You nurtured and grew your business and now you want to sell it.
You find a buyer, negotiate the price, and perhaps the terms of payment.
Do you now shake hands and exchange the keys for the cash, or do you need a purchase agreement?
If you need a purchase agreement, can you simply download a form purchase agreement off the internet? Do brokers have forms? If only it were so easy.
You will almost certainly want a purchase agreement.
If you are a seller who is selling all the stock or assets of a business for cash, and you know your buyer will take care of the business, then handing over the keys for cash is not a bad idea.
However, sellers often expect the business will be sold “as is, where is,” while buyers are relying upon statements that were made in the sales process and expect they are getting a clean business with no responsibility for past actions.
Thus, if you are a buyer, or a seller who finances the purchase or has concerns whether the buyer will honor all the existing obligations, a purchase agreement is critical to clarify the assets that are being sold and the liabilities being assumed.
Identifying the assets sounds easy: just list them.
Unfortunately, the devil is in the details. Is the purchaser acquiring the cash and accounts receivable or will she need her own cash to keep the business afloat the first few months?
If receivables are included, who takes the risk that they can be collected? Are any of the assets leased or subject to liens? Will the buyer be assuming all the ongoing contracts of the business? Are those contracts even assignable?
What is expected of the seller following the closing?
Will he need to be involved in the business to preserve the goodwill of the business? If yes, in what capacity, and what happens if that relationship terminates? Is there an expectation that the seller will not start a competing business or hire the employees away for another business?
The answers to these questions are not the same for every business, and a good business attorney, who has experience with buyers after the sale, can help you identify and address these issues.
The majority of the issues that arise between buyers and sellers revolve around the liabilities of the business.
They typically discuss the payables and known liabilities, but what about the unknown liabilities? What happens if a vendor stops selling to the business because of actions that occurred prior to the closing?
These issues are even more difficult with unknown liabilities. For example, what if the business has not complied with employment or environmental laws or the Americans with Disabilities Act?
Typically, the seller will be liable for the past activities, but who will be responsible for the large investment required to bring the business into compliance or fix outstanding problems?
Those darn warranties
Every purchase agreement has a section for representations and warranties. This section allows the parties to clarify what they understood in reaching their agreement. Typical representations include verbiage about the accuracy of the financial statements, significant customer and vendor relationships, and significant contracts that affect the business.
The representations should also address the condition of the assets and their adequacy to operate the business, compliance with applicable laws, and any outstanding liabilities.
This is not to say that every seller needs to represent that the business is unblemished.
An ongoing business has risks and liabilities to go with the assets and benefits. It is through the representations and warranties that the parties can identify these risks and liabilities, and allocate them to avoid future disputes.
Unfortunately, a form agreement that is not specific to the business will not help the parties identify or allocate these risks. Likewise, purchase agreements prepared by brokers frequently contain few representations and warranties and lead to many surprises for buyers.
Sellers may need protection, too.
To this point, this article has focused primarily on protections for purchasers. However, if the seller is not receiving all cash for the business, then the seller needs to be certain its future payments are protected.
Will the seller receive a security interest in the assets so that if the buyer does not make the payments, the seller can take back the business? If the purchaser has other financing, that may be impossible, as there will be a lender who will come ahead of the seller.
What protections does the seller have to guard against the buyer siphoning cash out of the business, and leaving the seller holding a worthless note? Even in an all cash transaction, the seller needs to be certain any guaranties he has given to a landlord or suppliers will be extinguished at closing.
Finally, has anyone considered the tax consequences of the transaction?
If not, buyers may find they cannot deduct the purchase price from their income or, if they can, they must spread the deduction over 15 years as the purchase of goodwill.
Sellers, on the other hand, could face a double taxation, first at the entity level, and then at the personal level, if the transaction is not properly structured. These issues cannot be addressed after closing because the terms of the purchase agreement dictate the tax treatment of the sale.
Get it in writing
The purchase agreement for a business is important to both buyers and sellers. A printed form works for the purchase of a home, but a business is essentially a fluid, living entity and a one-size-fits-all approach simply does not work.
The process of negotiating a purchase agreement gives both parties an opportunity to identify concerns they may have, and address them up front. It also assures everyone understands exactly what is being bought and sold, and helps avoid disputes that result in a last-minute cancellation of the transaction, or a significant surprise for buyer or seller after closing.
Contact: Chuck Modell is an attorney with Larkin Hoffman, the Twin Cities law firm: 952.896.3341; cmodell@larkinhoffman.com; www.larkinhoffman.com.
