Steps to completing the sale of your business

Steps to completing the sale of your business

Once you have a general agreement with the buyer, the buyer usually drafts and signs a non-binding letter of intent. The buyer will then conduct a due diligence investigation. If this goes well, the purchase agreement will be drafted. You will want to make sure every detail is covered and reviewed. Finally, the buyer will obtain the financing, the deal will close, and you will be ready for your next great adventure.

Once you have located a buyer for your company and agreed to the significant terms and price, you are ready to move into the process of actually closing the deal.

The significant steps involved in the sale of a business are:

  • Letter of intent.The buyer outlines the terms and price you have informally agreed to in a written, nonbinding letter and promises confidentiality so that you will allow it to investigate your company further.
  • Due diligence.Each side of the deal has a limited period to investigate each other thoroughly, to see whether they will proceed with the deal.
  • Generally, the buyer will not simply pay cash for the business. Outside or seller financing will need to be arranged.
  • Purchase agreement.Suppose due diligence turns up no nasty surprises. In that case, the parties’ respective lawyers will hash out the purchase agreement details, any mortgages or financing between the parties, and supplementary contracts such as non-compete or consulting contracts.
  • Law compliance.Laws commonly require that the selling company’s creditors be notified about the pending sale, so they can move to protect their interests. States may also require that the corporate stockholder of the buyer and the seller vote on the transaction, that minority interests be cashed out, that the parties obtain tax certificates, transfer or buy business licenses, pay sales or transfer taxes, etc.
  • Closing the deal.When all the details have been agreed upon, the parties will sign the contracts that transfer ownership, promissory notes, security interests, etc., as well as any documents required by third-party lenders; you get the down payment, the buyer gets possession of the business, and the transaction will be complete.

The Letter of intent captures the basics of agreement

Once you have a general agreement with the buyer regarding the price and terms of the sale of your business, the buyer usually drafts and signs a non-binding letter of intent. The Letter of intent lays out the general terms of the deal, and if signed by the seller, it indicates that both parties intend to move forward in completing the transaction.

Generally, when the buyer submits the Letter, they will also make a monetary deposit on the purchase price, similar to the earnest money used in a real estate deal. If the deposit is large, the seller may agree to a “no-shop” agreement, which prevents the seller from further marketing the company. However, the Letter is usually nonbinding because either party can break off negotiations at any point, and the buyer’s deposit will be returned.

Once signed and accepted by the seller, the Letter can be shown to third parties, such as lenders and stockholders, as evidence of the parties’ seriousness. The buyer will begin a thorough investigation of all aspects of the company (known as “due diligence.”) The Letter should give the buyer permission to contact your lawyer, accountant, banker, etc., to find out more about your operation. In the meantime, your respective lawyers can begin to hash out the contractual language of the purchase agreement.

Insist on a binding confidentiality agreement.

There is one part of the Letter of intent that should be binding on the purchaser, and that is the section in which the buyer promises to keep confidential the fact that negotiations are proceeding and also promises not to disclose any information learned during the investigation or negotiations. This provides you with some protection if the deal falls through. However, we recommend that you do not rely solely on this agreement — it is still a good idea to keep the most sensitive trade secrets or other information to yourself until you are sure the buyer will sign the contract.

Controlled auctions result in multiple letters of intent.

Sometimes, business brokers will conduct a controlled auction describing the seller’s company to several likely purchasers. They will solicit bids in the form of letters of intent to be presented to the seller on a specified date. In this situation, you may receive several letters of intent without having done any significant negotiations with the buyers.

You will need to work with your broker to find out as much as possible about the potential buyers and then choose one of the letters to accept. In these situations, buyers generally make their best offer the first time, so it is usually best to accept one without attempting to continue to pit buyers against each other or expecting them to make additional offers and counteroffers.

Do you need a letter?

The Letter of the intent stage can be skipped if you know your purchaser well (for example, the buyer is your child or a key employee) or if the deal is a tiny one and it looks as if you can move directly on to negotiating the purchase agreement. However, even if you and your buyer decide to dispense with the formal Letter, we would still recommend that you have the buyer sign a confidentiality agreement before moving on to thorough due diligence.

Due diligence protects both parties

Usually, after the buyer signs a letter of intent to purchase a business and the seller accepts the Letter, the buyer will have a specified period to conduct a due diligence investigation of the seller and the company. During this period, your buyer should have access to your financial and other records, facilities, employees, etc., to investigate before finalising the deal.

Ideally, you will have collected and examined most of the information the buyer wants as you prepare your company for sale. The vast majority of it is in the form of paper. The buyer will want to see copies of all leases, contracts, and loan agreements in addition to copious financial records and statements.

They will want to see any management reports you use, such as sales reports, inventory records, detailed lists of assets, facility maintenance records, aged receivables and payables reports, employee organisation charts, payroll and benefits records, customer records, and marketing materials.

The buyer will want to know about pending litigation, tax audits, or insurance disputes. Depending on the nature of your business, you might also consider getting an environmental audit and an insurance checkup.

If your financials were unaudited, especially if they were prepared in-house, the buyer may want you to pay for updated statements by an accountant of their choosing as a condition of closing the sale. The buyer will then perform an independent financial analysis of your company. For example, the buyer may look at your key financial ratios and examine the trends over time, compare them to industry averages, create projected statements for the business using their assumptions, etc.

A wise buyer will also want to look at your facilities, and spend some time “in the trenches” with you and/or your employees as you do your business. We suggest that you accommodate this request, even if it will cause some disruption to your everyday operations.

Buyers will be most suspicious if they think you are hiding something. They tend to be more concerned about what they do not know about minor or even major problems that might arise in an investigation. If you know that specific problems exist, you are much better off disclosing them and discussing possible solutions rather than shoving them under the rug.

Buyers will also look at the environment your business operates in, including the size and makeup of your market, principal suppliers and customers, competition, and industry. They may ask you for more and more information until you feel overwhelmed! We suggest you respond patiently and cooperate as much as you reasonably can. Keep your mind on the goal — selling your company at a price and terms you can live with — and you will get through this potentially very trying period.

Your due diligence.

It would be best if you also did some serious investigating. You will want to find out the buyer’s credit record, management experience, reputation, and the plans they have for your company’s future operation. This is particularly true if you plan to continue an employment or consulting arrangement with the buyer after the sale or if some part of the purchase price will be paid in the future through a financing arrangement or an earnout. However, even if you plan to collect all your cash at the closing, walk away, and never look back, you should satisfy yourself that there is at least a reasonable likelihood that the buyer will be able to operate the business successfully.

If they fail miserably, there is more likely that you may be sued for fraudulently misrepresenting the business’s financial state, assets, products, or any other straws the buyer can grasp at.

Purchase agreement details terms and conditions of sale

The purchase agreement for your business is one of the most important legal documents you will ever sign. After all, many years of hard work will culminate in this single transaction, by which you will put a dollar sign on the value of your entire operation. You do not want to have problems collecting the money you need or legal problems haunting you in the future. A carefully constructed purchase agreement can be your best insurance policy for preventing such catastrophes.

Customarily, the buyer’s lawyer provides the initial draft of the purchase agreement for a business. This makes sense since the buyer has to live and work with the company while you will walk away into the sunset with the cash (theoretically, at least). However, we suggest that your lawyer draft the most important sections for you. In most cases, that means the clauses containing representations and warranties about the business.

Ideally, it would help if you tried to avoid or limit the making of any warranties or guarantees for which you can be held legally accountable. You may also negotiate closely with the buyer as to which liabilities they are assuming and which will remain with you. Here is where a top-notch lawyer can save your skin. Make sure you maintain ongoing liability insurance for any liabilities that will remain with you — for example, product liability insurance on products sold during your tenure as owner.

Indemnity provisions, in which you promise to reimburse the buyer for certain types of expenses if they occur, are often a hotly disputed area of the contract. If you agree to any indemnifications, ensure a time limit, such as two years on the buyer’s claims, and a dollar limit, such as 20 to 25 percent of the business purchase price. Depending on the value of your business, you should also insist on a dollar-limit floor for claims so that the buyer does not nickel and dime you to death with lots of minor problems.

If you are selling the assets of your business, as opposed to the stock, you will need to allocate the purchase price among the assets for tax reasons. The allocation should be part of the purchase agreement, so there’s no dispute later.

The purchase agreement is likely to be a lengthy, complicated document. The contract plus attachments can run into hundreds of pages for some of the more elaborate deals. You should go through it carefully with your attorney and ensure you understand the implications of whatever is in there.

Once both parties have agreed on the language of the purchase agreement, it will be signed by both parties. The contract will state the date the final transfer of ownership and business possession will occur and when the seller will get the money. With a signed purchase agreement, the buyer can finalise any financing arrangements with outside lenders in anticipation of the closing.

You must follow local laws

Local laws can impose various obligations on the seller and buyer of a business. Our purpose here is to alert you to some of the implications of the most common requirements. For more detailed information on the requirements in your locality, consult your attorney.

Bulk sales acts require notification of creditors

Many jurisdictions have laws on their books requiring that when a business sells the “bulk” of its materials, supplies, merchandise, or other inventory outside the regular course of business, it must formally notify all of its creditors at least ten days before the pending sale. Otherwise, the sale will be ineffective against those creditors, meaning that they can still repossess the goods from the new owner to repay the debt.

In some localities, the creditors will also have a lien on the proceeds of the sale. Even if your business does not have inventory, you may be covered by the law because many states have extended it to certain service businesses, most commonly gas stations, restaurants, and bars.

The purpose of the law is to give your creditors a chance to try to collect anything you owe them before you pack up and leave town. After all, your creditors know nothing about your buyer and might or might not have extended credit to him if they did know. The notification process can be pretty cumbersome if there are a lot of creditors, although some states permit printing a notice in a general circulation newspaper as an alternative.

Another drawback to the law is that you may prefer that news about your impending sale be restricted until it happens. The local laws generally waive the notification requirements if both parties agree. Still, then the buyer will want you to agree to indemnify them against any claims made by your creditors.

Another part of the bulk sales act requires you to give the buyer a list of all your known creditors, their business addresses, and the total amounts owed. The list must also be filed with the appropriate state agency so that creditors can access it.

Expect the buyer to perform a lien search

Before the buyer closes the deal, they will want to be sure there are no recorded liens or other security interests against any of the assets. Therefore, the buyer’s lawyer will order a search, much like a title search for real property, through the appropriate state, county or other records. Once the deal goes through, you will need to have your lawyer record any security interests in the buyer’s business or particular assets, such as their home or other property.

Local tax certificates may be required

In some localities, you must obtain a certificate from the appropriate tax authorities showing that no taxes are currently owed and provide this to the buyer. The most common taxes covered are sales and use taxes on sales to your customers and unemployment insurance taxes on your employees’ payroll. If you owe any taxes, the buyer may be required to hold back enough of the purchase price to cover your bill and remit it directly to the local tax authorities.

Account for state sales or transfer taxes

In some localities, the sale of a business or its assets can be subject to VAT, sales or use tax. Other localities tax the sale of stock or other securities. The tax is not usually significant enough to sway your decision to sell stock or assets if you are incorporated; nevertheless, you will want to know your tax liability for planning purposes.

Obtain directors’ and shareholders’ approval

Local laws and your corporate charter may require that your Board of Directors approve the transaction for businesses organised as corporations. In some situations, the stockholders must also vote. This is most commonly necessary for sales of business assets (rather than stock) and tax-free mergers and reorganisations. A vote of the buyer’s Board of Directors and stockholders may also be necessary. However, shareholder approval is not usually required when the deal is structured as a stock sale.

Comply with rules protecting minority shareholders’ rights

If you have any shareholders who are not pleased about the deal, your locality law may give them certain protections. In many jurisdictions, minority shareholders have the right to an independent valuation of the business and have the right to be cashed out based on the appraisal at the time of the sale. In addition to state laws, your corporation may have buy-sell agreements that must be honoured.

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