If you are contemplating selling your business or buying a business, you need to understand the necessary steps to be taken to properly protect yourself. Countless conflicts arise from the sale or proposed sale of a business, and such conflicts could result in substantial legal expenses and lost business profits. Often, through careful preparation of the purchase documents and a thorough investigation of the acquired business, the risk of a potential conflict and your risk of potential liability as a buyer or seller can be minimized or avoided all together.
Letter of Intent
Prior to negotiating the terms of the transaction, the buyer needs to value the business. Often buyers use the assistance of an appraiser or accountant to confirm that the price to be paid for a business is reasonable. Upon completion of the valuation process and the negotiation of the terms of the transaction, the parties should sign a letter of intent detailing the essential terms of the proposed deal. The letter of intent is an agreement to agree and is not legally binding on the parties. Although the letter of intent is a non-binding document, the letter of intent assures at an early stage that the buyer and seller have agreed to the basic deal terms. The letter of intent should identify, at a minimum, the purchase price, the closing dates, a feasibility period for buyer to conduct its due diligence, a description of the business assets, what will happen to current employees, and whether the transaction is an asset purchase or a stock purchase. In an asset purchase, the purchaser is acquiring assets, and only those liabilities expressly assumed. In a stock purchase, the purchaser is acquiring all of the assets and liabilities of the company. The seller and buyer generally negotiate indemnity provisions to cover certain situations.
Due Diligence
During the feasibility period, the buyer needs to conduct a due diligence review of the business. An attorney should review all company agreements including property and equipment leases, supplier and client contracts, advertising commitments, insurance policies, employment agreements and benefit plans. Inquiry should be made as to all potential claims and litigation against the company, including warranty and product liability claims, employee disputes, current and potential environmental liabilities, and intellectual property disputes with competitors. Additionally, the buyer’s attorney will want to assure that the acquired business is properly organized and has the authority to conduct such business in the State of Arizona, that the acquired business has adequate protection of its tradename and other forms of intellectual property, and that there are no liens or encumbrances against the real property or any personal property to be acquired. A litigation search and UCC search should also be conducted.
Purchase Agreement
The purchase agreement is signed in advance of closing and governs the conduct of the business and who bears the risk of the business during the interim period. It also includes the complete terms of the sale, including seller’s covenant not to compete with the transferred business, detailed provisions regarding which obligations and liabilities the buyer will assume, and identifies the collateral which will secure the purchase price, the payment of broker’s fees and prorations of taxes, insurance, and assessments. The purchase agreement should describe liquidated damages, indemnity, and other remedy provisions to govern what happens in the event either party is in breach of the purchase agreement.
The agreement also should contain a list of documents to be delivered at closing, such as consulting agreements, employment agreements, assignments and consents for assignment of agreements, customer lists, operating manuals, security deposit lists, a bill of sale, a pending litigation list, a list of service or maintenance contracts and vehicle title documents. Additionally, if the buyer is paying the purchase price over a period of time pursuant to a promissory note, the seller may require additional documents to secure the payment in the event buyer defaults under the promissory note, including a deed of trust on real property, a personal guarantee, a pledge of stock or a bank letter of credit. The parties may designate an escrow agent to receive required documents and payments in the interim and to release the documents at closing to the other party if all conditions are met.
Perhaps most importantly, the purchase agreement should include representations and warranties by both the buyer and seller. The terms of the representations and warranties are negotiated between the parties. Typical seller’s warranties usually include that the business is duly organized and in good standing, the sale is not a breach of its corporate obligations, seller owns the business free of encumbrances, the financial and other information it provides is accurate, there is no pending litigation against the company, it has not violated applicable laws, its assets are free and clear of all liens and encumbrances and are in good working order, its taxes are current, and if any material change occurs, it will disclose such change promptly. The buyer should request that the seller indemnify the buyer against any loss or damage to the buyer as a result of a breach of any representation or warranty. Examples of buyer’s representations and warranties include that the entity acquiring the business is duly authorized to enter the transaction (if not an individual purchaser) and that the purchase will not violate any other agreement or any law applicable to buyer.
Closing
Prior to closing, all conditions to the closing must be satisfied and all documents to be delivered at closing must be approved by the parties. Both buyer and seller should prepare for the closing by having their counsel prepare a checklist of the documents to be exchanged at the closing. Although the process of buying or selling a business is extensive and may seem document intensive, the thorough preparation required for a smooth sale of a business is essential to avoid unnecessary conflicts and expenses.
This column is for general information purposes only and does not constitute legal advice. If you need more information about buying or selling a business, consult an attorney. Kurt Brueckner is a principal of TBL, and can be contacted at 480-483-9600, or directly at kbrueckner@tbl-law.com.