When a seller chooses to sell their business it is a big decision. Choosing to sell a business is complicated. Sellers are not only selling the business; they are selling everything the business represents. Along with the name and location of the business, the seller is selling their reputation, customers, and hard work. The seller gets to reap the rewards of their hard work by getting a large sum of money upfront for the established business. Unfortunately, the seller also has to deal with the downsides of selling a business, including loss of cash flow and accounts that may be worth much more than originally determined.
Given the pros and cons of selling a business, sellers need to be aware of what protections they are afforded. There are many terms and conditions that can be implemented in order to protect the seller in a business acquisition. Having a clear understanding of what the document actually says will leave the seller in a better position.
Sellers should be aware of the following key terms when deciding to sell a business:
Letter of Intent: A letter of intent is a non-binding document offering to purchase the business. The intent is usually required by sellers before they will provide sensitive information to the potential buyer about the business. The letter of intent should state the proposed price and terms and conditions to purchase the business. It is also important for the letter to clearly state that either party may revise or quit the discussions if they so choose.
Confidentiality Agreement: This is an agreement usually required by the seller before they will share sensitive information business. Generally, the confidentiality agreement requires all information obtained about the business to only be used for making a determination about buying the business.
Form of Payment: The method of payment that is expected. It is very important for the seller to know what method of payment is being offered and what they are willing to accept. The type of payment should be clearly defined. The seller needs to be able to inform the buyer of what there expectation is. Sellers can determine if they want the buyer to pay cash, debt, stock options, or a combination thereof. Understanding how the payment will need to be made will allow the seller to ensure they are working with a buyer who can meet this demand.
Buyer Financing Representation: A letter provided by the buyer highlighting what financial institutions are backing them and the amount of capital and debts being carried by the buyer. This letter is protects the buyer because it highlights to the seller the buyer is making serious offer that contains sufficient financial backing. The letter should include a covenant that the buyer will make all reasonable efforts to obtaining the financing.
Earn-out: A provision written into some financial transactions in which the seller of a business will receive additional payments based on the future performance of the business. If there is going to be an earn-out agreement, the seller will need to ensure they agree to amount or percentage they will be happy with. The seller will always want to ensure the agreement has a set number of years to ensure they get the full amount they are entitled to.
Working Capital Adjustment: Any changes to the purchase price that will be triggered if the seller varies from a certain predetermined amount as of the closing date. Having this term included can help ensure the buyer does not pay the less then the business is actually worth.
Legal Structure: The type of legal structure to be used in the purchase. Options may include a triangular merger or asset purchase. It is important for the seller to choose a legal structure that will give them the best tax options available.
The seller should abide by a series of conditions when deciding to sell their business. The conditions designed to protect the buyer include:
Legal Help: As a condition of selling the business, the seller needs to insist that all documents and terms are reviewed by a business law attorney of their choosing. The seller should not rely on the buyer’s counsel, since that counsel represents the interests of the buyer only. Having independent counsel will make sure the seller is getting legal advice that will guide them in a direction that will work towards their benefit. The seller should also decline to work with one attorney handling the transaction for both parties. Independent is always going to be in the seller’s best interest.
Binding: The conditions of the terms need to be clearly defined as binding or not. Generally, the terms are not binding, and there will be a clear statement that the terms are subject to an eventual negotiation of a purchase agreement.
Financial Statements: Before sharing the company’s financial statements, the seller should have statements reviewed and certified buy a reputable independent accounting firm. Having the financials reviewed and certified will instill confidence in the potential buyer and help the seller get the best possible purchase price.
Tax Returns: Before selling the business, the seller should compile at least three years of tax returns. Having three years (minimum) of tax returns will show the buyer the business is profitable and there are not outstanding liabilities.
Responsibility for Expenses: This is condition that defines which expenses each party is responsible for. The seller needs to know what costs they will have to cover and what costs the buyer will need to absorb. Common expenses include: attorney’s fees; accounting expenses; closing costs; and other expenses that may arise due to the acquisition of the business.
Acceptance Period: The acceptance period is a condition which dictates for what period of time the terms are being offered. Generally, the terms are required to be signed within the acceptance period. Putting this condition in place does not mean the terms are binding, and the parties are usually allowed offer a different set of terms if circumstances change.
When making a decision to sell a company it is important for the seller to have a clear understanding of the terms and conditions. If the seller is not aware of what the terms and conditions mean, then the seller will lack necessary and important protections they are afforded. It is important when advising a client in selling their business for the attorney to ensure the client understands what they are getting into by signing purchasing agreement and selling their business.
Rebecca Rouse, Legal Extern
JUX Law Firm