The art of a business deal
Whether you are buying or selling a business, it is important to have an experienced business attorney involved as early as possible in the process. In some cases, a business broker or other professional may be involved in the transaction. The broker or one of the parties to the transaction may prepare a letter of intent setting forth the major points that have been agreed upon. A letter of intent is normally non-binding, but it does set the parameters of the deal and expectations of the parties, so it should be reviewed by an attorney before it is signed. Whether or not the deal starts with a letter of intent, it must eventually be formalized by a comprehensive purchase/sale agreement covering all the terms of the deal as well as the rights and responsibilities of the parties.
ASSET OR STOCK DEAL?
The first issue for a business purchase/sale is the structure of the transaction. Whether it is an asset or a stock purchase/sale will have important implications for both sides. Buyers usually seek an asset purchase for tax and liability advantages. An asset buyer starts with a clean slate because he does not inherit liabilities or contracts of the existing business and is able to depreciate the business assets starting at their purchase price. On the other hand, a stock buyer steps into the shoes of the stock seller, and the business continues with its existing tax structure, contracts, and liabilities. Stock sales are often used for businesses that have contracts or licenses that are not readily assignable, or there may be other operational issues that make a stock sale more appealing. These are just some of the issues involved in the decision of how to structure a business transaction. All aspects of the deal should be discussed with both an attorney and a CPA.
THE PURCHASE PRICE:
The purchase price of the business should be justified by the income or potential income of the business and the value of the assets, inventory, and goodwill. Sellers should have a set of financial records for prospective buyers to review. Prior to making an offer, buyers should review tax returns and financial records to come to a basic understanding of the profitability of the business. A confidentiality agreement is often necessary to protect the parties during this stage. A CPA, appraiser or other business valuation expert may be involved at this stage. If real estate is involved, a marked analysis of comparable sales is helpful. Upon reaching an agreement on the purchase price the deal may be summarized in a letter or intent or the parties may go straight to the contract stage.
After the structure, price and other major terms are agreed upon, a comprehensive purchase/sale agreement should be drafted. All business contracts should contain certain basic elements, but every transaction is different, so we do not use standard forms. The contract phase of a business transaction can consume much more time and money than necessary without an experienced business attorney. We have handled the purchase and sale of restaurants and bars, retail businesses, manufacturing businesses, medical and dental practices, CPA firms, financial services firms, consulting firms, real estate businesses, and a wide variety of other businesses. Each purchase/sale agreement is based on the nature of the business and the specifics of that transaction.
The purchase/sale agreement should specifically list the assets or stock being sold as well as any assets that are excluded. It should guarantee that the buyer is getting good title to the assets or stock free and clear of liabilities, except for those liabilities that the buyer has agreed to assume. It should detail the contracts, accounts and liabilities of the business that are being assumed by the buyer and should contain indemnification provisions so that the buyer is not responsible for pre-closing liabilities and the seller is not responsible for post-closing liabilities. It should contain both buyer and seller warranties and representations. If there are any consulting or non-compete obligations, those should be clearly outlined in the purchase/sale agreement or in ancillary agreements. Non-competition agreements can be particularly problematic if not carefully drafted. Finally, the agreement should list all conditions to the obligations of the parties and all contingencies, such as the buyer’s ability to obtain financing or obtain licenses. This is by no means a complete list of provisions that should be included in all business contracts. Again, each business is different and each contract is different. As you can see, an experienced business attorney can make a complicated process go much smoother.
DUE DILIGENCE REVIEW:
Some due diligence review takes place prior to a contract being signed, but after a business is under contract the buyer will want to complete an extensive due diligence review. Financial due diligence for a buyer involves reviewing financial statements, tax returns and other records of the business, and again, a CPA should be involved. If the business owns real estate and/or hard assets, a buyer should conduct physical due diligence such as property and asset inspections, environmental studies, surveys, and other testing dictated by the nature of the business. A thorough due diligence review should also involve title, lien, bankruptcy and tax searches and confirmation of the validity and authority of any entities involved in the transaction. We routinely handle assist with all aspects of due diligence review.
During the due diligence phase the buyer should secure financing, obtain licenses and insurance and set up an entity to own the assets or acquire the stock. The lender may have an extensive list of requirements to be satisfied during this phase, especially if SBA-guaranteed financing is involved. Meanwhile, the seller will need to prepare for the sale by providing access and information to the buyer and preparing transfer documents. Both buyer and seller may need to work together on issues such as the assignment of leases and advising customers and employees of the sale.
It is not often that a buyer is able to pay cash for a business. Financing plays a major role in most business transactions. Seller financing is one option. Since the financial crisis, commercial financing has become more difficult to obtain, so seller financing often fills the void. Seller financing normally involves a promissory note, personal guarantees, and security documents, such as pledges, UCC asset filings, or deeds of trust against real estate. We can handle all aspects of a seller-financed transaction, either for the buyer or the seller. We also handle all forms of commercial financing, including Small Business Administration (SBA) guaranteed loans. We have extensive experience with SBA loans, which can be very time consuming and expensive for those unfamiliar with the SBA loan closing process. Finally, we handle transactions involving funds drawn from or borrowed from self-directed IRAs or 401k vehicles.
After financing is in order, all conditions of closing have been met, and all transfer documents have been prepared, the coast is clear for closing. There are many moving pieces to getting a deal over the finish line. If a lender is involved, the lender’s closing instructions will dictate much of the closing process. There should be a comprehensive settlement statement showing the receipt and distribution of funds. This document is important for tax purposes. Expenses need to be pro-rated. If the business has inventory or work-in-progress, those items need to be valued and correctly allocated between buyer and seller. Liens on the business assets or stock need to be paid off and released. In the case of an asset sale, title to assets needs to be transferred, and in the case of a stock sale, the stock needs to be transferred and the corporate records updated as of the closing date. Finally, funds are distributed to the seller.
There are often a number of post-closing responsibilities for the parties, and for the attorneys, in a business acquisition/sale. The seller may have consulting responsibilities. The lender may have post-closing requirements and security filings that need to completed. The buyer may need to transition employees and customers, update contracts and business forms, obtain licenses, etc. Our involvement does not end at closing. We provide complete representation to business clients.