The purchase or sale of a business usually involves such a large amount of money relative to the party’s other investment or net worth; that it is a good time to be careful in how you go about conducting the transaction and choose the structure. So let’s follow the nine key steps in a business sale/purchase.
- Advisors. It is always surprising to see many advisors are involved in a business transaction. Frequently there will be a business broker, escrow agent, appraiser, lender, accountant, buyer (or seller) and, if real estate is involved, then also a title company and real estate broker.
- Pre-Sale Process. Ideally a seller will start working on the sale long before the business is offered. The financial statements should be cleaned up, intangible assets trademarks protected, personal expenses reduced, key employees retained on a long term basis, etc.
- Listing the Business. Most brokers will not place your business on a “multiple listing service”, but will use different and more private channels to contact qualified buyers. The broker will want the seller to sign a listing agreement which will include a guarantee by seller that information given the broker (who passes it on to the prospective buyer) is true and accurate.
- Purchase Documents. The purchase documents usually consist of the broker’s listing agreement, the confidentiality agreement with the buyer, an initial offer plus counter offers, escrow instructions and the final, more complete, documents including promissory note, security agreement, bill of sale, list of assets, intangibles, covenant not to compete, employment agreement for seller, transition work or for retaining key employees and so forth. Often, at the beginning of the process, the parties will forego an offer document and prepare a letter of intent (“LOI”). The key for using a LOI is to obtain agreement on those important terms of the sale but not to get too detailed, otherwise the sale process will become delayed and negate the purpose of the LOI, which is to state the basic terms and facilitate moving on to the next step, due diligence and formal documents.
- Asset or Stock. This is one of the early decisions to be made since it will set the stage for other aspects of the transaction, especially the tax and liability consequences. This should be agreed upon before the documents are drafted. Document Preparation. When each party has a lawyer after the basic terms are agreed upon, it is the buyer’s counsel that usually drafts the first set of formal documents, since buyer’s have more concerns and will want many more representations from the seller regarding the condition of the business.
- Tax Allocations. In an asset sale of a business there is a specific method for determining the tax consequences of the parties. The purchase price is allocated to certain categories of assets, both tangible and intangible. Each category may have different tax consequences and the amount allocated does necessarily match the fair market value. For example a large portion of the purchase price will be allocated to goodwill resulting in capital gains for the seller and 15 year “writes off” for the buyer as opposed to a much shorter period (and more beneficial for equipment). These amounts are negotiated usually with help from the parties’ accountant. Suffice it to say, get good tax advice.
- Due Diligence. This is the process that a buyer goes through to determine the nature, characteristics and condition of the business. This is started by the seller providing current and past financial statements, tax returns, contracts, equipment and real estate leases, employment agreements, history of repairs, land reports regarding hazardous waste, American with Disability Act compliance, and so forth. It is very important to set deadlines to make the information available and for the buyer to complete its review.
- Representatives and Warranties. There are many issues that can’t be determined by looking at a piece of paper, record or contract. In these cases the buyer will require the seller to make statements regarding the condition or presence of something. Examples are (i) whether there are any threatened pending lawsuits, claims or governmental actions against the seller and (ii) whether the financial statements are true and accurate.
- Escrow, Bill of Sale and Clearances. Parties vary on whether they want an escrow by the size of the transaction and may be used in small (e.g., $75,000) transactional, as well as large ones ($15,000,000). If there is inventory the parties will usually file a notice of the sale which is published in a local newspaper (the “Bulk Sale” notice) and also arrange for governmental reports to show that there are no sales, or employee taxes, due (e.g. withholdings), state income tax or liens affecting the business.