Legal rules governing the sale and purchase of a business are covered to a large extent by common law and to a lesser extent by statute. Share sales will implicate additional rules covering securities and likely others concerning public corporations. Since the relevant laws vary so greatly based on the type of transaction, this article limits itself to key aspects and terms for sellers.
Structure of Business Acquisitions & Sales
The sale of a company’s business may occur in two ways: (1) a share sale whereby the sellers are the shareholders of the company and sell those shares to a buyer; and (2) a business or asset sale, whereby the company is the seller of some or all of its assets to a buyer
Share Sales: in a share sale, shareholders sell all of a company’s assets, liabilities, and obligations. Only the ownership of the shares in the company are transferred. A share sale is preferable for sellers as it allows for the complete transfer of responsibility to the buyer.
Business Sales: in a business sale, only specifically agreed to assets and liabilities are transferred to the buyer. This route allows buyers to select the parts of the business it wants while leaving others behind with the seller and making it potentially less preferable to sellers.
Key Aspects & Terms
Seller Memorandum: the principal sales and marketing document used by a company to generate buyer interest. The aim of the selling memo is to convince a potential buyer to further investigate a potential deal, not to solicit an offer. A business broker may be engaged at this early stage.
Due Diligence: due diligence is the most crucial component of any business transaction or sale and may span several days to several months depending on the complexity of the deal. Due diligence is an investigation into a target company or asset. As a seller, it is important to be prepared to disclose information asked for by the buyer. In addition to legal due diligence, sellers must be prepared for financial, business, and accounting due diligence. Due diligence should also be mutual in that the seller should confirm the ability of the buyer to make the purchase. This will all occur prior to the execution of the purchase agreement and closing and should be covered by letters of intent, nondisclosure, and confidentiality agreements.
Letter of Intent: an ‘LOI’ is a non-binding agreement between the buyer and seller listing key terms and conditions upon which the buyer proposes to buy the business. A Term Sheet or Memorandum of Understanding (MOU) may be used in lieu of an LOI depending on the type of transaction. The LOI will likely include a non-disclosure agreement and an exclusivity period during which both parties do not talk to other potential deal partners.
Data Room: the buyer’s counsel will often make a lengthy and over-inclusive due diligence request. Sellers should be prepared to provide copies of requested documents relating to material contracts, pending and past litigation, employment and labor issues, financials, taxes, and other aspects of the business. Sellers should house these documents in an ‘data room’, which may be a physical or—more often—virtual location.
Mutual Nondisclosure Agreement: nondisclosure and confidentiality agreements incident to potential sales of businesses are important, especially where trade secrets must be revealed. The agreements help give recourse if they are abused by a party on the other side, brokers, legal or professional advisors. The confidentiality agreement itself needs to be executed at the very earliest stages and in advance of the exchange of confidential information.
Exclusivity Agreement: an agreement for a period of time during which the parties do not speak with other potential deal partners. This will give assurance to sellers when negotiating a deal.
Purchase & Sales Agreement: counsel will play an essential role during purchase and sale negotiations, which require extensive documentation tailored to the specific deal. In an asset sale, this agreement will identify all assets to be purchased by the buyer as well as any liability that will be assumed. Typically, an asset sale will be structured such that the buyer will purchase the business free of certain or most liabilities In a share sale, this agreement will describe the ownership structure of the selling business and identify the seller’s stock to be transferred to the buyer.
Representations & Warranties: representations are statement of fact about the business, and a warranty is a promise to make the recipient whole if the statement turn out to be untrue.
Disclosure Letter: sellers should address the risks of potential warranty claims by having counsel prepare a disclosure letter, which properly qualifies any warranties
Legal Opinions: seller’s counsel, buyer’s counsel, or both will often be expected to render a legal opinion at the closing of the transaction. Counsel will rely on information provided by the seller and through the due diligence process.
Additional Areas of Potential Concern
Sellers can best protect themselves by engaging legal counsel early to lay out a road map to allocate and manage risk. Counsel can work with the seller to bring on board additional tax and financial advisors as well as a business broker to navigate a potentially long due diligence process. In addition to the broad strokes covered above, the specifics of a given transaction will call for varying levels of complexity. Counsel will be able to advise sellers on potential international, antitrust, regulatory, and tax implications of a transaction. There will likely be further ancillary issues such as real estate, licenses or permits, and agreements with suppliers and distributors.