Buying a Business, Do I really need an Escrow?

A common misconception is that escrows are only for buying a house or commercial property.  Often times a novice business buyer will buy a business and simply hand a check to a seller.  Yikes!  Using a bulk sale escrow is an important legal step in buying a business in California.  What is a bulk sale escrow?  Glad you asked!  In the sale of a business as an ongoing concern there is usually the transfer of some inventory and business equipment.  When more than half of the inventory and business and equipment are sold at one time, as is the case in the sale of a business, California law dictates that the sale follow the Bulk Sale Laws as defined in the Uniform Commercial Code of California.

The main purpose of the Bulk Sale requirements are to protect unsecured creditors of the business.  The law provides for this by mandating an advance notice of the sale in the form of the Notice to Creditors.   The Notice to Creditors has to be published for a minimum number of days, which is 12 business days in most cases.  Creditors of the subject business have to place claims into escrow for money they are owed during the bulk sale notice filing period, or risk not getting paid.  Types of companies that are typical creditors who would place claims would be equipment leasing and finance companies.  It is important to know how much is owed to the equipment leasing and finance companies, so that the payoffs can be arranged for through escrow.

Keep in mind that some equipment leasing and finance companies are quite large and it may take them some time determine payoff amounts.  Also, if there is an attempt to assume the financing or lease payments, then the application process itself may take more than 12 business days.  Thus, identifying the equipment leasing and finance companies should happen early in the Due Diligence Period, prior to opening a Bulk Sale Escrow.

This bulk sale notice and period offers the buyer some peace of mind, because it offers a chance to verify the seller’s claims about debts, and also, allows the buyer to eschew legal responsibility for the debts should the creditors fail to respond to the Notice to Creditors in a timely manner.  What happens if a creditor finds out after the close of escrow, their only legal recourse is to find the seller, though be aware they will try to collect from the buyer.  Buyers should keep copies of their escrow paperwork, because creditors who are late and didn’t get paid from escrow will knock on the door of the business demanding money.  The buyer needs to firmly let the creditor know that they missed the bulk sale notice period and that they need to track down the seller.

There is much more to a bulk sale escrow than just the notice to creditors.   Critical to properly closing a bulk sale escrow are receiving releases and clearances from the various state agencies.  The common agencies that need to give a clearance to escrow would be the Employment Development Department (EDD), the Franchise Tax Board (FTB) and The State Board of Equalization (SBOE).

The EDD is responsible for overseeing labor issues.  Obtaining an EDD clearance has never been much of a problem in the transaction we have been involved in.  If there are EDD problems, then be careful, because it means there are problem with the employees, which could leave a buyer in a real bind after taking possession.

The Franchise Tax Board is responsible for making sure the business and its owners have been paying their state taxes.  If there is a balance due by the business or the seller, make sure it is paid off before taking possession.  This is another good reason to have a Bulk Sale Escrow officer involved in the transaction, buyers want to make sure they are not taking a over a business or the corporation owning the business that has past due taxes, as that burden will to pass on the buyer.  We have run across transactions in which the seller owed back taxes.  Those situations were quite messy, and took some time to resolve.  So be prepared if there are tax problems for the seller, then it will take longer to close the transaction.

By far the biggest obstacle in completing a transaction is the State Board of Equalization (SBOE).  In our experience, the SBOE has delayed matters frequently, and they are a pain to deal with.  It really takes an experienced escrow officer to get any kind of response from the SBOE, let alone the response that is needed to close the transaction.  SBOE is responsible for collecting the Sales Tax due on the amount allocated to the Furniture, Fixtures and Equipment.  Buyers need to remember to budget for the sales tax amount.  Bear in mind that bulk sale escrows will withhold the seller’s proceeds pending the State Board of Equalization sending escrow a final release.  To get the final release, the seller needs to immediately file the Final Sales Tax Return for the business after the last day of ownership.  This means that the final SBOE release can not even be obtained until the buyer takes possession.  What happens here is the funds are withheld from the seller until the final release is obtained.  This final release is a challenge to get, which is another reason to work with an experienced Bulk Sale Escrow Officer.

Aside from the three releases, the bulk sale escrow officer will check for liens on the business with the Secretary of State’s office and local offices.

For More information on how Just Elementary, Inc, Commercial brokers can help you with buying a business call our Client Care Manager Sonia Chhabra at (888) 926-9193 or email cs@justelementary.com