The basics of buying and selling a business
Pro Bono Publico
The complexity of buying and selling something usually correlates with the value and complexity of the property being exchanged.
Consider, for example, the sale of a house, a transaction that typically entails a 16-page contract, several thousand dollars in earnest money, months of due diligence, and numerous contingencies. Yet most residential real estate transactions go off without a hitch, likely because standard forms address almost all of the material concerns in some fashion and Realtors, lenders, lawyers, title companies and other professionals are there to guide the parties down every step of a complicated yet well-traveled path.
The purchase and sale of a business is anything but a well-traveled path. Almost every business sale entails unique and unusual considerations. The uniqueness of each business sale counsels in favor of the parties, especially the seller, being intentional and proactive with regards to the sale of the business, enlisting the aid of competent professionals in the process, often years before going to market.
The worst thing that a business owner can do is sell the business under the duress of a health scare or other circumstance. Robert Minor, a business broker in Carbondale with whom I spoke in preparation for this column, recommends that if a business owner wants to sell the business on the open market, the owner should start the process at least a year ahead of time. Unlike a home, cash flow and other unique factors typically drive the value of a business, requiring a business appraisal to determine a suitable listing price. Meanwhile, certain actions can be taken to enhance the value and marketability of a business. Making a business “due diligence ready” takes time. Also, the sale of a business will be a taxable event, so the business owner needs to carefully evaluate the tax consequences of selling the business, which will factor into the timing and price. According to Mr. Minor, once a business hits the market, even under ideal circumstances, it typically takes three months to a year to sell.
Business sales typically take one of two forms: an asset sale or a stock sale. In an asset sale, the buyer purchases only the assets of the company, including the physical assets (inventory and equipment), intangible assets (such as client lists, Internet domains and trademarks) and goodwill. In a stock sale, typically the only thing that changes hands is the company stock or membership interests.
The buyer typically prefers an asset sale, which tends to have favorable tax attributes for buyers, especially when the assets are depreciable. An asset sale also has the greatest potential to cut off business liabilities that accrued to the business prior to closing. The seller typically prefers a stock sale, which favors the seller from a tax perspective and which typically results in the transfer of business liabilities to the buyer.
Stock sales are generally appropriate when the sale is to key employees or other part-owners of the business. Asset sales are more common when the buyer is a third party. In any event it’s negotiable.
Colorado law generally disfavors noncompetition agreements as a restriction on trade, but statute specifically permits noncompetition / nonsolicitation agreements in connection with business sales. Buyers will commonly want assurances from the seller that the seller will not compete against the transferred business after the sale or lure away key employees. The noncompetition / nonsolicitation agreement must be reasonable in scope and duration.
Seller financing tends to be more common in the purchase and sale of a business, mostly because it tends to be difficult to get a bank loan to finance a business sale. Seller financing can be risky. The seller will typically take a security interest in the business and its assets, but taking back the business after a buyer defaults is often the last thing the seller wants to do. The decision to accept a seller-financed deal should only be made if the seller can achieve a comfort level with regards to the ability of the buyer to repay the loan and ideally if there is a large down payment.
Like a real estate transaction, a business sale will typically involve a due diligence period. In addition to inspections of the physical assets, due diligence will include an evaluation of the financial performance of the business, payroll and employment contracts, and other sensitive business and financial records. Because of the sensitivity of this information, the buyer typically signs a confidentiality agreement as a part of the purchase agreement or at the point when due diligence documents are made available for inspection.
Numerous matters will need to be addressed to ensure a smooth transition of the business. Sometimes a buyer will need to provide a bonus or other considerations to key employees to ensure that they don’t jump ship. Leases, franchise agreements, payment systems, supplier relationships, IT, and other contracts and services will need to be transitioned, often requiring significant planning and pre and post-closing work. It is not a bad idea for the seller to stay on as an employee or consultant for the purposes of training the buyer and facilitating the transition, especially if the seller is financing the sale, in whole or in part.
Much could be written about business succession or “exit” planning, which is a long-term process of maximizing an owner’s value from a business that often involves tax planning, estate planning and other proactive strategies. Important as that is, long-term exit planning is a topic for another day.
Matthew Trinidad is a transactional attorney with Karp Neu Hanlon PC. He can be reached at email@example.com. He appreciates Robert Minor’s contributions to this article. Mr. Minor can be reached at firstname.lastname@example.org.
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