Should the E-2 Treaty Investor buy an existing business, or build its own?
Each of these strategic options comes with its own joys, and sorrows. But the importance of this decision cannot be underestimated.
To gain the E-2 Treaty Investor visa, our clients must demonstrate that they have invested, or are actively in the process of investing, a substantial amount of capital in an active U.S. business. The investment is necessarily going to take shape either as our client’s creation of its own business in the U.S., or our client’s purchase of an existing U.S. business. While there are plenty of variations on each theme, there is no getting around the decision having fundamental importance not just in obtaining the E-2 visa, but in laying out the direction of the enterprise in the near and medium term.
In this article, we will comment on the question from the standpoint of a small to medium-sized investor. A large company may approach the issue from a different standpoint. For example, a foreign tire manufacturer who wishes to enter the U.S. tire market may decide to do so by first acquiring an existing U.S. brand, through an acquisition of stock, which it will eventually integrate into its own operations. That kind of transaction involves considerations beyond the scope of this short article.
1. Does the investment represent a new business to the investor?
The E-2 Treaty Investor visa does not require that the investment represent the same business in which the investor engaged in its home country. A person who owned bakeries in the Philippines can become a landscape designer in California.
However, to the extent our client is moving in a completely new direction, and is “learning-as-it-goes,” our advice is that it should consider buying an existing business rather than starting one from scratch. This advice may seem obvious but we can still elaborate.
As someone once said, there are the “known-knowns” and “known-unknowns,” but true risk arises from the ‘unknown-unknowns.” A client coming to the United States to do a business it has never been engaged in before has two sets of “unknown-unknowns,” (i) the business itself, and (ii) the United States. The two combined can be overwhelming.
Where does a given business get its workers, supplies, furniture, customers? (Not to mention, how does it make a profit?) How does it advertise its business? What laws and regulations govern its operations at the federal, state and local level? What licenses and permits are necessary in this kind of business? Which relationships with third parties are crucial? The list goes on and on.
With the right analysis, acquiring an existing business can provide a classroom into the study of these unknowns. And it may provide an almost instantaneous means of skipping the learning curve altogether, or greatly shortening it.
2. What is the real "goodwill" of the business?
“Goodwill” is an American accounting term that refers roughly to the value of a business in excess of its tangible or at least measurable net assets. (The value of these physical assets approximates another accounting term, “book value,” which is often calculated as actual cost less depreciation).
Let us illustrate goodwill with the easy example of two physically identical apartment houses in the same neighborhood. One is 90% occupied, has stable residents, has a long-time staff, and is part of an apartment-leasing company that enjoys a good reputation in the area. The other was closed by the city because of continued narcotics violations. You can probably assume that the first operation sells at a premium over the second, even though the cost of knocking down both businesses, and rebuilding them, would be exactly the same. The first not only needs at least a year to build up its occupancy, but must overcome the negative image it has gained in the community. It must also hire and train a competent staff. Its goodwill is negative.
In the context of an E-2 Treaty Investor, goodwill can be used as a rough description of what such investor may pay to acquire an existing business, in excess of what the investor would pay to simply acquire the assets itself. In some cases, this analysis assists in determining whether it is better to buy than build.
First, it requires the foreign investor to familiarize itself with the physical assets that are truly necessary to the operation of the business in the United States — an exercise that is extremely worthwhile. (Knowing the assets, the investor can also quickly determine what those assets, or better versions of them, would cost new.)
Second, it allows the investor to isolate the amount of goodwill, or premium, it is being asked to pay, and begin to analyze its various components. There are some components of goodwill that are truly valuable and are worth paying for. It is good to know what they are. The following are just a few components of goodwill that may be valuable, or not:
a. Taking over the lease of an existing business. Location is extremely important in some businesses. Every foreign investor must spend time studying the general subject of location in the United States, because of likely differences in that country, chief among them the existence of an “automobile culture.” The investor may think an existing business enjoys a good location, but then must look at its lease. Does the rent correctly reflect the commercial value of the location? Perhaps it understates, or overstates, it, reducing, or enhancing, goodwill. Another very significant question is whether the lease permits assignment and, under what terms. What are its provisions regarding renewal? Your lawyer should tell you what these are and what they mean. You may learn that the business has a good location (increasing goodwill) but a “bad” lease (lowering goodwill).
b. Employees. U.S. employment has recently tightened particularly at entry-level positions. In addition, a nation’s employment laws represent a significant part of the learning curve. If your business employs a fair number of people, an existing slate of stable, performing, and contented employees constitute an important element of goodwill.
c. Degree of regulation, permitting, licensing, etc. Almost any form of business in the U.S. is subject to government regulation, that may also involve obtaining permits or licenses. With the help of your lawyer, you must evaluate the regulatory requirements. You must pay special attention to whether a change in ownership of the business causes a problem with existing permits and licenses. For example, you must have a license to practice pharmacy. This license is personal. If you purchase that pharmacy, you cannot take over that license. A license to sell alcohol may or may not be transferable to a new owner.
d. Customer base. A strong, steady and loyal group of customers may be the most valuable component of goodwill.
However, this goodwill must be analyzed and understood. In our article on franchises, we said a good franchise has two main qualities: a good brand, and a set of pre-existing expectations among the public. The new owner has only to work hard, continue to promote the brand, and do nothing to change those expectations in order to succeed in most cases. In the traditional franchise, the new owner’s personal characteristics should remain in the background. In fact, the great majority of customers do not even know who the owner is.
So in taking over a business, be it a delicatessen or an oilfield services company, ask yourself: How much of the loyal customer following arises from the personal qualities of the existing owner, that is, an asset that is being lost? Or, does it arise from assets that stay with the business and can be preserved with simple hard work and unremarkable competence?
e. Unknown liabilities. Unfortunately, doing business in the United States exposes even the best businesses to claims, liabilities, and risks that may take time to even become known and which, at any point in time, may comprise the “unknown-unknowns.” Claims for almost anything (accidents, employee demands, action by the government), can be quite substantial. When large corporate enterprises are being acquired, lawyers, accountants and other professionals may spend weeks or months attempting to make these “unknowns” become known.
In another article, we will explain how you can greatly reduce these unknown risks when acquiring an existing business. But they still loom large and may reduce a large part of a business’ goodwill.
3. Time spent prior to starting business
Obviously, it might take an investor a longer time to assemble the various components of a new business, than acquire an existing one. However, acquiring an existing business is not — or should not be — a matter of only a couple of months. Once the investor has identified the business, and the specific location (processes that probably take several months), it may take additional months to identify a specific purchasing opportunity and negotiate the terms of purchase Then another month at least shoud be devoted to “due-diligence,” prior to actually closing the transaction. If the investor itself must apply for operating licenses, the pre-closing period may take longer.
Similarly, the process of building a business from the ground up may not be as lengthy as some would imagine, because the process of acquiring the various physical components of the business is more direct and is subject to fewer conditions. Take machinery, which can be identified, inspected, purchased and delivered within a matter of weeks. No weeks of negotiations. No weeks of due diligence.
4. Time spent in U.S. prior to starting business
It is probably the need to have a pre-closing presence in the United States that most distinguishes the two options discussed in this article. Putting a business together requires the investor to spend some time in the U.S. (at least a few weeks at a time), or to have a trusted agent who will be present for it.
The good news is that in the U.S., there is a large, well-identified and well-trained infrastructure of human resources: third parties who can handle a lot of the work for the investor. This infrastructure includes real estate brokers, advertising companies, transportation companies, marketing specialists, employment agencies, engineers, architects, lawyers, building managers, plumbers, electricians, contractors, people who water your plants, and even persons who procure necessary licenses and permits.
In addition, the information and materials available online are enormous. For example, without leaving your apartment in Bogota, it is possible, within 60 minutes and without spending a peso, to learn exactly how many vehicles pass in front of a given location in Houston, Texas, and how many single mothers earning between $20,000 and $40,000 per year, live within 1 kilometer. It would also be possible to use AliBaba to fabricate a certain piece of equipment in Guangzou, ship it to Long Beach, California, and, with the transportation infrastructure of the U.S., deliver it to a certain location in Iowa.
5. Timing: the E-2 investor visa application process
As we keep emphasizing, the E-2 investor visa requires a showing, at the time of application, either that the investment has been made, or is in the active process of being made.
In the case of acquiring an existing business, we noted in another article how the escrow could be used to minimize the financial commitment needed to demonstrate that the applicant is “actively in the process” of investing. This is because the transaction contemplated in the escrow normally comprises an entire business already in operation. If the visa is eventually granted, the applicant steps into that business immediately.
However, this mechanism may not appear as useful when the investor is building the business from the ground up. The use of escrow as a practical indicator of the investor’s commitment depends on the nature of the business. The escrowed purchase of raw land, for example, that will comprise 50% of the value of the eventual enterprise is probably a good candidate for the use of this mechanism, as a means of demonstrating commitment at the time of application.
Aside from these considerations, the candidate for the E-2 investor visa, who wishes to build its enterprise rather than acquire an existing one, is probably required to enter into transactions demonstrating a higher level of financial commitment, which will be more difficult to back-track if the visa is denied, and the investor does not wish to proceed with it. These unavoidable transactions would probably include so-called “soft” costs, for example pertaining to professional services, which cannot be recovered in the event the investment is cancelled. On the other hand, the cost of acquiring some assets, such as real estate, may have a better chance of being recovered.
Closing thoughts
Investors may prefer to acquire an existing business, rather than build one from the ground up, if:
(i) they are unsure about the business they have chosen, or are unsure about their present knowledge of how that business, or business in general, is conducted in the United States.
(ii) they see a particular business with “goodwill” in the accounting sense (see above) that is not being properly valued in the asking price.
(iii) they wish to save time and decrease risk in the application for the E-2 treaty investor visa.
(iv) they are more conservative in their approach to business, willing to accept a smaller return if it reduces their risk.
Investors may prefer to build their own U.S. business, rather than acquire an existing one, if:
(i) they are bringing their own business, products or services to the U.S., and are confident of their ability to succeed in that market, based on some comparative advantage, or their own skills.
(ii) the market for buying existing businesses excessively overvalues goodwill in the accounting sense (see above).
(iii) they are entrepreneurial, willing to accept more risk if it means more profit and growth.
The SIGNET Law Firm
We are dedicated to helping foreign business invest and operate in the United States successfully. As part of our services, we specialize in helping our clients procure the E-1 and E-2 visas, which enable them to live in the U.S. while they manage and operate their businesses.
Thank you.
We hope you have found this information useful. If you would like to speak with us, we are available.