One of the common issues that arises when buying or selling a small business is how to tackle unearned income. This is an area that is often overlooked during the negotiations and can present unwelcome surprises for the Seller, the Buyer, or both, depending on how it is addressed, or if it is addressed, in the Asset Purchase Agreement.
The following are a few examples of common situations in which unearned income can become an issue:
- Mailbox Stores – It is a common practice for customers to pay for their mailbox rental 3 months, 6 months, or even 12 months at a time. In such cases, the Buyer will be providing the mailbox services to these clients and incurring all the business costs from the date the transaction closes until the date in which the customer's mailbox renewal is due again.
- Tutoring Center – Many tutoring facilities sell tutoring services in blocks of hours. What happens when customers have paid for 50, 60, 80 or even 100 hours of services which have not yet been provided when the business transaction closes? The Buyer will incur the costs of providing those services for the customers including payment to staff as well as overhead associated with the business premises.
- Website Development – Web Design companies frequently take deposits before they begin to design and develop the client's web site. It is not uncommon for part of the deposit to be earned while the other portion remains unearned at the close of the transaction.
When buying any company, all customer deposits and fees which have been received by the Seller for services which have yet to be rendered should be credited to the Buyer at closing. As a Buyer, make sure you understand whether customer deposits or prepayments have been received by the Seller. Have the discussion and make sure the purchase agreement clearly states that customer deposits will be credited to the Buyer at closing. Otherwise, you may find yourself providing services for hours, weeks or even months, for which the Seller has been paid and you have not.