Selling a business can be lucrative but it’s complicated. Consider these points and contact a business lawyer for help today. 1. What are You Selling? Early in the negotiations, buyer and seller must agree on what is being bought and sold—company stock (or other equity interests) or business assets. Ordinarily, the seller would prefer to sell the company stock, because that will make unknown company liabilities the buyer’s problem (subject to seller’s indemnification commitment). However, the seller might favor a sale of business assets because getting the cooperation of all the stockholders and option holders might be difficult. 2. Don’t be Coy Be open and honest in responding to the buyer’s due diligence investigation requests. Every company has taken shortcuts along the way which it might not want to disclose, but the consequences for misleading a buyer are much worse. Expect to put a lot of time and work into responding to due diligence, have a good Non-Disclosure Agreement, and let the buyer have at it. 3. The Straight and Narrow Avoid general, open-ended representations and warranties in the sale agreement. Certainly, there are some issues for which seller “should know,” and reps about these issues are just about risk allocation. But whenever you can get away with it, the seller should keep its reps and warranties as narrow and focused as possible. “To seller’s best knowledge” is a welcome (if rarely accepted) qualifier. 4. Run Out the Clock The seller should expect to indemnify the buyer for costs or losses resulting from the inaccuracy of seller’s reps and warranties. However, the obligation to indemnify the buyer should not go on forever. The seller should limit the time period for its indemnification as much as possible. Often, different indemnification periods will be appropriate for different potential liabilities. 5. Taxes as Usual Sale of the business will likely result in a lot of taxes. There’s capital gains tax on the sale of the stock or business assets, which could be quite high if basis is low. The seller is responsible for his or her own capital gains taxes, but responsibility for other taxes is negotiable. The seller and buyer should agree on responsibility for sales taxes, documentary stamp taxes, or intangibles taxes, if they apply. 6. Delayed Gratification The seller would probably love nothing more than getting a big check at the closing table, but the buyer might insist on holding back part of the purchase price. This might be because an accurate value for the business cannot be determined until all the numbers are in for a given period. Holdbacks are sometimes reasonable, but the seller should insist that the money is placed with an impartial escrow agent. 7. Something for Nothing Remember how happy your employees were when they got those stock options? Don’t expect them to remember now. Unless they’ve completed the “incentive stock option maneuver” perfectly, your employees are going to have a big tax bill on the exercise and sale or redemption of their option stock. And they won’t be happy if they have to wait on a holdback either. 8. Unbind the Ties Most business owners, when the business is growing, are required to personally guaranty every bank loan, trade credit, and other obligation of the business. The seller must be sure to negotiate a release of all of those personal guaranties as part of the sale. If a creditor refuses to release the seller, the buyer should at least indemnify the seller for liability resulting from the personal guaranty. 9. Trust But Verify Often buyers will want to pay part of the purchase price in installments over a period of time. Now the seller needs to be the cautious trader. The seller must conduct its own due diligence investigation of buyer’s ability to pay. The buyer’s obligation should be documented in a promissory note (on which doc stamp taxes are paid) and secured by the purchased stock or assets. 10. A New Hat Buyers often insist on the seller continuing to work or consult for the business for a period of time. This requires a separate agreement between the buyer and seller, which should be fully negotiated and documented at the time of closing on the sale. Especially watch out for non-competition restrictions.
Buying a business is a great way to hit the ground running as a business owner. Understanding these ten issues will help reduce your risk and maximize your profits when you buy a company. 1. The Next Right Step After agreeing in principle to buy the business (through a Letter of Intent, Term Sheet, or handshake), the buyer and seller must decide on what comes next. The seller might favor negotiating and signing the purchase agreement, followed by a period of due diligence investigation, followed by a closing. The buyer would probably prefer to take care of the due diligence first, and then “sign and close.” 2. What are You Buying? Stock or assets? The seller will probably want to sell the stock (or other company ownership interests) of the target company, but this exposes buyer to greater risk from liabilities arising prior to the sale. The buyer might prefer to buy all the business assets, but valuable contracts and rights belonging to the company might be subject to transfer restrictions, making an asset purchase difficult. 3. Says Who? It is important to know, as early as possible, whose approval is required for the transaction. Certainly, the stock (or other equity) owners of both buyer and target company, but what about option holders? What about the target company’s lenders, landlord, or other contract parties? What about government agencies? 4. Kick the Tires The most important step in the purchase process is a thorough due diligence investigation of the target company. Insist that the seller answer all of your questions and let you review every contract, record, and detail about the target company. The purchase agreement should make the seller liable for misleading the buyer, but it’s easier to do the due diligence up front than to rely on seller’s contractual obligation. 5. On the Hook The purchase agreement should include detailed representations and warranties from the seller that the target company is clean, except for “warts” that are specifically identified and acceptably dealt with. The purchase agreement should also explicitly provide that the seller will indemnify the buyer for any losses or costs resulting from an undisclosed “wart.” 6. Get Back. Representations, warranties, and indemnification are a must, but they only give the buyer the opportunity to sue seller over any breach of the purchase agreement or liability not assumed by the buyer. Lawsuits are never much fun, and the results can be surprising. A safer means of protection is to hold back payment of part of the purchase money (or put it in escrow) until the indemnification period is over. 7. Taxes for All You know that seller will pay capital gains taxes on the sale of the stock or business assets, but the buyer might be liable for taxes as well. Purchase of certain business assets (especially vehicles) might give rise to sales taxes. Purchase of real estate will require documentary stamp taxes, and payment with a promissory note may trigger intangibles taxes. Who pays these taxes should be negotiated. 8. Thanks, Internal Revenue Code An election under IRC Section 338(h)(10) allows the buyer to purchase corporate stock but the seller to effectively sell the business assets. This takes the tax sting out of a stock purchase by allowing the buyer to allocate the purchase price to the basis of the business assets. 9. Stay or Go Should the seller be required to continue working in the business after the transaction? Don’t expect sellers to work as hard for the buyer as they did when it was their company. On the other hand, the seller has valuable information about running the business. 10. This Ain’t a House Beware a purchase contract that is no more than a broker’s form real estate contract with “Business” written at the end. These contracts don’t protect buyers at all. In fact, they mostly just protect the broker. You need a real purchase agreement (and a real business attorney). Contact us today online or by calling 407-660-2964.