What are the Average Legal Costs for Buying a Small Business?

For many entrepreneurs, starting a new business can be both their life-long dream and an intense nightmare. The difficulties with formulating a sound business plan that coincides with their passions, handling all the legal paperwork, and dealing with funding and other logistical hurdles, can often discourage many from following their dreams.

Because of this, some entrepreneurs who are in the position to circumvent all this nonsense decide instead to purchase a pre-existing small business. The benefits of doing this are numerous, but there is often at least one downside: cost.

Many people want to know exactly how much it costs to purchase a small business that is already set up. The answer is somewhat complicated and depends on a variety of factors. To shed light on the answer, let's discuss some of the considerations and differences that can affect the true cost of buying a small business.

Selecting Your Business Type

Arguably, the biggest factor in determining legal costs in acquiring a small business is whether the business is fully developed and turning a profit or is merely a shell company that exists on paper.

A shell company that has been incorporated and is ready to do business can be purchased for as little as a few hundred dollars, says business lawyer Roger R Phipps from csbgroup. In cases such as this, the small business will have no assets, no revenue, and no employees – but purchasing a small business that exists in name only can save entrepreneurs from hours of paperwork, legal fees, and other obligations. There will be relatively few legal costs associated with transferring a shell company from one owner to another; potentially $1,000 or less.

Small businesses that are already operating and generating profits are substantially more expensive. In most situations, small businesses are sold for several times their annual adjusted net profit. A business that generates $100,000 per year in profit might enjoy a fair market price of $500,000 to $1 million, depending on the exact type of business. There are several variables that affect small business valuation, however.

Actual Legal Fees

In general, legal fees are affected by the overall price of the small business itself. Some lawyers operate by charging a percentage of the transaction while others may offer a flat rate based on the extent of legal work required. However, more often than not, the legal fees are calculated based on the number of billable hours.

This effectively results in the legal fees being calculated by the complexity of the sale and transfer. When dealing with smaller lawyers in smaller cities, these fees may amount to as little as $100-200 per hour. If you are purchasing a small business with the services of a senior partner at a law firm in a major city, however, expect the legal fees to quickly rise; anywhere from $500 to $1,500 per hour.

General Estimates of Legal Costs

While not applicable in every situation, a good rule of thumb in calculating legal fees for purchasing a small business follows predictable estimates.

For shell companies and other highly-affordable businesses that only exist on paper, you can usually expect legal fees to mirror that of the cost of the business itself. For small businesses that generate profits comparable to that of an average person's salary each year, this number will usually encompass about 20% of total costs.

For small businesses that have relatively large profits (six figures), anywhere from 10-15% of the total acquisition cost will be in the form of legal fees. Last, but not least, small businesses with very large valuations (in excess of a million dollars) will usually result in legal fees that are around 5% of the cost of the business itself.

Buying a small business can be a more streamlined way to follow your entrepreneurial dreams. However, there are substantial costs associated with doing so – with legal expenses being one of them. Expect to pay anywhere from $500 to hundreds of thousands of dollars, depending on the size, profitability, niche, and complexity of the small business in question.

FAQ

Q: What are the main factors that determine the legal costs of buying a small business?

A: The main factors are whether it is a shell company or an operating business, the valuation and profitability of the business, the complexity of the transaction, and the hourly rates of the lawyers involved.

Q: How much do legal fees typically cost for a small shell company?

A: Legal fees for acquiring a shell company are usually very low, around $1,000 or less.

Q: What percentage of the total cost do legal fees represent for larger businesses?

A: For small businesses valued at an average salary, legal fees are around 20% of the total cost. For six figure businesses, it's 10-15%, and for seven figure businesses, around 5%.

Q: How are legal fees generally calculated?

A: Most often lawyers charge hourly rates, so fees are based on the number of hours required for the legal work. Rates can range from $100/hr to $1500/hr depending on experience and location.

Q: Are there other ways lawyers charge for this type of transaction?

A: Some lawyers charge a flat rate or a percentage of the transaction value rather than hourly fees. But hourly is most common.

Q: What can increase the legal fees in buying a small business?

A: More complex transactions, higher business valuations, the use of high-priced lawyers, and a greater number of billable hours can all increase the legal costs.

Q: How can I estimate the total cost including legal fees?

A: Look at the asking price, factor in approximately 5-20% for legal fees depending on the size, get fee estimates from lawyers, and add other transaction costs. 

Conclusion

In conclusion, while buying an existing small business can help entrepreneurs avoid many start-up hurdles, the legal costs involved should be carefully considered. Do research to understand typical legal fees based on the business type, valuation, profitability, complexity, and hourly rates. Consider these costs as part of your overall budget when pursuing the dream of business ownership.

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