Numerous legal and operational issues will arise when selling a business. Proper preparation by assembling the right group of professionals and material business documents will save time and costs, and ensure the transaction is as smooth as possible.
Retain an attorney immediately
After a business is offered up for sale, a purchaser may prepare and submit a letter of intent (LOI) for the seller’s review and approval. A LOI is a legal document that sets forth the form of the transaction (whether it’s an asset or stock sale) purchase price, manner of payment, deposit terms, transaction conditions, due diligence terms and timeline, choice of law and other relevant terms of the sale. Business owners often make the mistake of not engaging an attorney until after the LOI has been signed. By failing to retain an attorney to negotiate the LOI, a business owner may be stuck with unfavorable terms or may have missed the opportunity to ask for something valuable at the onset.
Engaging an attorney can save significant costs and time because imperative business issues can be discussed and agreed upon in the early stages, and if the parties cannot come to an agreement, they can go their separate ways as opposed to wasting time, costs and the efforts involved with both negotiating a purchase agreement (PA) and conducting due diligence. The attorney will also ensure that the LOI contains a timeline or expiration so that if the sale is not completed by a certain time, the seller can move onto another interested party without issue. The LOI will continue to be a material part of the entire transaction even as the PA is negotiated. If something is agreed upon in the LOI and one party tries to differ from the LOI terms during the PA negotiation, the other party will point to the LOI for support—often successfully.
Review the business’s governing documents
It is crucial that the business’s governing documents are complete and accurate. A sophisticated purchaser will review the business’s articles of organization or incorporation, operating agreement or bylaws and timely filed annual reports. A purchaser will raise issues and have concerns if a seller cannot provide complete and accurate corporate records.
The owner of a business with multiple shareholders or members selling the business via an asset sale should review the bylaws or operating agreement to confirm the percentage of owners that must agree to the sale in order for it to occur. The sale of all or almost all of the business assets is a standard situation that requires majority consent. A business owner intending to sell via a stock or membership interest sale should review all governing documents to confirm whether there are drag-along or tag-along rights. A drag-along right allows the majority shareholder of a business to force the remaining minority shareholders to accept an offer from a third party to purchase the entire business. There have been situations where a minority shareholder objects to the sale and prevents it altogether. A tag-along right is also known as “co-sale rights.” When a majority shareholder sells their shares, a tag-along right will allow the minority shareholder to participate in the sale at the same time for the same price for the shares. The minority shareholder then “tags along” with the majority shareholder’s sale. Any drag-along or tag-along rights provided in the business’s governing documents should be addressed as soon as possible to ensure such rights are provided and to deal with any disputes.
Gather financials and assets
One of the most important and lengthy parts of any business sale is due diligence. Due diligence is the process in which the purchaser requests to review various documents, data and other information in order to familiarize itself with the business’s operations, background and to identify potential liabilities or issues related to the business or transaction’s closing. The results of the due diligence process can cause the purchaser to react in a variety of ways, from requesting more documents, a reduction of the purchase price or terminating the transaction altogether. The most important documents to a purchaser will be tax returns, income statements, balance statements, a list of accounts receivable, accounts payable, a list of inventory and a list of personal property and equipment. A seller will do itself a huge favor by gathering such documents, saving them electronically and organizing them. This way they can be easily sent to the purchaser or uploaded to a data site. A seller will also have to make representations and warranties based upon the accuracy and completeness of such documents so it is in the seller’s best interest to have organized and complete files.
Gather existing contracts
Another standard due diligence request from a purchaser is to review all of the seller’s existing customer contacts, purchase orders, vendor and supplier agreements. The purchaser will want to determine, among other things, what work is ongoing and what liabilities and expenses it can expect. This can be overwhelming for a seller in the event the documents are not organized or stored in a readily accessible manner. A business owner considering a sale should gather and save all of such agreements electronically and in an organized manner so they can be easily uploaded for the purchaser’s review.
Consider third party consents
A purchaser should review if the business’s existing agreements are assignable or able to be terminated as the purchaser will likely want to assume some and terminate others. Therefore, it is imperative that a seller identify and understand the assignment, change of control, and termination provisions of all existing contracts so that a seller can plan ahead and be prepared to take action at the appropriate time. A business owner should review existing agreements, including leases for such provisions, to identify whether an agreement can be assigned or terminated and, if so, what is required for each assignment or termination.
Typically, an agreement requires a certain number of days’ notice to the third party or the third party’s written consent to assign the contract from the seller to the purchaser. For stock sales, the seller should identify whether the existing agreements have change of control provisions. If consent of the third party is required then it may be prudent for the seller to contact the third party as soon as possible to determine whether the other party is willing to consent. For contracts that a purchaser may not want to assume, a seller should review the termination provisions and identify if there are any fees or penalties for termination. Closings can be delayed over a seller’s failure to receive an important third party consent. This issue arises often with landlords that do not wish to consent to the assignment of the lease from the seller to the purchaser and agreements with highly restrictive assignability provisions, which are often included in contracts with governmental agencies or highly sophisticated corporations.
Contact a Chuhak & Tecson Corporate Transactions & Business Law attorney as we are ready to help you with the sale or acquisition of a business.
Client alert authored by Margaret M. Walsh (312 855 6126), Associate.
This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.