Buying or selling a small business can seem bewildering but the process has a logic to it that sharp entrepreneurs can understand and use to help manage the time, direction, and strategy of their business lawyers and other professionals who help them in the process. This article gives you an overview of what you need to work with your professionals intelligently and effectively in buying or selling a small business.
Three Types of Small Business Sale
A small business can be sold by asset sale, stock sale, or merger, with asset sale being the normal vehicle of choice for many small businesses.
Business Sale — Canned versus Customized
Sometimes the sale of a small business is done via a basically canned process through a broker. In that case, a buyer and seller get a homogenized process that may or may not suit their legal needs. The documentation www.carstream.us will be “standard” but contract terms will not be customized for the parties. Such documentation will cover minimum terms but little else.
Better by far in all but very small sales is to use customized deal documents prepared and reviewed by qualified business lawyers. Typically, a seller will get legal and accounting advice on how to structure the sale and will then work with a prospective buyer to get the basics of the deal documented in a term sheet or letter of intent. A term sheet, though not legally binding, provides a useful framework for moving forward. The parties may of course skip right to a formal contract instead.
Business Sale — The Purchase Agreement
The formal contract is a purchase agreement. It normally contains covenants or promises (“I will sell to you and you will buy from me x assets or x stock shares,” etc.), warranties and representations (“as seller, I warrant and represent that I have good title to what I am selling you and that there are no liens on it and no lawsuits against it,” etc.), and conditions to closing (“our deal with close only at such time as x, y, and z conditions are met,” as for example getting a landlord’s consent to a lease assignment).
The Escrow Process, Due Diligence, and Confidentiality Agreements
The contract is signed and an escrow normally established as a mechanism by which to get to a closing where the sale will consummate. Procedurally, such an escrow works much like that set up when a home is sold, except that (for example) instead of waiting for the results for a title search the parties may be waiting for a liquor license approval or some other condition pertaining to a business sale.
Due diligence is a critical part of this process, mostly on the part of the buyer. This is the process by which a buyer inspects the books and records of the business being sold and takes other steps to ensure that what is being sold is authentic and worth the value being paid. Lawyers and accountants typically assist with this process.
Detailed due diligence can be done before or after a formal contract signing or it can be done in stages — limited due diligence prior to signing a term sheet with detailed due diligence during the escrow period. Buyer satisfaction with due diligence is often a condition to closing.
Due diligence is not normally allowed until a buyer has signed a confidentiality agreement.
Common Traps and Pitfalls in the Sale of a Small Business
Many traps and pitfalls can arise during a sale. Sometimes a buyer will claim to want to buy a business while in fact scheming to gain access to key information that will be used competitively against the seller. A confidentiality agreement helps here but this may prove cold comfort to a seller stuck with a lawsuit. Be discerning in this area.
A serious seller risk is to take a carry-back loan with inadequate protections. Proper collateral (UCC and otherwise) is usually key to dealing with this in case of default.
Buyers normally face the greater risks. Unscrupulous sellers can play all sorts of tricks to make a deceptive sale. The nature and range of tricks used, or even mistakes inadvertently made, is vast and varied. This is often the major area of focus by attorneys and CPAs in shaping a seller’s representations and warranties and in handling due diligence.
From a buyer standpoint, the structure of the deal can affect liability risks: in a stock sale, a buyer will inherit the entire corporate history, good and bad, along with the purchase; in an asset sale, a buyer can normally limit the inherited liability risk considerably if not altogether.
Most businesses are sold with a premium placed on good will, consisting generally of the going concern value of having a particular customer base, a recognizable name, and so on. Most buyers then will want a non-compete agreement from the seller or, if the seller won’t give it, at least a non-solicitation agreement relating to existing customers.
Watch out especially for distress sales. Unless a distress sale proceeds by UCC foreclosure, or out of bankruptcy, any buyer of a business overwhelmed with debt can potentially inherit all or part of that debt even if the contract specifies that the buyer is not assuming any liabilities. Given the risks, distress sales are typically radioactive for a buyer.