Business Entity Compliance from CT Corporation — Partner with the Industry Leader
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Learn more about considerations to take when closing or selling a business.
The major steps involved in the sale of a business are:
Once you have a general agreement with the buyer as to 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, at the time the buyer submits the letter he or she 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 in the sense that at any point, negotiations can be broken off by either party, 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 seriousness of the parties. 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 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 don't rely solely on this agreement — it's still a good idea to keep the most sensitive trade secrets or other information to yourself until you are sure that the buyer will sign the contract.
Controlled auctions resulting in multiple letters of intent. Sometimes, business brokers will conduct a controlled auction in which they will describe the seller's company to a number of 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'll need to work with your broker to find out as much as you can 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's 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 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 very small 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.
Usually, after a buyer signs a letter of intent to purchase a business and the seller accepts the letter, the buyer will have a specified period of time in which 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 finalizing the deal.
Ideally, you will have collected and examined most of the information the buyer wants, as you prepared 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.
He or she 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 organization charts, payroll and benefits records, customer records, and marketing materials.
The buyer will want to know about any 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, and especially if they were prepared in-house, the buyer may want you to pay for updated statements by an accountant of his or her 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 his or her own assumptions, etc.
A wise buyer will also want to take a look at your facilities, and spend some time "in the trenches" with you and/or your employees as you go about your business. We suggest that you accommodate this request, even if it will cause some disruption of your normal operations.
Buyers will be most suspicious if they think you are hiding something. They tend to be more concerned about what they don't know, than they are concerned about minor or even major problems that might turn up in an investigation. If you know that certain problems exist, you're much better off disclosing them and talking about 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, your principal suppliers and customers, your competition, and your industry. They may ask you for more and more information until you feel overwhelmed! We suggest that you respond patiently, and cooperate as much as you reasonably can. Just 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 own due diligence. You should also do some serious investigating of your own. You'll want to find out the buyer's credit record, management experience, reputation, and the plans he or she has 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 into the future though 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's at least a reasonable likelihood that the buyer will be able to operate the business successfully.
If he or she fails miserably, there's a stronger likelihood that you may be sued for fraudulently misrepresenting the business's financial state, assets, products, or any other straws the buyer can grasp at.
The purchase agreement for your business is one of the most important legal documents you'll ever sign. After all, many years of hard work will culminate in this single transaction, by which you'll put a dollar sign on the value of your entire operation. You don't want to have problems collecting the money due you or to have legal problems haunting you into the future, and 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 should draft the sections that are most important to you. In most cases, that means the clauses containing representations and warranties about the business.
Ideally, you should try 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 he or she is assuming, and which will remain with you. Here's where a top-notch lawyer can really save your skin. Make sure that you maintain ongoing liability insurance for any liabilities that will remain with you — for example, product liability insurance on products that were sold during your tenure as owner.
Indemnity provisions, in which you promise that you will 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, make sure there's 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 doesn't nickel and dime you to death with lots of small problems.
If you are selling the assets of your business, as opposed to the stock, you'll 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 about it later. The allocation will also have to be reported to the IRS on Form 8594 , Asset Acquisition Statement.
The purchase agreement is likely to be a lengthy, complicated document. For some of the more elaborate deals, the contract plus attachments can run into the hundreds of pages. You should go through it carefully with your attorney and make sure that 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 at which the final transfer of ownership and possession of the business will occur, and when the seller will get the money. With a signed purchase agreement in hand, the buyer can finalize any financing arrangements with outside lenders in anticipation of the closing.
State laws can impose a variety of obligations on both 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 state, consult your attorney.
Many states 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 10 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, in repayment of the debt.
In some states the creditors will also have a lien on the proceeds of the sale. Even if your business doesn't have inventory, you may be covered by the law because a number of states have extended it to apply 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 quite 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 actually happens. The state laws generally allow the notification requirements to be waived if both parties agree, but then the buyer will want you to agree to indemnify him or her against any claims made by your creditors.
Another part of the bulk sales acts requires you to give the buyer a list of all your known creditors, their business addresses, and the total amounts owed to them. The list must also be filed with the appropriate state agency, so that creditors have access to it.
Before the buyer closes the deal, he or she will want to be sure there are no recorded liens or other security interests (known to lawyers as UCC-1 filings) 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 in turn will need to have your lawyer record any security interests you will have in the buyer's business or in particular assets such as his or her home or other property.
In some states, 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 due on sales to your customers, and unemployment insurance taxes due 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 to remit it directly to the state tax authorities.
In some states, the sale of a business or its assets can itself be subject to sales tax. Other states 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're incorporated; nevertheless, you'll want to know what your tax liability will be for planning purposes.
For businesses organized as corporations, state laws and your own corporate charter may require that your Board of Directors approve the transaction. In some situations the stockholders must also vote. This is most commonly necessary for sales of business assets (rather than stock) and for tax-free mergers and reorganizations. A vote of the buyer's Board of Directors and stockholders may also be necessary. Where the deal is structured as a stock sale, however, shareholder approval is not usually required.
If you have any shareholders who are not pleased about the deal, your state law may give them certain protections. In many states, minority shareholders have the right to an independent appraisal 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 in place that must be honored.
Business Entity Compliance from CT Corporation — Partner with the Industry Leader
Contact your CT service representative now!
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