At Venture Law, we assist our startup and small business clients in small business acquisitions, mergers, and purchases as well as in litigating their business purchase disputes. After many years of counseling and representing our clients regarding these business matters we have developed expertise in avoiding common issues resulting in losses worth hundreds of thousands of dollars – if not millions. Here is a general outline of the process you will encounter when purchasing a business along with a few key issues we help our clients avoid.
Conduct Market and Business Research
The first step in purchasing a business is determining its value. Determining the value of a business is tricky. Two identical businesses can be sold for drastically different prices. Thus, it is very important for a purchaser to do proper research prior to committing to any purchase. A purchaser should ask for corporate records and documents regarding employees, customers, finances, accounts receivable, contracts, equipment owned or leased, real estate owned or leased, tax, and all other assets or liabilities. These documents can be shown to an attorney who can help spot legal issues and a qualified business appraiser who can help evaluate the business’s financial situation and determine its true value. Additionally, you may communicate with an experienced business broker to gain a better understanding of the market for similar businesses.
Determine Deal Structure
Once you have decided the price you are willing to pay for purchasing the business, you must decide how you will structure the deal. This is where hiring a business lawyer becomes necessary. There are three main options for structuring a business purchase deal, all of which have varying legal and tax consequences. The first is to merge an existing business you own with the business you seek to acquire. The second is to purchase all the ownership shares of the business. The third is to purchase all the assets of the existing business.
Asset sales involve the transfer of assets from the seller’s entity without transferring the entity’s shares. The benefit to you is that you may avoid some of the entity’s liabilities and obligations such as employment contracts and loan debts. The downside is that you will not be subject to the benefits of the entity’s contracts. For example, If the seller’s entity has a lease you seek to assume, you will have to negotiate with the entity’s landlord for an assignment of the lease. Asset sales can be great in sales where the seller’s business main value derives from its equipment and real estate assets or contracts, such as is the case with most small restaurant businesses.
In contrast, a share ownership sales contract involves the sale of the seller’s business entity along with all its assets and liabilities. If the true value of the seller’s business lies not only with its assets, but with its contractual relationships with other parties, then a share ownership sales contract may be the better option. Additionally, share ownership sales contracts can provide added protection to purchasers since, by the nature of the contract, the purchaser may sue the sellers personally if they withheld assets from the sale or otherwise failed to perform.
Agree on Key Terms
After deciding with your attorney the legal path you will take to acquire the business, you may negotiate and agree with the sellers on the key terms including purchase price, deal structure, non-competition covenants, the status of the employees, and timeline. The key terms will be written on a non-binding letter of intent which your attorney will reference as a basis for drafting the purchase agreement. The letter of intent, however, may bind you from disclosing seller’s confidential information and bind the sellers from negotiating the business sale with any other party.
Negotiate Purchase Agreement
Your attorney will draft the first draft of the purchase agreement. Once the draft is ready, the seller’s attorney will review and insist on changes to the draft. The purchase agreement draft may go through many rounds of editing by both sides prior to closing. The purchase agreement will typically explicitly include all of the assets or shares of the company the buyer is aware of so that there can be no ambiguity on what items are subject to the agreement.
The seller’s business will most likely be under contract with other third-parties. For example, the business may have a lease contract with a landlord or a purchase agreement with a supplier. Your attorney will review these contracts to determine whether the third parties will need to consent in order for the contracts to survive the business sale and remain valid as to you. If consent is needed, your attorney will pursue the third party’s consent and condition closing on obtaining consent.
After the negotiations are complete, the parties may sign and execute the final version of the purchase agreement. The purchase agreement will usually allow for a due diligence time period before closing where the purchaser may terminate the purchase agreement if certain issues are discovered.
Due Diligence
Due diligence is your opportunity to examine whether the seller’s business is free from hidden issues or liabilities and is financially sound. During the due diligence period your lawyer will want to make sure at the very least (1) the equipment or property you are purchasing do not have outstanding liens on them, (2) the business does not have any unpaid judgments against it, (3) the sellers of the business are in fact the owners and only owners of the business, (4) the business is not subject or likely to be subject to any tax or legal violations, (5) the business owns what is says it owns, (6) the business’s purported leases are on a legally sound basis, and (7) the business does not have outstanding loans or other liabilities. If you discover during due diligence any issues, you can either walk away, renegotiate, or place the curing of any issue as a condition to going ahead with the purchase.
Closing
After all due diligence items are satisfied and the purchase agreement is signed by both sides, your attorney will arrange a closing where ownership of the assets or shares are transferred. Typically, the purchaser will advance the purchase price and the sellers will advance their ownership documents through the purchaser’s attorney. The purchase will at that point be complete and your attorney will prepare a bill of sale evidencing the shares or assets have been transferred. If the purchase agreement calls for partial payments, the sellers may ask for a security agreement and a lien against the assets until all the payments are made.
Purchasing a business requires multiple steps and the omission of one step can make what otherwise seems like a great business opportunity turn into a liability nightmare. As summarized above, purchasing a business without counsel is highly inadvisable. As such, this article is not meant to be a replacement for legal representation, but to provide prospective business purchasers a bird’s-eye perspective regarding the process.
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