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Beyond the Menu: 10 Important issues to Keep in Mind when Selling or Purchasing an Established Restaurant

Joanna Renner with Douglas Burgess, Esq.*

Owning and operating your own restaurant is a dream come true for many individuals, but for the novice businessperson, there are issues and steps required that could be overlooked. On the other hand, experienced restaurateurs may be tired of the hectic pace and many demands of the food industry and are ready to get out of the business but are unsure of their responsibilities. This article acts as a primer to enable those interested in purchasing or selling a "going" business to know a little more about what is involved.

1. The Contract: The contract should include, as the basic terms and conditions, the full corporate names and addresses of the parties, purchase price, assets being purchased, due diligence / feasibility period, and date of settlement. However, there are many other factors to take into consideration when drafting a contract. For instance, from the Buyer's perspective, if there are employees, do you want to keep them, and if so, how many and under what conditions? The Seller and Buyer also need to come to an agreement on the bulk sales transfer taxes due - meaning are they going to split the difference or is the Seller or Buyer going to pay the full amount?

In addition, read carefully any language regarding indemnification of the other party, take into consideration bulk transfer notice requirements, and, as a Buyer, consider a "holdback" to ensure the cooperation of the Seller after Settlement for any lingering issues such as a transfer of a liquor license and payment of any state sales or withholding taxes. The Buyer needs to be sure to allow enough time for due diligence - so always overestimate how long it will take to negotiate a lease agreement or assignment with the landlord, go over the books and records of the business and get to know the area, type of work, and the employees.

It is a good idea to hire an experienced attorney to at least look over your contract and point out any trouble areas and to do any research in zoning, environmental and building issues for the feasibility study. From a Buyer's perspective, if purchasing a business from a corporate Seller, it is always preferable to purchase the assets of the corporation rather than the common stock of the owners of the selling corporation. When purchasing assets, you obtain a step-up in cost basis for depreciation purposes and you can acquire the assets free and clear of Seller liabilities (see #6 below). On the other hand, if common stock or membership interest is purchased the assets within the entity retain all of their existing tax attributes and liabilities, including potential contingent unknown liabilities.

2. Lease Negotiation/Assumption: Do your homework before beginning negotiations with the landlord. Find out what similar businesses in the area are paying per square foot of leased space. It could save you money in the long run to hire an expert to do that research for you, as they have established contacts and should know which figures are standard and which terms and conditions proffered by the landlord are out of sync with established practice. Knowing in advance what the area's going rate is gives you some ammunition when the landlord's new lease terms seem high or a little too one-sided. In addition, as a tenant you want to include as many renewal options as you can in the lease and also negotiate for an assignability clause.

3. Business Entity Information: If you have not already formed a limited liability entity, whether it is a corporation or a limited liability company, "LLC," contact your attorney and form one. Operating as a corporation or LLC will give you increased protection from personal liability should anything untoward occur. The main differences between a corporation and an LLC is the way they are taxed by the IRS. An attorney or an experienced accountant can explain these differences in more detail in order to help you decide which type to form. Additionally, if you choose to operate as a corporation you might want to think about making an "S" corporation election for income tax purposes.

Keeping a "Minute Book" that organizes all your corporate/company documents and other important papers makes future transactions, like refinancing a loan or purchasing a second business, proceed smoothly. In addition, if you are purchasing or selling essentially all of the assets of a corporate entity, Maryland law requires that Articles of Sale and Transfer be filed with the Maryland State Department of Assessments and Taxation.

4. Bill of Sale: This document is the "title" to the business. It is what actually transfers ownership. The Bill of Sale should contain language that the Seller covenants that it is the true and correct owner of the business assets being sold/purchased, and it should also reference the contract, the purchase price, list what assets and intangibles are being purchased, and that the assets are free and clear of all liens. Most of the items included in the Bill of Sale should have been negotiated as a part of the initial contract. The Bill of Sale helps to protect the Buyer if, at a later date, another individual or entity asserts a claim on the purchased business or assets. The Bill of Sale also has attached, as exhibits, documents showing the breakdown of the purchase price toward personal property, goodwill and other intangibles, the non-compete agreement, inventory, etc.

5. Liquor License Issues: A liquor license is a permit that enables the restaurant/tavern/bar to serve and/or sell alcoholic beverages. In Maryland, a liquor license is issued by the local City/County liquor board. Generally, two or three people involved in the business are required to apply for the liquor license and to be considered holders of the license, otherwise known as "licensees." Most counties require that at least one licensee be what is called a "resident agent." This means that the resident agent licensee must have lived in the county where the restaurant is located for at least two years, own his/her home, and be registered to vote. Please be aware that the licensees do not own the liquor license, however, they are considered the responsible parties for any violations, fees and fines issued by to the local liquor board.

Depending on the county/city where you are purchasing a business with a liquor license, and, if that liquor license is held by the Seller instead of the landlord, the Buyer must apply for a transfer of the license as soon as possible. (As an aside, even if the landlord holds the liquor license, chances are good that the new tenant will need to apply to remove the old tenant/add the Buyer to the license along with the landlord). Liquor license transfers are time-consuming and an experienced attorney can provide helpful guidance and information about the type of license, how to file the application, etc. One way to cut down on expenses is to do most, if not all, of the legwork yourself, including gathering the information to fill out the transfer application, getting any signatures required, and, after the application has been filed, arranging for any inspections and other miscellaneous tasks.

Remember, you must also do an inventory of all alcohol being transferred and report that inventory to the Maryland Comptroller on a bulk transfer application form. If the transfer process will not be complete before Settlement takes place, then it is imperative to have a management agreement in place to protect the Seller while the Buyer uses the liquor license that is in the Seller's name. Liquor license violations can be costly and could result in removal or suspension of the license.

6. Bulk Sales Act Compliance: Maryland Code, Commercial Law Title 6, a/k/a Bulk Transfers, requires that the Seller furnish the Buyer with a list of existing creditors, including business addresses. The Buyer must then notify the creditors AT LEAST ten (10) days prior to Settlement that the business is being sold. This affords protection to the Buyer so that if the Buyer is completely compliant with Title 6, then the creditors cannot hold the Buyer responsible for the Seller's debts. Additionally, do not forget to notify the State Comptroller, the IRS and, if there are employees, the Office of Unemployment Insurance.

As for the bulk sales tax, it is five percent (5%) of the amount allocated in the Bill of Sale toward tangible "personal property" transferred, such as equipment, supplies, inventory, leasehold improvements and receivables. Intangible personal property, such as goodwill, is excluded from the sales tax. Bulk sales tax on personal property is due after Settlement on the business and, if paid by the 21st day of the month following Settlement, there is a discount.

7. Upgrades & Improvements: Should you envision a brand new storefront or outdoor seating in your new restaurant, beware! While wonderful and possibly great additions to the premises, these additions could be in violation of local zoning codes if you do not get the required permit. Sometimes, getting the permit or a zoning variance is an easy process, though, invariably, there are snags because permits and variances may require the submission of plans, plus inspections of the premises, and possibly administrative hearings. Above and beyond hiring a contractor to remodel or add-on to the premises, the costs could also include filing and attorney's fees, hiring experts, i.e. engineers and professional permit "pullers" - who facilitate the permit process - as well as further negotiations with the landlord for its approval.

8. Accounting Services: Unless you have previous experience in business, including keeping track of income, expenditures, payroll and taxes due, it is a good idea to hire an accountant or accounting service to give you a little respite from the rigors of running this new business. An accountant will help with deciding how much of the purchase price to allocate to personal property, leasehold improvements, liquor license (if applicable) and goodwill, all of which have an effect on taxes due in the present and the future for both Seller and Buyer.

9. Non-Competition Agreement: This is a clause put in the contract and then attached to the Bill of Sale that requires the Seller to refrain from interfering with the purchased business and/or owning/operating a similar business within a certain distance and for a certain time period, i.e. 2 miles, 3 years, from the business purchased by the Buyer.

10. Miscellaneous Licenses, Permits and ID #s: In order to operate a business one must bow to the inevitable and give the government its due. In order to pay sales & use and withholding taxes in Maryland a business is required to submit a Combined Registration Application to obtain a retail sales tax license. A restaurant may also be required to have a Trader's license, which may be transferred from the Seller at a lower cost than applying for a new license. In addition, there are the usual health, electrical, building and fire department inspections required in order to be issued a food service permit and certificate of use & occupancy.

Purchasing or selling a business can be complicated. However, if you break the steps down to their parts, it only requires a moderate amount of preparation and research to make the transaction move smoothly. As a Buyer or Seller, hiring an attorney to represent your interests during the course of the transaction can take much of the burden off your shoulders. Buying that busy corner deli or restaurant two blocks over is a great idea, but remember that doing what you love has its mundane aspects as well.

This document is intended as a general guideline and is not intended to be legal advice. You should seek specific legal advise regarding your particular situation prior to proceeding further.

*Ms. Renner is a paralegal at Nolan, Plumhoff & Williams, Chtd. and a law student at University of Baltimore School of Law. Mr. Burgess is an attorney at Nolan, Plumhoff & Williams, Chtd. a general practice law firm in Towson, Md. with an interest in restaurant and liquor license matters. They can be reached at 502 Washington Avenue, Suite 700, Towson, Maryland 21204 (410)-823-7800.