the fundamentals of the online business you want to buy without having to spend time researching. A lawyer should have at least two years of e-commerce transactional experience and five years of general transactional experience.
Doesn’t reinvent the wheel
The right lawyer will not require you to pay for them to reinvent the wheel. This includes both learning the fundamentals of e-commerce regulations or drafting legal documents from scratch. The lawyer will already know the law and have documents from prior deals that can be tailored to protect you in your purchase.
It’s reasonable to request a flat fee quote for the lawyer’s professional services (e.g. a percentage of the purchase price or other fixed fee). However, there are two important exceptions where it is likely you will pay legal fees at the lawyer’s hourly rate.
First, if the lawyer has to review legal documents furnished by the seller or the seller’s broker it may take time for the lawyer to analyze what’s missing and clauses that should be revised to protect you. Although sometimes these documents are professional and require minimal review, more often than not your lawyer will analyze a variety of legal provisions pieced together for the seller by a non-lawyer that have major flaws and key omissions. It may make sense for everyone involved to have your lawyer use his legal documents as a framework than try to repair something that was prepared by a non-lawyer.
Second, your lawyer’s flat fee quote may only cover one draft and perhaps one set of revisions to the legal documents needed for your e-commerce acquisition. This to prevent a “time suck” situation where one or more parties insists upon many sets of minor revisions rather than getting the deal done.
Deal-maker while protecting the client
A good Internet transactional lawyer will focus on how to make the deal work with a “win-win” mindset. This type of lawyer is often referred to as a “deal-maker.” In short, this type of lawyer is a professional problem solver.
If there are legal problems with the deal, the lawyer will work with you and collaborate with the other parties to see how the issues can be resolved rather than trying kill the deal by throwing up road blocks.
This does not mean that your lawyer will be abandoning the role of protecting you. However, they will present legal issues to you with proposed solutions. If there’s a risk that you’re willing to assume, you will be given all the information needed to make an informed business judgement.
Why an Experienced E-Commerce Financial Advisor is Important
When deciding whether or not to buy an online business, picking the right type of financial advisor is important in order to determine whether or not the numbers work for you.
Understands e-commerce companies
Like your business lawyer, you’ll want to retain a financial advisor who has e-commerce experience. Otherwise you’re overpaying for your advisor to learn the basics that an experienced advisor would already bring to the table. In addition, a financial advisor who is a novice to e-commerce will likely miss key financial details and benchmarks that can make the difference between a good deal and a bad one.
Helps determine value through due diligence
Examining the seller’s financials, your financial advisor will be able to use various methods to help you determine the true value of a potential acquisition to you. While a seller’s valuation may be based on the Internet business’ revenues, it’s likely that your advisor will focus on discretionary earnings or a similar profit-based methodology rather than actual or potential revenues.
A common mistake made by sellers and inexperienced seller brokers is to price an e-commerce company based upon the business’ future potential rather than as it currently exists. The typical pitch is that the company is worth more because you can increase profits by doing certain things to grow the business after buying it.
An experienced financial advisor representing your interests will be able to identify and debunk crystal ball financial projections based on future speculation. Even if the numbers are accurate, there’s no reason to pay twice for them. In other words, the seller should not be paid for value that doesn’t yet exist while you pay again in time and money by doing the things necessary to make those profits a reality after buying the business.
Services may be provided to seller via business broker
Financial advisor services may be provided in-house by the seller’s broker or to the seller via a third party. Although those may be a good starting point, to perform due diligence correctly you’ll want to have your own financial advisor crunch those numbers to determine actual profit, discretionary expenses that can be removed upon acquisition.
Structuring a Transaction
Asset Purchase versus Buying Equity
One of the most important decisions you’ll make when buying an online business is whether you’ll be making an asset or equity purchase.
Difference between an asset and an equity purchase
When making an asset purchase, you’ll be identifying key assets of the seller’s company that you will be purchasing. In contrast, with an equity purchase you will be buying the equity in the seller’s company that owns the assets.
Benefits of an asset purchase
There are many benefits to an asset purchase. From a legal standpoint, the primary reason to do this instead of an equity purchase is to reduce your liability risks. Your entity acquires the assets it needs to continue business operations but generally not the existing or potential liabilities of the seller’s entity.
An asset purchase may also be advantageous to the seller too. For example, if the business being sold is just part of the seller’s online ventures owned by a common entity, the seller will likely want to retain that entity to continue operations of the ventures not being sold. In addition, there may be certain hard assets (e.g. company vehicles and computers) that it makes sense for the seller to retain because they would be of limited value to you after acquiring the assets you truly need to run the business.
Dangers of an equity purchase
In contrast to an asset purchase, buying a privately held company’s equity is a high risk gamble from a legal liability standpoint. Common risks include unpaid taxes and penalties, lawsuits for conduct prior to the sale, and unfavorable contracts with suppliers and employees. As noted above with an equity purchase, you may be overpaying in order to compensate the seller for assets you really don’t need to operate the business.
Unless your financial advisor and legal counsel provide you with valid reasons for making an equity purchase, you should insist that any acquisition is an asset purchase instead.
Picking the Right Business Entity to Protect Yourself Online
Types of business entities
The four most common legal structures for owning an online business are sole proprietorships, general partnerships, corporations, and limited liability companies (LLCs).
Selecting an entity for your e-commerce business
Sole proprietorships and general partnerships should not be used to acquire an internet business because there is unlimited personal liability for the company’s obligations. For example, if there’s a lawsuit, your personal assets can be confiscated in some circumstances to satisfy any judgment. This can include taking your home, vehicles, bank accounts and other assets.
Many Internet entrepreneurs use a limited liability company because it offers the same type of personal asset protection as a corporation, but with less paperwork to form and maintain the business entity.
Some choose to use a corporation instead for protection but it is more time-consuming to set up and maintain the entity. Unless your lawyer or financial advisor has a good reason for using a corporation to acquire an e-commerce business, it’s likely that an LLC will be the better choice.
Observing entity legal formalities
Whether you opt for an LLC or a corporation, it’s essential to maintain the formalities of the business structure in order to keep the entity’s liability shield to protect your personal assets. Commingling personal and business assets, failing to maintain proper entity records, and signing contracts in your individual name instead of on behalf of the entity are examples of self-sabotage that can expose you unnecessarily to personal liability in transactions that would otherwise be protected by the entity’s shield.
Author Bio: Mike Young
For more than 21 years, international business lawyer Mike Young has helped clients set up, protect, buy, and sell companies. President of the Internet Attorneys Association LLC, Mike also serves as a foreign legal consultant in the Republic of Panama.
Happily married, Mike enjoys spending time with his family, his Pembroke Welsh Corgi dogs, and training in Krav Maga self-defense. To learn more, go to MikeYoungLaw.com. While there, be sure to subscribe to his complimentary newsletter where you will receive important e-commerce business legal news and tips by email.