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Legal Issues When Selling a Business
Today, we are going to cover the legal questions a business owner should be aware of when selling a business. We have three highly respected and experienced attorneys with us — collectively, they have more than 80 years’ experience practicing business law. They’re giving us a look behind the scenes at the conversations they have with business owners who are looking to sell.
What do business brokers need to know about reps and warranties?
In every asset purchase agreement, there are certain statements of the seller that the buyer can rely upon. These “representations and warranties” can be very general or very specific.
This document typically says:
1. There are no lawsuits pending.
2. The seller has all licenses necessary to run the business.
3. The seller has paid all the taxes of doing business.
4. The seller has no pending regulatory claims or anything of that nature.
Essentially, representations and warranties are about the buyer wanting to know there is nothing negative about the business that they’ll discover after purchase. If any part of the representations and warranties turns out to be false, the buyer will expect the seller to indemnify them: in other words, provide recourse for any damages that arise in the event that they are injured. Sellers will want to minimize the scope (and possible financial liability) of whatever representations and warranties they’re making.
What kind of conversations do you have with a business seller about reps and warranties?
You need to be truthful, or there’s a good chance it’ll come back and bite you later. It’s important for brokers to go over some of what those reps and warranties are expected to be. Explain to the seller why they’re important. Get a good feel for the profit-and-loss statements and other documents the seller provides to you, to then provide to the buyer. Early on in the deal, make sure the seller is able to make reps and warranties as to their financial and tax situations
What are “baskets and caps” and how do they work?
Let’s say that the seller sets the basket for $25,000. This means you will not have to pay any money out of pocket unless the buyer has issues costing $25,000 or more. Sometimes baskets are a good thing, sometimes we want to stay away from them. It depends on what type of transaction, and how large a transaction. Sometimes a seller will want to use the reps and warranties to cap the time and money they’d theoretically have to spend on indemnification. Keep in mind that many times a buyer will ask that seller to personally guarantee those obligations and indemnifications.
If you’re selling a business, be sure to ask your legal representation about including an anti-sandbagging clause. This type of clause is inserted to protect against a situation where the buyer is already aware of a misrepresentation prior to closing, but waits until the deal closes to make a legal issue out of it.
Obviously, a business’s assets make up a large and important portion of that business’s sale. What kind of conversations do you have with a seller about assets?
It’s important to first talk about what condition they’re promising those assets to be in. Are they in as-is condition? Good working condition? Some other definition? The seller will need to make sure those assets are in that condition at the time of closing. Sellers should also make sure they’ve thought through which assets should be excluded from the deal. Maybe there’s a personal cell number that they get business calls on. Establish ahead of time that your cell phone, desk, personal computer, or personal vehicle doesn’t come with the business.
Make sure you know which assets are owned by which company (and that you aren’t promising an asset you lease, rather than owning outright). That may sound obvious, but sometimes a seller will own four or five companies. If—according to the IRS—the wrong company owns a particular asset, you’ve got a huge mess.
Sometimes people get confused by the meaning of “working condition.” Let’s say you’re selling a restaurant. The refrigerator and walk-in freezer both work, but they’re not being kept to the legal temperatures. Those assets are not in working condition, they’re as-is. Stay up to date on all maintenance and inspections of assets!
What do business sellers need to think about, as far as employees go?
Prior to closing, a buyer is going to look at whether employees have accrued a lot of unused sick leave or vacation time. The buyer would prefer that those days be taken prior to closing, so they won’t have to inherit the obligation. As a seller, you’ll also want to (confidentially) get a feel for which employees will remain once the new owner comes in.
Technically, at the closing of a business sale, the seller fires all of their employees at that time, and the buyer hires them into the “new” company or business entity. You’ve got to determine what impact that will have on health coverage, benefits, salary, etc.
The biggest issue I see with employees is: The seller has key employees who contribute massively to the business’s success, but there’s no written employment agreement and no written non-compete agreement. The buyer of course expects to maintain those employees — especially in the sales or insurance business. If those key employees are not under assignable, non-compete agreements, the buyer has no recourse. On many occasions, I’ve had employees hold up the closing or cause it to fall through because the buyer didn’t ask for formal agreements before closing. Sellers should make sure those agreements are in place before employees learn there’s a potential sale.
A few times, we’ve stipulated in the contract that if the employee stays with the “new” business for 18 months, they’ll get a $25,000 bonus. That $25,000 comes out of the money the buyer put up at the closing table. In other words, it comes out of the seller’s proceeds of the business sale. If the employee does leave or gets fired, the $25,000 is donated to charity. That way, there’s no conflict of interest. That has worked out very well on several occasions to make employees want to stay around for a while post-closing.
What about the lease of the premises?
Make sure there’s actually a lease in place! Oftentimes, the lease expired and was never renewed. As a result, once the landlord finds out you’re trying to sell the business, they’ll want some sort of premium. Determining when to contact the landlord is another issue. In some instances, it’s probably better to wait to contact the landlord until the sale is closer to closing. If you anticipate any issues, it’s good to do it upfront. In a lot of closings, the landlord has the right to (within reason) approve or not approve the buyer. I’ve had landlords agree to approve the buyer — on the condition that the rent or some other term changes to their benefit. Sometimes they’ll want part of the purchase price in order to approve a lease
assignment. Remember that in some states, the other parties can close the deal without the landlord’s consent if the landlord is being unreasonable. The seller could also recover damages against a difficult landlord, thanks to something called tortious interference. Don’t let the landlord control the transaction like this when you have a buyer who’s credit-worthy and financially responsible.
A lot of people don’t realize that re-assigning the lease from the seller to the buyer doesn’t necessarily impact a personal guarantee at all. The seller may still be on the hook. The seller needs to make sure that’s addressed in the assignment or a separate document. Sellers can bring it up with their landlord like this: “Hypothetically, if somewhere down the road, I
decided to sell the business, how difficult would it be to transfer the lease? What would you be looking for in that situation?”
When a buyer is looking to get a lease put in their name, they’ll send over all the information that the landlord wants. Sometimes the buyer doesn’t realize just how critical this situation is — they’ll just throw the documents together and send them over. It’s always great to have the buyer send the information to the broker first. The broker can make sure everything is in order and easy for the landlord.
What are the most common misconceptions or problems sellers tend to have?
Unused gift cards are a huge issue that sellers need to be aware of. If, later on, the buyer keeps getting presented with more gift cards than they expected, they’ll come after the seller. Make sure the seller has looked at and thought through any outstanding liabilities, like lines of credit — even if they’ve never actually drawn from those lines of credit. The transition of ownership itself can also create a lot of issues. Sellers need to plan how they are going to transition the business to the buyer. Oftentimes, that depends on the type of the business. If you say you’re going to give two weeks of training, you’ve got to be present. You can’t book a vacation starting the day after the deal closes, for example.
One final tip from Boss Group International’s James E. Parker:
Sellers, be truthful and honest in your discussions—and work with a buyer who you really believe will be successful post-closing.
The information contained in this blog first appeared as part of our webinar Legal Issues When Selling a Business. Head over to our YouTube channel to learn more from business attorneys Deborah Carman, Kenn Gluckman, and Steven Kutner along with BGI’s very own James Parker.