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Buying a Restaurant: Key Legal Issues to Consider

Buying a restaurant is often thought of as a less risky option than starting your own restaurant business from the ground up. However, without proper research, due diligence, and consideration for the essential legal steps and potential liabilities involved, it can be even more risky than starting your own restaurant.

For example, are there existing liabilities, such as unpaid overtime or healthcode violations? Has the previous owner been in compliance with tax law? Is the business adequately insured? What are the terms of the seller’s commercial lease?

These are just a few of the questions that you need to ask as you approach the purchase of a restaurant. The points below comprise a short list of the legal aspects involved in buying an existing restaurant.

  • Always use a qualified business attorney to help you pursue the purchase of a restaurant. There is a reason, or several reasons, why a restaurant owner chooses to market his or her restaurant for sale. A business attorney will be able to spot potential legal issues involved in the purchase, advise you as to your liabilities upon purchase, and help you structure a suitable business entity, such as an LLC or corporation, for the acquisition.

  • Perform your due diligence. Have your attorney help you ascertain whether there are any outstanding or existing liabilities relating to the business, such as unpaid overtime for staff or health code violations. Are workers fully documented? Have detailed employee files been created? Are any employees being misclassified as independent contractors? Have sales taxes been paid? These are all questions you must ask yourself (and your attorney). If there are existing liabilities, one solution may be to purchase only the assets of the restaurant and not the liabilities. In other words, don't buy the business, just buy the assets. For example, using an asset purchase agreement, acquire the location, equipment, name, inventory, and goodwill. Form a business structure, commonly an LLC, to purchase these assets. Employees, in most cases, are terminated at the end of their last day under old ownership and hired by the new LLC the next day. However, if taking this approach, be conscious of non-compete laws in the State of California (discussed below).

  • Negotiate a non-compete clause if a) you intend to purchase the business (not just the assets); b) the seller is an LLC or corporation; and c) you intend to purchase substantially all of the seller's shares or interests. Otherwise, the non-compete clause will likely be unenforceable under State law. This can be a major issue for new business owners. If the seller has the legal right to open a competing restaurant next-door, this is something that you should be aware of before you purchase.

  • Obtain approval from the California Alcoholic Beverage Control (ABC). You cannot simply purchase a liquor license. You must first obtain ABC approval for transfer of the license. This is a time-consuming and somewhat complex process. Transfers are closely scrutinized by the ABC and there is often a 55-65-day waiting period. Transfers cannot occur for at least 30 days. It is, however, possible to receive a temporary permit pending final approval of the transfer. ABC approval may be used as a condition in the asset purchase agreement allowing you to "back out" of the deal if approval cannot be obtained.

  • Use a letter of intent or memorandum of understanding to outline the terms of the transaction. If appropriate or desired, ensure with your attorney that the document is binding pending execution of a complete asset purchase agreement. This will, in effect, preserve your right to purchase the restaurant, even if another buyer makes an offer.

If this much has not been made clear, there are several key legal issues to consider before you purchase a restaurant. Always seek the advice of qualified tax and legal professionals before acquiring any restaurant business.

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