Legal Issues When Buying a Business

Today, with the help of three experienced business attorneys, we’re going over the legal issues that might pop up for someone buying a business.

 

 

Let’s jump right in.

 

Question: When would you suggest that a buyer use an asset purchase agreement, versus a letter of intent?

 

Steven Kutner, The Law Office of Steven R. Kutner, P.A.

I would suggest using a letter of intent sparingly: i.e. only in larger transactions where there are many terms of the transaction that the parties need to be aware of. Typically, a lot of time is wasted on letters of intent—especially if attorneys are involved—because lawyers get worried about details of the language. Generally, a letter of intent is non-binding, which means much of the time that goes into crafting it is unnecessary.

Deborah Carman, Carman Law Firm, P.A.

I agree with Steven. I’d much prefer to have an asset purchase agreement over an LOI [letter of intent]. These days, the only times you really see LOI are when a large company is looking to acquire several different businesses. Those LOIs usually run 15 or 20 pages long, even without a contract!

 

Question: A lot of southern states and regional organizations have standard asset purchase agreements. Are these good to use, or would you recommend drawing up an agreement from scratch?

 

Kenn Gluckman, Moran Kidd Strategic Business Counsel

It depends on the size and sophistication of the deal. If you have a more complex deal, the standard contract won’t be so effective, because more detail and more information is needed. If it’s a smaller deal, it makes sense for the broker to put together a standard contract (with an addendum if needed).

 

 

 

 

It’s important for us business brokers to remind buyers and sellers that you can’t sign a contract and then go to an attorney. If they want to have an attorney review any contract, that needs to happen prior to signing.

 

 

 

Question: Which is better for the buyer, a stock sale or an asset sale?

 

Deborah Carman, Carman Law Firm, P.A.

Most of the time, it should be an asset sale. Sometimes, we’ll do a stock sale for one of a few different reasons (like a landlord situation, or because it makes that particular licensing easier). It really depends upon what the buyer wants to accomplish.
A good 99% of the time, we are going to do an asset sale—which is better in the sense that there are no liabilities. With a stock sale, you are assuming all liabilities.

Kenn Gluckman, Moran Kidd Strategic Business Counsel

Think of a company as being like a bucket. In that bucket, you have assets and liabilities. The best thing to do is to scoop out those assets that you want and leave the liabilities in the bucket.

Question: How (and why) do you encourage buyers to opt for contingent or deferred payments when
buying a business?

 

Steven Kutner, The Law Office of Steven R. Kutner, P.A.

Especially in this economic climate, you can't rely upon a business’s past successes and financials. No matter the circumstances, it’s best for a buyer to keep the seller honest—to make sure the buyer gets what they think they are getting.

In other words, the buyer of a business is purchasing a stream of income. More than buying assets, you want the income from those assets. So of course you’ll want to know how stable and reliable that income is.

Deferred (or contingent) payments are tied to either client retention or to future revenues of the business. Sellers will almost certainly resist agreeing to these kinds of payments, but buyers should push hard for them regardless. If I were buying a business now, it would never be based solely on prior income, without some tie to future income.

Question: What do you discuss with buyers when it comes to licensing issues?

 

Kenn Gluckman, Moran Kidd Strategic Business Counsel

We’ll take a look at whatever intellectual property the business has. Is a franchise company involved? We need to understand who the franchise company is, how they structure their franchisees, if there are transfer costs, etc. Some entities do it via licensure. Oftentimes, it is not actually proper for the buyer to just license intellectual property if the entity holds additional controls. (That’s the difference between a franchise and a license deal.) It is important for a buyer to understand what’s being licensed, what the terms of that license are, whether the license is transferable, how it’s transferred—and how this all impacts the buyer post-closing.

 

Question: What would you say to a buyer in terms of governmental licensing?

 

Deborah Carman, Carman Law Firm, P.A.

Great question. You need to have an understanding of the business and see if the buyer actually is a qualifier of that particular business. When a business covers healthcare under the ACA [Affordable Care Act], there are a lot of different governmental rules and regulations that need to be carefully followed. A buyer can find themselves very dependent on a seller in those cases.

 

 

 

 

 

If you are doing an SBA loan, remember that the banks or the SBA does not like when the seller carries the license for the company for over a year. Plan to get that transfer of license done within 12 months of the sale.

 

 

Question: Can you talk a little bit about reps and warranties from a buyer’s perspective?

 

Steven Kutner, The Law Office of Steven R. Kutner, P.A.

From a buyer’s perspective, there’s probably nothing more important in the contract than the representations and warranties. As the name implies, these represent certain aspects of the business via a written contract. The reps and warranties will include anything material to the sale of the business that a buyer would want to know is true and accurate. Along with the representations and warranties, there’ll be a paragraph in the contract where the seller agrees to provide indemnities if anything turns out to not be true. This paragraph also gives the buyer the right to walk away before closing if any detail is determined to be untrue.

Deborah Carman, Carman Law Firm, P.A.

Make sure that the duration of the reps and warranties is included—and personal liability on the part of the seller, too. Those both give a little more weight to the reps and warranties.
COVID has made this whole situation much more interesting, because there are so many unknown factors. For instance, a landlord could have granted extremely generous lease terms to the seller, terms that the buyer doesn’t know about. On the other hand, there could be a PPP [Paycheck Protection Program] loan that the lender wants the buyer to assume. Those are just two of the different issues that COVID has brought forth.

Steven Kutner, The Law Office of Steven R. Kutner, P.A.

There are certain financial documents that you'll gather for a buyer. In my professional experience, profit-and-loss statements and tax returns for the last two years have been particularly relevant. In every transaction where I represent a buyer, I insert a rep and warranty stating: “The attached financial documents are materially accurate.” If you want to keep the seller honest, you’ll do that. A seller is less likely to provide financials that are inaccurate when they have to specifically state in the contract that these are attached to the contract, and that the buyer can rely upon them to be accurate. (This also helps if you have to sue for fraud down the road.)

Question: What conversations do you have with buyers about liabilities?

 

Steven Kutner, The Law Office of Steven R. Kutner, P.A.

In an asset sale, most liabilities don’t transfer unless they show up as liens or there’s a UCC [Uniform Commercial Code] filing. You can check these online. I’ll generally check to see what a seller has out there in my first meeting with a buyer, so we’re aware of that in our initial conversations. Generally, a buyer isn’t going to hold liability (except for sales tax liens or other tax liens in certain instances). That’s why we do asset sales. Again, in the contract it’s best to have a very clear warranty from the seller that there are no liabilities
other than X, Y, and Z. That way, those liabilities don’t carry over to the buyer (or if they do, the buyer has some recourse).

Question: What conversations will you have with a buyer about employees currently working for the
business?

 

Deborah Carman, Carman Law Firm, P.A.

It depends upon what type of business it is. One thing we tell all buyers: You need to find out exactly what the current compensation, sick-leave, and vacation-pay policies are. Everything has to be taken care of at the time of closing. You don’t want to have any issues with unhappy employees once you take over as the buyer. It’s also very important to work out how buyer and seller will cooperate on a smooth transition. You can’t just spring that on someone at closing. Plan to meet with the seller on a regular basis.

 

Question: What conversations do you have with buyers about noncompete agreements?

 

Steven Kutner, The Law Office of Steven R. Kutner, P.A.

The noncompete clause or agreement needs to be very specific. Buyers need to know who has to be a party to the noncompete: The seller? The principal? The principal’s spouse who comes in periodically? Basically, anyone who is involved with the business and has strong client relationships needs to sign a noncompete. The noncompete needs to be even more specific if the seller wants to stay in the industry: i.e. valid for at least be 3 to 5 years. It can even go up to 7 years, if the seller is willing.

All of that said, I also like to know why the seller is selling the business. Plenty of sellers regret selling their business when they get bored a few years down the road. In that scenario, the buyer can sue. However, that costs money and time—and their business could be destroyed in the interim. It’s always best to ensure that the seller has good motivation for selling, such as retirement or other unrelated businesses they’re choosing to concentrate on instead.

Question: What do buyers need to know about the lease?

Kenn Gluckman, Moran Kidd Strategic Business Counsel

It’s really important for the buyer to get a copy of the lease to understand what’s in it:
 Is the seller personally guaranteeing the lease?
 Does the seller expect the buyer to personally guarantee the lease?
 What are the terms of the lease?
 How much time is left in the current lease?
 Does the buyer need a new lease, or can they get a re-assignment of the old lease?
 Will there be a fee for re-assigning the old lease?
 How are the current interactions between the seller and the landlord?
 Is the seller current on their lease term, as in properly paying rent and taking care of the space
etc.?

All of this is very important to understand as early as possible in the process.

 

 

 

Business brokers, talk to your buyers and sellers about getting an attorney who’s used to doing transactions like this all the time.  They’ll know what’s right and wrong, what’s normal and not normal. A good attorney  will fight on your behalf to get you the best dealpossible. At the same time, they’re not going to dig in their heels to such an extreme that the deal endsup dying.

 

 

 

The information contained in this blog first appeared as part of our webinar Legal Issues When Buying a Business. Head over to our YouTube channel to learn more from business attorneys Deborah Carman, Kenn Gluckman, and Steven Kutner — not to mention BGI’s very own James E. Parker.