What to Expect When Buying or Selling a Business Part I
Buying or selling a business can be a scary situation. Who should negotiate? What's involved? What's the step by step process? What are some of tax traps? I don't promise the following as a comprehensive guide, but hopefully you will leave with enough to feel more informed and confident as you plan on expanding or reducing your personal empire!
Disclaimer: The following information does NOT constitute legal advice and is only for general educational purposes. Each situation is different and specific legal issues usually require additional research and investigation, so do not rely on this article to address a particular legal issue; use this as a starting point to gain a general understanding. This article, although educational in purpose and substance, nevertheless, might be deemed attorney advertising, and prior results do not guarantee future success.
Supplemental Disclaimer: The complexity and sale of a business may vary from transaction to transaction, some being relatively simple and omitting certain steps, and others being exceedingly complex and involving a great deal more. In every such transaction, other professionals should be consulted, including your accountant and/or tax advisor, and possibly others such as architects or engineers, environmental experts, zoning specialists, and so forth. Although I endeavor to be aware of general tax concepts, I do not hold myself out as a tax expert and usually require access to my client’s tax advisor to complete a deal for them.
Businesses are bought in sold in many ways. Sometimes, a Buyer, completely unlooked for, approaches the Seller out of the blue. Sometimes a Seller hires a broker to find a Buyer. Other times, friends may introduce the two parties. Oftentimes, Buyer and Seller will meet or otherwise communicate (in writing, by email or on the telephone) and work out a general understanding - an overall price, when the sale should take place more or less (on this date, within three months, next year, etc.), some idea of what is and is not included in the sale, and maybe a few other specific conditions. Then what?
Like purchasing a house, there were will be many steps in between the initial “let’s do this” phase and the actual exchange of money and papers denoting the sale. A lot of stress, especially for the Buyer, but also for Seller. There are many ways of structuring the deal, things that can go wrong, opportunities for disagreements, and plenty of chances for possible misunderstandings. For instance, one of my favorite scenarios of confusion is when the Buyer believes they are obtaining “everything” in the store, and the Seller obviously meant to exclude certain objects, such as handcrafted furniture handed down through their family that they used to give their store special flair, as well as personal jewelry and knick-knacks on display. What is “obvious” to the Seller is often not so to the “Buyer” and vice versa.
There also will be a number of professionals involved, and many of them will not come without substantial expense. Although quality of advisors, level of service and prices vary widely, it is not uncommon to spend a percentage of the deal on accountants, brokers, consultants, engineers, insurers, lawyers, tax specialists, and others. The bigger the deal, the total dollar value of experts is likely to increase. The sale of a tiny candy store business is likely to involve far fewer such fees whereas the sale of chemical plant could cost hundreds of thousands or even millions of dollars for such expert assistance.
2. Who is Negotiating for You?
The process may vary quite a bit depending on your own level of desire to be involved, education, and experience. Some want their broker or lawyer to work out all the details and just quickly brief them on the big picture, and then sign whatever they have to sign, and then write or receive a check. Others want to be intimately involved and review every paragraph. It’s important for you to communicate your intention upfront to whoever is representing you.
If your broker found the Buyer or Seller and is negotiating everything for you, you may be following their lead. On the other hand, if you found the Buyer or Seller yourself, and wanted to save money on a lawyer, you might be negotiating all the main points and only asking the lawyer to weigh in when necessary or at the very end. Or, you may establish a collaborative process whereby you and your professional are regularly on the phone with a lot of give and take. No one size fits all, neither for the Buyer or Seller or any given transaction.
Remember, though, no one knows your business like you, you’re the expert on both the Ins and Outs of your business, and only you know what you truly want to get out of this deal, and what are deal breakers and makers for you. Don’t be shy - tell your lawyer (or whoever is advising you) your concerns and questions. Once you sign papers and certainly once money changes hands “backsies” are very difficult to do and usually involve litigation.
3. Is A Letter of Intent Necessary?
As with all the things with law the answer is “maybe.” A Letter of Intent (“LOI”) is a fancy name for a “pre-contract.” A LOI usually spells out basic terms. I have seen LOIs the size of a cocktail napkin that basically say “Buyer Barney will purchase ACME Business for $100,000 by September 30, from Seller Sally; both parties agree to use good faith to complete the deal.” I also have seen LOIs that rival college term papers in size. The thing to remember is that it’s basically a pre-contract.
Why do I say “pre”contract? Because the final agreement between Buyer and Seller probably will be either an Asset Purchase Agreement or Share Purchase Agreement or Membership Interest Agreement, all of which are much longer and cover more ground. So, if it’s a “pre-contract” is it enforceable? What if someone doesn’t honor their side of their bargain? Again, that depends. Some LOIs are aspirational and are not meant to be binding (broadly describing what both parties *hope* will be included in the final binding deal). Other LOIs are meant to lock the parties in to key terms with the understanding the sale will go forward no matter what. Other LOIs fall in between.
If the LOI is binding (or found to be binding by the court which is sometimes a surprise to one or even both of the parties), one party could force the other party to complete the sale or pay damages. Therefore, before committing to a binding LOI, it is wise to consider how much flexibility you might want in cancelling the purchase/sale if matters are not proceeding as smoothly as you would like. Technically, you do not need an LOI at all, and you could proceed directly with a handshake until you draft the longer agreement or just start with the longer agreement.
4. What About The “Real” Longer Agreement?
The real “guts” of the deal usually will be spelled out in a longer agreement. The name of that agreement depends on whether you are buying the company’s *Assets* or whether you are buying the *Membership Interests* or *Shares* in the company itself. Therefore the agreement is usually called something like either, an “Asset Purchase Agreement,” a “Membership Interest Purchase Agreement” or yes, you guessed it, a “Share Purchase Agreement.” Remember, Limited Liability Companies (LLCs) do not have shares, they have “Membership Interests” although sometimes people insist on calling those “units” or something. Corporations always have shares (that includes both C and S Corps).
Membership and Share Purchase Agreements tend to be more similar than Asset Purchase Agreements, because the former two will focus on ownership of the company whereas the latter is buying “stuff” from the target company. That said, all these agreements follow common sense. Buyers will want to be protected and get the value of their deal and not be cheated by hidden issues. Sellers will want to get as much money as they can, as safely and as soon as possible, under the most favorable tax circumstances, and leave with as little lasting liability as possible.
So for instance, agreements will talk about when the sale is to take place, how much money will change hands and when and what kind of money (cashier checks, wire, promissory notes, etc), and how much of it will be held in escrow against the Seller’s unpaid debts and liabilities. Also discussed: whether inventory and accounts receivables are included, furniture, vehicles (such as cars and trucks, or airplanes and ships if you’re big enough!), the fate of intellectual property (brand names, copyrights, customer lists, trademarks, websites, etc.). Things like that.
As I said, you can start with an LOI and sign a longer agreement later, or you can start with the longer agreement and forget the LOI.
more to follow in a future article