WHAT YOU SHOULD KNOW ABOUT BUYING OR SELLING A SMALL BUSINESS
Updated: Dec 5, 2022
Samantha M. Alecozay
November 18, 2021
Congratulations! You’ve decided you’re ready to buy or sell a small business. Such a milestone can be exciting, but keep in mind there are important steps buyers and sellers must take when going through an acquisition. Additionally, the process of an acquisition requires teamwork, patience, andsignificant negotiation.
In this article, we’ll guide you through the acquisition process from start to finish and share some helpful tips. However, please keep in mind that this is not legal advice. For legal advice, Alecozay Law Firm, PLLC is available to answer such questions during standard office hours or by email at email@example.com.
Before stepping into the marketplace, are you truly ready to buy or sell a business? There are advantages to buying an existing business. For instance, if you want to avoid the startup process and get into an existing market, buying a business is a great option. Other advantages include having established operation plans and procedures in place and acquiring existing customers, employees, and vendors.
However, there are potential disadvantages as well, such as the cost of buying a business, needing to improve operations, unexpected financial issues, and employee conflicts with the new business owner.
What to Consider When Buying
Before you begin, you’ll need to ask yourself if you’re in a good financial position to move forward. If not, do you have proper financial backing? Are you ready to handle the burdens of operating a business? Does the market look good for the type of business you’re interested in? There’s much to reflect on before buying.
What to Consider When Selling
For sellers, there are also pros and cons. Selling your business can be a great way to separate from a project you’re not passionate about anymore, get a good sum of money fast, and/or have more time for a new venture or retirement.
However, if you sell to the wrong buyer (not all buyers are created equal), have a change of heart after closing, or consummate the sale without proper protections in place, the damage can be considerable. Furthermore, selling a business you’ve grown from the ground up is difficult emotionally, so make sure you’re prepared for that process.
Overall, buying or selling a business is a major decision. Do some internal reflection on your motivations for buying or selling and whether it is the right move for you at this time (or at all).
The Search and Connection Phase
So, after reflecting, you’ve decided you’re ready to move forward. Great! But do you have a buyer/seller lined up? How does the local market and general economy look for the type of business being sold? These factors require careful thought, and the search process for both parties, especially buyers, can be quite lengthy. On average, it can take several months or more to find a party that is the right fit, and many deals fall through before the execution of a Purchase Agreement/Membership Sale Agreement, requiring the search to start over.
Selling tools such as business listing sites, broker firms hired to market a business, personal referrals, and other resources can help you identify potential parties. Additionally, it’s a good idea to make a checklist of “golden rules” you have for finding the right business or buyer. To do this, write down all key traits and interests the other party must have for you to consider working with them. The list can have whatever you want in it, such as financial considerations, industry-related factors, and even personal requirements, but make sure the items are reasonable. Your checklist should be a guide to either say a quick “yes,” “no,” or “maybe.”
Another important step before negotiations is to assemble your acquisition team, or your “A-Team” (cue theme music!). In this section, we’ll explain who all should be included in your A-Team: attorneys, accountants, and other business professionals.
First, hire an attorney that understands the complexities of acquisitions, can determine the correct form of sale for the deal, can draft all the necessary documents, and will work well with all parties involved. At Alecozay Law Firm, PLLC, we’ve done this many times, and we’ll be happy to work with you.
Many clients forget to consider the personality of the attorney they hire in an acquisition, but the way an attorney works with the parties can make or break a deal. We have personally witnessed a situation where a buyer’s attorney was so aggressive and uncooperative, the buyer had to fire them because the parties could not handle the attorney’s behavior. Therefore, consider the attorney’s approach to working with others in addition to his or her knowledge of acquisitions.
Second, find an accountant who can provide advice about both the purchase value and tax consequences, because no matter how your deal is structured, there are specific tax consequences unique to each business sale. Make sure the accountant has experience with acquisitions as well and a good track record.
Third, if you are a seller who wants to use a business broker for marketing, hire a firm that fits your needs and can market to the right type of buyer. Check the firm’s credentials, track record, and client references before contacting them. Furthermore, assess whether they have a solid sales strategy and confidentiality plan. Having a confidentiality plan is incredibly important because you will be releasing financial information about your business to potential buyers.
Finally, make sure you have a right-hand person to refer to throughout the deal, such as a business partner or advisor, spouse, family member, or another person you trust who can provide helpful feedback. Acquisitions are stressful, so having another person on your side can be a major boon.
Having your A-Team assembled early on can reduce unnecessary chaos. Invest in the right people best suited for your needs.
Letters of Intent, Term Sheets, and Other Preliminary Documents
Once a buyer and seller get together and assemble their respective A-Teams, the parties will often execute preliminary documents before going full speed ahead. The most common preliminary documents in small business acquisitions are Letters of Intent, Term Sheets, and Confidentiality Agreements.
Letters of Intent
Letters of Intent may be used to initiate the due diligence phase (explained later) and/or further negotiation. These documents often include non-binding language stating the parties’ interest in further negotiations and buyer’s due diligence, the form of sale (e.g., an asset sale), a potential purchase price, some key economic and financial terms, and other language. They may also include binding provisions such as confidentiality agreements and “no-shop” or exclusivity clauses to protect the company's confidential information during information exchange and keep the parties focused on the deal.
Please note, however, that binding provisions in a Letter of Intent can create much debate amongst the parties. Thus, it is important that your lawyer understands your desires in this regard and what provisions are actually helpful to include.
So, if a Letter of Intent ends up not having binding provisions, what’s its purpose? These documents, even when not binding, can be used as evidence towards loan approvals, provide a skeleton for the Purchase Agreement, and may help keep the parties honest throughout the purchase process based on a sense of obligation to operate in good faith. In general, a Letter of Intent is helpful for facilitation of the acquisition process.
A Term Sheet is another common preliminary document. Term Sheets are for parties that may want to avoid using a Letter of Intent. These documents will often have less detail and may be left unsigned, but essentially have the same information as a Letter of Intent. Therefore, if the parties are unsure about signing a Letter of Intent, they could instead draft it as a Term Sheet for reference only.
Confidentiality Agreements or NDAs
Finally, a Confidentiality Agreement, also called a Non-Disclosure Agreement (NDA), may also be signed early on if a seller is concerned about releasing sensitive company information. Often, confidentiality agreements take the form of a binding provision in a Letter of Intent.
This might not be necessary to execute initially, depending on the amount of sensitive information held by the business, but it can be used to put the seller at ease.
Once the preliminary documents are settled, or in some instances when a Purchase Agreement is executed much before the closing date, the buyer should begin due diligence. Due diligence is the process of gathering information about the target business so that the buyer can make an informed decision before closing.
The seller may make due diligence materials available at the outset of a transaction, but a buyer will usually need to make further requests to examine potential issues, such as standing of the entity, litigation concerns, and creditor liens.
Below is a list of common categories a buyer will need information about. Keep in mind this is not an exhaustive list! You may need to examine other information not listed depending on the entity type and structure.
Basic corporate information and documents of a non-stock corporation
Capitalization and member information, as applicable
Material contracts, agreements, intellectual property, and additional literature relevant to the company
Real and personal property interests
Any creditor documents and lien information, if applicable
Necessary licensures for operation
Litigation documents, if any
Audit documentation, if any
Employee matters and contracts
Financial reports and statements (going back at least 3 years)
Tax return information and tax status (going back at least 3 years)
Environmental status and reports, if applicable
Most buyers prefer to find out about serious problems before the acquisition is completed so that they are able to negotiate an appropriate purchase price or, in extreme cases, pull out of the acquisition. Due diligence findings can also impact protections the buyer seeks from the seller in the form of representations, warranties, and indemnities.
Purchase Agreements, Membership Sale Agreements, and Ancillary Documents
Depending on the timeline and structure of the sale, a Purchase Agreement or Membership Sale Agreement (depending on the form of the sale), is usually drafted by buyer’s counsel and will be executed either during or after the due diligence phase. This will depend on whether or not the closing date is simultaneous with the Agreement’s execution and if a Confidentiality Agreement was signed as a preliminary document.
The Purchase Agreement/Membership Sale Agreement is the most important document for the parties, as it outlines the structure of the sale, what is to be sold, any protections the parties will receive, how the parties can terminate the deal if need be, non-compete information, and more. If a lender is involved, they will likely also need a copy of the Agreement before approving a loan.
Common Purchase Agreement/Membership Sale Agreement Provisions
Below is a list of common Purchase Agreement/Membership Sale Agreement provisions.
Recitals and Definitions: who’s involved and the defining of certain terms used throughout the agreement
Assets: what is actually being sold and what’s not
Deal Points and Purchase Price: who does what to whom, and for how much
Representations: statements that look backward, such as the status of any litigation and environmental claims of the business
Warranties: statements that look forward, such as an assurance that execution of the Agreement will not violate any existing agreements or laws
Covenants: what the parties will and will not do before closing
Conditions to Closing: what will need to occur or be executed to actually close the deal
Indemnifications: protections given by each party to the other in varying degrees, scope, and time frames that create an obligation to pay for settlements and judgments should a specified incident occur (e.g. a breach of representations or warranties)
Confidentiality and Non-Competes: documents specifying the manner in which the parties agree not to disclose confidential information to the public, and that the seller agrees not to compete with the business
General Provisions: provisions such as what State’s laws will govern the contract, treatment of acquisition-related expenses, taxes, legal notice, etc.
Signature Page: signature of the parties as a final and separate page of the agreement
Appendices and Exhibits: additional documents attached to the Agreement for reference such as itemized lists of the assets to be sold, descriptions of real property, seller notes if applicable, purchase price allocation, a list of current employees, and anything else the parties may want to specify without taking up space in the Agreement
This is not an exhaustive list. Make sure to hire an attorney who will know what terms are important for your deal. A lender may also require certain terms in the Agreement as a condition of loan approval, such as specific items for indemnification, non-compete scope, and use of an escrow. Also, make sure the parties have identified a title company to help execute the deal when real property is involved.
Bill of Sale
A Bill of Sale is a short document outlining what personal property is being sold to the buyer. This document is used to transfer title or purports to transfer title to personal property.
Earnest Money Contracts
Earnest Money Contracts are used as an additional contract to consummate the sale of business assets by having the buyer provide an earnest money deposit. Earnest money is a monetary deposit made in good faith from the buyer. Generally, the earnest money deposit can be anywhere between 1-10% of the sale price, but often in small business acquisitions, the amount will be nominal. The contract itself sets the conditions for refunding the deposited amount as well.
Finally, a Promissory Note may be drafted to execute a loan being made by the seller to the buyer towards purchase of the business. This can be done in a variety of formats and payback schedules, so long as the Note complies with State laws (and a lender’s requirements should an official lender also be involved).
Once you have all the necessary documents negotiated, approved, and signed, you can finally close the deal.
Closing and Post-Closing
Closing refers to the completion of the transaction and the transfer of ownership. It is the date from which the buyer has actual control over the business. This is an exciting date worth celebrating, but keep in mind there are still finalization and post-closing matters to consider, as the parties are not out of the “acquisition woods” just yet.
First, make sure all parties deliver on what is outlined in the documents. Failure to actually execute what has been signed for can delay the transfer, create major headaches, and even cause the deal to fall apart.
Second, as the buyer, make sure you are on top of all integration matters, such as hiring any new employees, service providers, and other needs the business may have that are not covered by the deal or current employees that stay.
Third, be vigilant with situations that may adjust the purchase price before execution of closing, such as any liabilities, asset fluctuations, or actions of the seller/buyer that may affect the business.
Finally, be mindful of any post-closing issues such as indemnifications or failure to make payment towards Promissory Notes.
Contact Alecozay Law for Your Business Acquisition Needs
To recap, there’s a lot to consider when buying or selling a business. This can be an exciting time for all parties involved, but it’s important to do your research, have a good team on your side, and understand the acquisition process.
If you are considering buying or selling a small business in Texas, contact us to schedule a free consultation! You can schedule an appointment via email at firstname.lastname@example.org or by phone at 210-774-2741 during standard office hours. We look forward to hearing from you!
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Our attorney, Samantha Alecozay, has established herself as a unique and accessible option for small business owners in the San Antonio area needing assistance who goes above and beyond traditional legal counsel.
Samantha has a diverse background that allows for a thoughtful approach to legal services. To learn more about Samantha's expertise and background, visit our "Meet our Attorney" page.
If you have any legal questions or need counsel for business law matters, please contact us at (210) 774-2741 during hours of operation or send us an email at Sam.A@alecozaylaw.com. You can always visit us online at alecozaylaw.com.
We look forward to assisting you!