Why you should perform a lien search prior to buying a business
When you buy a business, it’s common sense to know exactly what you’re getting into – so be sure to do your due diligence before you part with your money. Buying a business can be a fantastic opportunity to make money or a disaster is simply waiting to happen, depending on how much work you put into making sure that it’s the right step.
Before you take the plunge, you should investigate the business to detect any hidden issues and problems, by asking all the right questions and making sure that you get a good look at all the paperwork. Some information will be available from public sources, such as the extent of equipment liens, but you’ll also need to be prepared to ask the current owner of the business, and perhaps its employees, to find out everything that you can before deciding whether or not this organization will be a worthwhile investment.
Before you begin, you should be ready to sign a confidentiality agreement – this lets the current owners know that any information you’re given will be used only to check out the business, even if you don’t end up making the purchase. The agreement should allow you to share the information only with your accountant and your lawyer – two important people to consult when it comes to making your decision.
Investigating Business Finances
When it comes to due diligence before buying a business, the first step is to learn as much as you can about the financial condition of the business – the good, the bad, and the ugly. You should get hold of important documents like the current balance sheet, profit and loss statements for the past five years, income, employment and sales tax returns for the past five years, accounts payable and receivable, any audited financial statements, and more if you can.
You should also obtain a list of business debts – and any further information on whether or not the creditors have a security interest on any business assets, which is basically the lien check. You or your lawyer can check public records at sites such as publicrecordsreviews.com to double-check on liens. This site allows you to search for any business and gain access to any public records on file. If you find that a UCC-1 form was filed by a bank, creditor or supplier when they extended credit to the company, then it’s important to understand that if the debt went unpaid, the lender can still seize any secured assets, even after ownership passes to you.
What is a Lien?
A lien is a legal interest or right on the part of a creditor in property or another asset owned by a borrower – either an individual or business. For buyers, this translates to the fact that if you purchase items that have a lien against them, the creditor has an interest in the property that you have acquired, and will be within their rights to seize it if debts go unpaid. This could be trouble for you as a buyer if the lien is still intact when the business changes hands. You should always be conducting due diligence by searching for lien records before buying, however, it is possible to word any purchasing agreement in a way that ensures that you are protected.
The Uniform Commercial Code (UCC) is made up of a collection of rules around how commercial transactions work in the US. Bear in mind that UCC liens are not a bad thing – it’s normal, and often common for them to crop up in the course of business. A lien may arise when purchasing real estate, purchasing equipment with trade credit, or securing creditor financing.
A UCC lien may be placed on a company when it is entered into a financial agreement, which is secured by assets offered as collateral. The purpose of putting the lien in place is to notify other lenders that the business is in debt to this lender and that the business’s assets are, therefore, of interest to the lender until the debt is repaid in full. The filing of a UCC usually begins when a business signs a security agreement to pledge assets to a lender. UCC liens are first come, first serve – meaning that the first creditor to file a UCC lien against a certain asset will be entitled to collect it in the event of default.
UCC liens are often a required step to protect lenders against borrowers who may try to get several loans using the same asset as security. For example, a business may be able to obtain two or more loans from different lenders using the same equipment or property as security or collateral, if not for the UCC lien notifying the lender that the asset is already secured.
Specific Collateral UCC Liens
This type of lien is filed when more than one specific asset is used as collateral, rather than every asset owned by a business. For example, the loan may be secured with one asset such as a certain piece of equipment or business property. This type of UCC lien is most often used when a loan is borrowed for specific purposes, such as inventory financing or purchasing equipment.
This type of lien is used when a lender has an interest in all the assets that a business owns. When a blanket lien is filed, it’s usually difficult for the borrower to borrow further money until the debt is fully repaid. This type of lien is more commonly seen when it comes to bank loans where lenders wish to ensure that their loan is fully secured. Blanket liens tend to act as an extra layer of security for lenders, as it gives them a right to all the assets owned by a business if a debt goes unpaid. For borrowers, blanket liens can have some advantages, too – agreeing to allow lender interest in all assets may allow for additional flexibility when it comes to underwriting or the speed of providing finance.
Unlike UCC liens, which are not usually a cause for concern, tax liens should be alarming for any potential business buyer. A tax lien is filed by the IRS when a business fails to pay taxes in a timely manner or owes tax that should have already been paid. The lien is generally filed on the business’s property, which also includes any assets gained in the future while the lien is still in effect. And, state and other local taxing authorities may also place a lien for unpaid state and local taxes on a business.
Judgment liens are put in place after a lawsuit or other court case is lost by an individual or business and a court judgment is entered against them. They can be placed on a wide variety of business assets including real estate, business vehicles, personal property, and property that is gained after the lien is filed.
How a UCC Lien Can Affect Your Business
Generally, as long as debts are repaid on time, and you do not need to borrow additional capital, a UCC lien will not have a huge effect on your business. However, there are some risks of UCC liens that will need to be considered if you are thinking about buying a business that has one filed against borrowing.
- Difficulty borrowing: A UCC lien can make it difficult for you to borrow money – even as a new owner of the business – in the future. Prior to repaying the debt, a UCC lien may stand in your way of obtaining additional financing, even if any previous financing was borrowed by the last owners. This may not always be the case with specific collateral UCC liens, as there is the option to use other assets as security, but will usually always be the case with a blanket lien.
- Your business’s credit report: Any UCC liens from the past five years will show up on your business’s credit report, even after you take over as the new owner. Although a UCC lien itself will not have a negative impact on your credit score, it will likely be taken into consideration in any future lending decisions when lenders review the report, even if the debt in question has been repaid in full and the lien is no longer in place. Bear in mind that the repayment history of the debt will affect your ability to borrow further finance for your new business, so be sure to check this before you make the decision to buy.
- Loss of assets: When assets are used as collateral for borrowing money, the business will always run the risk of losing these assets if they fail to make repayments. Therefore, if you are considering buying a business that has a UCC lien filed against certain assets by a lender, it’s important to be certain that you will be able to continue repaying the debt or you risk losing valuable assets. Any assets used to secure a loan should be considered at-risk until the debt is fully repaid.
For business buyers, liens can often pose a significant risk. It’s important for buyers to conduct due diligence and include a UCC, judgment, and tax lien search prior to closing a business transaction.