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Should A Buyer Be Allowed To Operate A Business Before Escrow Closes?



Posted By: Peter Siegel MBA: BizBen Founder, Lead Advisor.   Business buyers, brokers, owner/sellers all ask this question at some point. So I decided to ask some of the top Intermediaries in the California marketplace what they thought of the idea. Most of the ProIntermediaries on BizBen agreed with me on taking early possession before the close of escrow.

A business broker who is part of the BizBen Network and is newer in the California business brokerage industry just asked me a question - how I feel about his seller client who was asked by a buyer of the businessto start operating the business before the escrow period had finished.

I told him I didn't think it was a good idea under any circumstances to let a buyer start operating a business during the escrow process.

I would love to hear from other BizBen viewers: brokers, agents, advisors, escrow officers, etc. on what they feel on this topic - any positives to letting a buyer start running a newly purchased business before escrow closes?

I agree with many on this forum, and that a buyer should NOT be able to operate the business before the close of escrow. There are many reasons why the buyer should wait till after the close of escrow to operate the business or begin training, one of the primary reasons is a potential clash of leadership in the business, which could end a deal before it's done. I've seen deals either not close or almost not close, simply because the buyer and seller got into a disagreement over something inconsequential. A buyer also without proper training might become overwhelmed and decide not to buy the business.

I agree with many on this forum, and that a buyer should NOT be able to operate the business before the close of escrow. There are many reasons why the buyer should wait till after the close of escrow to operate the business or begin training, one of the primary reasons is a potential clash of leadership in the business, which could end a deal before it's done. I've seen deals either not close or almost not close, simply because the buyer and seller got into a disagreement over something inconsequential. A buyer also without proper training might become overwhelmed and decide not to buy the business.
NO. All the explanations and exceptions aside, I can't think of any circumstance in which this is a good idea. The only possible exception would be when the business has already "closed in escrow" and there is no option for the buyer to back out. Just be sure that the seller has a damn good attorney on his side.

NO. All the explanations and exceptions aside, I can't think of any circumstance in which this is a good idea. The only possible exception would be when the business has already "closed in escrow" and there is no option for the buyer to back out. Just be sure that the seller has a damn good attorney on his side.
Seldom do you see a situation where so many things can go wrong. But it can come up, right when a great sale is moving smoothly through escrow, the buyer decides they want to take over early. Once the fox is in the hen house, as they say, it is too late to close the door.

Why, do you ask, would a seller even consider the buyer's request? Well, I've seen my share of tempting circumstances;

1. The seller or a family member is facing serious health issues.

2. The seller is planning a move out of the area and time is of the essence.

3. The seller is short on operating capital; perhaps loans are coming due or credit card loans are eating up the cash flow.

4. The landlord may be pushing for back rent or wanting a new tenant.

After many years as a business broker, I can readily name a few potential pitfalls due to an early possession;

1. The buyer takes over prematurely and the once-dedicated employees suddenly lose all prior loyalty and proceed to bombard the buyer with all the operation's short comings based on their expertise.

2. Employees, seemingly en masse, begin to ask for raises they feel are long overdue.

3. Deferred maintenance issues rear their ugly heads in timely support of "Murphy's Law".

4. Buyer's remorse can hit once they experience first hand all the work entailed in the new venture and since escrow hasn't closed, they might elect to walk away.

I once had a restaurant in escrow where the seller agreed to allow the buyer take over with a temporary liquor license. First order of business for the new buyer was to change the name and embark on a major remodel. The buyer spent the balance of his cash on a total and dramatic makeover. After all, he had a partner that was going to fund the balance of the purchase at close of escrow. BUT, after thinking over the whole investment idea, the money partner walked away.

The buyer was unable to come up with the cash and the seller had to cancel the temporary liquor license in order to get him out. Long story short, the too-eager seller ended up closing the restaurant because the remodel did not work with his concept and his customer base had already been impacted during the take-over.

To avoid these pitfalls, get both buyer and seller together early on during the honeymoon phase and have them unequivocally agree to the following;

1. Place the entire purchase price in escrow.

2. Do not allow any changes to the business itself, until escrow is closed.

3. Have the parties agree to a predetermined period of training where the seller may shadow the buyer. This can occur during escrow with the seller remaining firmly in control of the operation, the staff and the cash.

Be clear as you can with the parties on these points. It's wise to cross the T's and dot the I's. Urge them to proceed through the escrow process as intended. In the end, the buyer can transition into ownership seamlessly and the seller will be appropriately compensated and able to move on.

Seldom do you see a situation where so many things can go wrong. But it can come up, right when a great sale is moving smoothly through escrow, the buyer decides they want to take over early. Once the fox is in the hen house, as they say, it is too late to close the door.

Why, do you ask, would a seller even consider the buyer's request? Well, I've seen my share of tempting circumstances;

1. The seller or a family member is facing serious health issues.

2. The seller is planning a move out of the area and time is of the essence.

3. The seller is short on operating capital; perhaps loans are coming due or credit card loans are eating up the cash flow.

4. The landlord may be pushing for back rent or wanting a new tenant.

After many years as a business broker, I can readily name a few potential pitfalls due to an early possession;

1. The buyer takes over prematurely and the once-dedicated employees suddenly lose all prior loyalty and proceed to bombard the buyer with all the operation's short comings based on their expertise.

2. Employees, seemingly en masse, begin to ask for raises they feel are long overdue.

3. Deferred maintenance issues rear their ugly heads in timely support of "Murphy's Law".

4. Buyer's remorse can hit once they experience first hand all the work entailed in the new venture and since escrow hasn't closed, they might elect to walk away.

I once had a restaurant in escrow where the seller agreed to allow the buyer take over with a temporary liquor license. First order of business for the new buyer was to change the name and embark on a major remodel. The buyer spent the balance of his cash on a total and dramatic makeover. After all, he had a partner that was going to fund the balance of the purchase at close of escrow. BUT, after thinking over the whole investment idea, the money partner walked away.

The buyer was unable to come up with the cash and the seller had to cancel the temporary liquor license in order to get him out. Long story short, the too-eager seller ended up closing the restaurant because the remodel did not work with his concept and his customer base had already been impacted during the take-over.

To avoid these pitfalls, get both buyer and seller together early on during the honeymoon phase and have them unequivocally agree to the following;

1. Place the entire purchase price in escrow.

2. Do not allow any changes to the business itself, until escrow is closed.

3. Have the parties agree to a predetermined period of training where the seller may shadow the buyer. This can occur during escrow with the seller remaining firmly in control of the operation, the staff and the cash.

Be clear as you can with the parties on these points. It's wise to cross the T's and dot the I's. Urge them to proceed through the escrow process as intended. In the end, the buyer can transition into ownership seamlessly and the seller will be appropriately compensated and able to move on.
Contributor: Business Appraisals, Valuations Advisor
Never! There is always the possibility of buyer's remorse even under ideal circumstances. This remorse usually disappears when a buyer gets to know the business which may take a few months. Letting him be involved in the business before the close of escrow can possibly end a perfectly great sale.

Never! There is always the possibility of buyer's remorse even under ideal circumstances. This remorse usually disappears when a buyer gets to know the business which may take a few months. Letting him be involved in the business before the close of escrow can possibly end a perfectly great sale.
I never recommend that a Buyer take over a business before escrow closes. Sometimes this has happened because the Seller can't continue to operate but it should be done only as a last resort. Get an operating agreement done, landlord consent and all funds in escrow before doing this. If you serve alcohol get a temporary permit.

I never recommend that a Buyer take over a business before escrow closes. Sometimes this has happened because the Seller can't continue to operate but it should be done only as a last resort. Get an operating agreement done, landlord consent and all funds in escrow before doing this. If you serve alcohol get a temporary permit.
I have never allowed my sellers to let a buyer into the business until escrow closes, except in the case of of early possession on an ABC License. The analogy I like to use is; it's like learning how to swim. If you drop someone in pool the edge is so close its easy to give up when it gets hard, but if you drop them in the ocean 100 yard off shore and point to beach they'll figure it out. Many buyers ask, but it is always a bad idea. If someone is serious about buying a business they'll learn all about running it when they own it.

I have never allowed my sellers to let a buyer into the business until escrow closes, except in the case of of early possession on an ABC License. The analogy I like to use is; it's like learning how to swim. If you drop someone in pool the edge is so close its easy to give up when it gets hard, but if you drop them in the ocean 100 yard off shore and point to beach they'll figure it out. Many buyers ask, but it is always a bad idea. If someone is serious about buying a business they'll learn all about running it when they own it.
Contributor: Due Diligence, Valuations Advisor
About ten years ago I had an accounting client in the Bay Area who entered into an agreement to sell his business. Buyer negotiated a contract to operate the business as general manager while financing was arranged for the purchase. The original 90 day contract was extended a few times as the buyer, seeing all the downside to the purchase, hesitated to close. Eventually the buyer did not perform and found reasons to withdraw his offer. Each sued the other for breach of promise (contract) or something. There were as usual no winners in that scenario. When you buy a business you have a right to complete a due diligence, but you do not have the right to try it out and see if you like the business, get along with the employees, or determine if you are able to maintain customer relationships. Allowing a buyer who has not closed the deal into the business is a serious mistake.

About ten years ago I had an accounting client in the Bay Area who entered into an agreement to sell his business. Buyer negotiated a contract to operate the business as general manager while financing was arranged for the purchase. The original 90 day contract was extended a few times as the buyer, seeing all the downside to the purchase, hesitated to close. Eventually the buyer did not perform and found reasons to withdraw his offer. Each sued the other for breach of promise (contract) or something. There were as usual no winners in that scenario. When you buy a business you have a right to complete a due diligence, but you do not have the right to try it out and see if you like the business, get along with the employees, or determine if you are able to maintain customer relationships. Allowing a buyer who has not closed the deal into the business is a serious mistake.
Contributor: Helen Yoo, Escrow Services: Southern CA
Actually we get this question asked a lot during the escrow process. If the parties do agree to do an early possession, I always tell them that the lease and insurance should be in the buyers name and all the consideration should be deposited into escrow plus that I would have them sign an early possession instruction. I had one case where there were no brokers involved and the seller was willing to give possession to the business without having the buyer put in all the consideration into escrow. After buyer took possession, they were making all the excuses why they will not pay for the total consideration amount that was initially agreed upon. It causes a legal problem for both parties. So, yes they can give early possession, please make sure they have a lease and insurance in the buyer's name, total consideration deposited into escrow and sign a mutual instruction covering each other from further liability associated with the early possession. Hope this helps.

Actually we get this question asked a lot during the escrow process. If the parties do agree to do an early possession, I always tell them that the lease and insurance should be in the buyers name and all the consideration should be deposited into escrow plus that I would have them sign an early possession instruction. I had one case where there were no brokers involved and the seller was willing to give possession to the business without having the buyer put in all the consideration into escrow. After buyer took possession, they were making all the excuses why they will not pay for the total consideration amount that was initially agreed upon. It causes a legal problem for both parties. So, yes they can give early possession, please make sure they have a lease and insurance in the buyer's name, total consideration deposited into escrow and sign a mutual instruction covering each other from further liability associated with the early possession. Hope this helps.

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