Common Mistakes to Avoid When Buying a Business

Buying an existing business can shorten the path to revenue, customers, employees, equipment, and market presence. But a company that looks profitable on paper can carry debt, aging assets, customer concentration, unfavorable contracts, tax exposure, or other obligations that become the buyer’s problem after closing.

Knowing the mistakes to avoid when buying a business helps purchasers test what they are actually acquiring before committing their capital. DiFalco & Fernandez lawyers in New York and Florida advise buyers on potential acquisition risks, negotiate protective terms, and structure transactions around their business and investment objectives.

1. Relying Solely on Tax Returns

Tax returns are useful, but they should not be treated as a complete picture of a company’s financial health. They are prepared primarily for tax reporting, not to tell a prospective buyer whether the business can reliably produce the cash flow needed to support its purchase price. Review tax returns alongside profit-and-loss statements, balance sheets, bank statements, accounts receivable, accounts payable, payroll records, sales reports, merchant-processing data, debt schedules, and other financial records. 

2. Failing to Investigate Existing Liabilities

A buyer should understand both recorded and potential liabilities before signing a purchase agreement. These may include loans, unpaid taxes, pending lawsuits, employee claims, lease obligations, vendor disputes, warranty obligations, regulatory violations, liens, or contractual commitments.

An asset acquisition may allow the buyer and seller to specify which liabilities are assumed, but buying assets does not automatically eliminate every historical risk. New York courts recognize circumstances in which a purchaser of assets may face successor liability, including an express or implied assumption of liabilities, a de facto merger, a buyer that is a mere continuation of the seller, or a transaction entered into fraudulently to escape obligations. Florida courts recognize similar exceptions.

Tax rules can create separate exposure. For example, a New York buyer of business assets in a bulk sale generally must notify the Department of Taxation and Finance at least 10 days before taking possession or paying for the assets. A buyer who does not may become liable for the seller’s unpaid sales taxes. Florida law can also impose transferee liability for certain unpaid taxes of a business that is transferred.

3. Assuming the Seller Owns Everything Being Sold

Another costly mistake is assuming that equipment located inside the business, intellectual property bearing its name, or software used in its operations necessarily belongs to the seller.

Equipment could be leased or subject to a lender’s security interest. Software licenses may be nontransferable. A trademark may belong to an individual owner rather than the company. Vehicles may have liens. Important contracts may require third-party consent before assignment.

Under New York and Florida law, a security interest generally continues in collateral after a sale unless the secured party authorized a disposition free of that interest or another statutory rule applies. Buyers should therefore verify title and ownership, conduct appropriate lien searches, review intellectual property records, and identify required assignments, releases, and consents before closing.

4. Calculating Seller’s Discretionary Earnings Incorrectly

Seller’s discretionary earnings (SDE) is a measure often used to evaluate closely held businesses. It generally begins with business earnings and adds back certain expenses associated with the current owner, but determining legitimate add-backs requires care.

A seller may characterize expenses as discretionary or nonrecurring even though a new owner will continue to incur them. Likewise, an owner who performs multiple operational roles may be paid less than the buyer will need to spend on replacement employees.

A buyer should test each proposed adjustment instead of accepting the seller’s SDE calculation at face value. Normalized earnings should reflect the likely economics of the business under new ownership.

5. Failing to Negotiate Enough Working Capital

The purchase price is not the only money needed to acquire a business. Payroll, inventory, rent, insurance, vendor payments, taxes, utilities, marketing, and the timing of accounts receivable can create significant short-term cash demands. A company can be profitable and still experience a cash shortage.

The purchase agreement should clearly address the level of working capital expected at closing and the method used to calculate any adjustment. Depending on the transaction, buyers may negotiate a working-capital target, escrow, holdback, purchase-price adjustment, or other mechanism.

6. Ignoring Upcoming Equipment Replacement

Profits can appear stronger when a business has delayed major capital expenditures. A manufacturing company may rely on aging machinery. Technology-dependent companies may require substantial software or hardware upgrades.

Buyers should review equipment age, maintenance records, service history, warranties, lease terms, and expected replacement dates. Projected capital expenditures should then be incorporated into valuation and post-closing cash planning.

7. Buying a Business That Depends on One or Two Clients

A business whose value depends heavily on one relationship requires additional scrutiny and may require additional purchase protections. If one customer accounts for 40% of annual revenue, losing that relationship after closing could have an immediate effect on cash flow and valuation. Buyers should calculate customer concentration, review the duration and termination rights in major contracts, evaluate historical retention, and determine whether customers must consent to an assignment or change of control.

8. Failing to Secure an Enforceable Seller Non-Compete

When much of a company’s value comes from goodwill and customer relationships, a buyer may reasonably want protection against purchasing the business only to have the seller immediately compete for the same customers.

Restrictive covenants must be drafted in accordance with applicable law. In New York, courts generally apply a more lenient reasonableness standard to non-compete agreements given in connection with the sale of a business than to employee restrictions, because those covenants protect the goodwill the buyer paid for. Florida Statutes § 542.335 requires that a restrictive covenant be in a writing signed by the person against whom enforcement is sought, that the party seeking enforcement prove a legitimate business interest, and that the restraint be reasonably necessary to protect that interest. For covenants given by a seller of a business, the Florida statute presumes that a restriction of three years or less is reasonable and that one of more than seven years is unreasonable. Because non-compete law continues to change, covenants should be reviewed under the law in effect when the agreement is signed.

9. Choosing the Wrong Deal Structure

How the acquisition is structured can affect liabilities, taxes, contracts, financing, approvals, and post-closing obligations. An asset purchase allows the buyer to identify particular assets and assumed liabilities. A stock or membership-interest transaction generally transfers ownership of the entity itself, leaving the entity holding its existing assets and obligations. Neither structure is automatically better for every acquisition.

Purchase-price allocation also matters in asset acquisitions. In an “applicable asset acquisition” under Internal Revenue Code § 1060, buyers and sellers must allocate the consideration among the acquired assets using the residual method and generally must each report the allocation on IRS Form 8594. The allocation affects the buyer’s basis in acquired assets and the seller’s tax treatment.

10. Missing Industry Disruptions

Historical financial performance explains where a business has been. Buyers also need to determine where its market may be going.

New competitors, artificial intelligence, automation, changing consumer behavior, expiring intellectual property, regulatory developments, labor shortages, supply-chain changes, or dependence on a declining sales channel can reduce future earnings even when past performance looks strong.

Due diligence should test the assumptions behind projected growth. Buyers should ask why customers choose the company, how difficult its services are to replace, what threatens its margins, and what investment will be required to remain competitive.

11. Bypassing Qualified Professionals

Trying to reduce acquisition costs by skipping professional review can expose buyers to much larger losses later. A transaction may require coordinated input from attorneys, accountants, tax advisors, lenders, valuation professionals, insurance advisors, and industry consultants. Each reviews the deal from a different perspective.

Legal counsel, in particular, can investigate corporate records and liabilities, review contracts and ownership rights, structure the transaction, negotiate representations and warranties, address indemnification provisions, coordinate third-party approvals, and help ensure that the closing documents reflect the negotiated deal.

Consult Us to Avoid Mistakes When Buying a Business

The most important mistakes to avoid when buying a business often have one thing in common: the buyer accepted an assumption without testing it. DiFalco & Fernandez can assist entrepreneurs, investors, and business owners evaluating acquisitions in New York and Florida, as well as multistate transactions. Working with lawyers before signing can help buyers evaluate the deal structure, uncover liabilities, protect purchased assets and goodwill, negotiate practical safeguards, and enter ownership with a clearer understanding of the business they are buying.

This article is provided for general informational purposes only and is not legal advice. Reading it does not create an attorney-client relationship. DiFalco & Fernandez attorneys are admitted to practice in New York, Florida, and/or Connecticut.