There are many good reasons why you should seek professional advice, both legal and accounting, when preparing business sale legal papers.
This becomes more important as you proceed through the sale process, as the stakes get ever higher. This is why you’re strongly advised not to adopt a, "do it yourself" approach to legal documentation.
Bear in mind that even if your business sells for a mere five figure sum, you must take care to protect yourself against any unknown liabilities that may surface after sale completion. This is a particular issue if you conduct an asset as opposed to a stock sale.
Another key factor is the difference in state laws, which impact document content and add particular nuances to the legal process. It’s a local attorney’s job to know their way around these specific legal requirements. They’ll draw up the key documents for you, in particular the Business Sale Agreement, which is the culmination of all the negotiations and Due Diligence.
Exit Adviser can’t possibly cater for all the inevitable state-by-state legal nuances.
This is why it’s so vital to seek professional advice, and only refer to the document templates provided by Exit Adviser as a way of familiarizing yourself with the content. Every business is different so please do not attempt to use these documents for your sale transaction, as they'll each need specific adaptation to meet your particular circumstances.
Video: Choosing a lawyer is a crucial part of the business sale process and the decision needs to be right. Tony Brown explains the key criteria lawyers should meet.
It may save money if one attorney, either yours or the buyer’s, is assigned to this documentation task (rather than both attorney's getting together). Either way, before proceeding to the next stage be sure to review any draft documents presented with your attorney and accountant, until you’re totally satisfied.
The purpose of this How-to Guide is simple.
To introduce you to the main legal documents you’ll come across during your selling journey, and the likely order in which they’ll be executed.
For convenience they’re placed in rough sequence of use with an accompanying explanation added for each:
- Non Disclosure Agreement (includes Sales Memorandum) - for your interested prospects
- Letter of Intent or Term Sheet - when one prospect gets serious
- Business Sale Agreement (asset or stock versions) - It's a "GO" decision
- Bill of Sale - it's a done deal!
1. Non-Disclosure Agreement (NDA)
An NDA precedes the start of negotiations.
It kicks off the legal journey because it’s the point at which you start to reveal confidential information to an enquirer, whom you’ve already qualified as a prospect.
It’s essential that you protect yourself before revealing proprietary information particularly to people you don't know. A signed NDA signifies the first real formality in your relationship with a potential buyer. It allows you to release the Sale Memorandum for them to study. Comfortable in the knowledge that any commercially sensitive facts and proprietary information included in it won’t be communicated beyond the prospective buyer and their immediate team of advisers.
The Sale Memorandum should never give away the "family silver". Later, once a Letter of Intent or Term Sheet has been signed by your preferred buyer, more detail can be revealed to them during Due Diligence.
There's a reason why the Sale Memorandum has been placed here alongside the NDA in the context of legal documentation. It's because you disclose facts about your business within the Sale Memorandum that you’ll be required to substantiate later on in the selling process. Indeed part of Due Diligence’s purpose is for a preferred buyer to check out the facts in your Sale Memorandum. There’s always the possibility that you may later be held legally accountable if you’ve knowingly presented misleading or false information in the Sale Memorandum.
An NDA typically covers:
- the names of the company, the seller and the enquirer/prospect
- a statement summarizing the information that's protected from disclosure
- the enquirer's responsibility for ensuring that his/her team is also bound by the NDA's terms
- the circumstances, beyond the enquirer's control, that would terminate the obligations on the parties bound by the NDA's terms
- the exclusion of information previously known to the enquirer
- expiry date of the agreement
- signatures of both parties
Again, it's necessary to tailor the content of the NDA to your specific needs, for example where proprietary knowledge about a machine or workflow is being demonstrated to the prospect. Regardless of any special additional clauses, all commercially sensitive written documentation disclosed should be clearly marked, "Strictly confidential, not to be disclosed".
2. Letter of Intent or Term Sheet
These documents are very similar.
They serve several important functions in the business sale process:
- to formalize the sale and purchase process, with a strong prospective buyer committing in principle to buy the business, subject to successful post Due Diligence negotiations, finalized terms and conditions, and an agreement from you, the seller, to set aside any competing offers
- to trigger a payment of a buyer deposit (if you make this a requirement before proceeding)
- to make it easier for the buyer to secure finance
- to set down in writing the outline sale terms and conditions agreed to date during negotiations
- to guide the respective legal teams in drawing up a final legally binding Business Sale Agreement, based on the incomplete and preliminary terms agreed so far in principle by both parties
- to enable Due Diligence to start
- to give the buyer chance to specify what they need from you in order to conduct Due Diligence
It’s not surprising therefore that the Letter of Intent, or Term Sheet, is normally drawn up by the buyer’s lawyer in the form of a provisional offer.
It’s then your job to check the document with the help of your attorney and accountant, which in all likelihood will result in a counter-proposal from you. This may lead to a series of draft document exchanges before signature can take place.
Once you've signed it too, the buyer then has license to examine your business in detail during Due Diligence. They'll take a careful look at your revenues, costs and business operations, as well as checking out the facts in your Sale Memorandum together with any other written or oral submissions that you've previously made. Their findings will be discussed during final negotiations which, if all goes well, will lead to a legally binding contract, drawn up by a lawyer for signature by both parties.
Provisional and non-binding are crucial descriptors applicable to a Letter of Intent or Term Sheet, whether from the seller or buyer standpoint.
The two documents differ mainly in their style. As implied by the title, a Letter of Intent is a direct statement of intent to buy your business, presented in formal letter format.
The Term Sheet on the other hand is less formal. It looks more like a proposal with the terms typically presented as a list. It's therefore less easy to misinterpret as a legally binding document should a subsequent court challenge occur.
Whether Letter of Intent or Term Sheet it's imperative that somewhere in the document there's an unambiguous statement that the agreement is non-binding on either party, and that it will be superseded by a legally binding Business Sale contract if the deal goes ahead.
A confidentiality statement is an important exception. This needs to be individually flagged as binding on both parties, rather than merely a guide for discussion and drafting of the final agreement, which typically applies to the rest of the document.
Avoid language such as "in good faith” that could be construed as implying a legal agreement. It’s another good reason to use an attorney's content authoring skills. They can tailor the document to meet the business situation and personal needs of both parties by adding specific provisions and allowances. For example, to cater for a stock or asset sale, the presence of inventory, and the addition of a non-compete clause should the buyer require it of you.
You would expect to see the following generic content in a Letter of Intent or Term Sheet:
- the purpose of the agreement
- names, addresses and contact details of the parties involved
- authority for both to enter further negotiations and execute the document
- the intention to move to a legally binding final agreement
- the non-binding nature of the agreement apart from its confidentiality clause
- purchase price before adjustments
- payment terms including earnest cash deposit, cash down-payment and details of any Promissory Note with conditions, such as repayment period, security provided and interest rate
- agreed specification for Due Diligence with timescales for completion
- expiry date of the agreement
- termination clause
- legal governance and dispute resolution
- confidentiality clause
- employee continuity details
- signatures of both parties
3. Business Sale Agreement (Asset or Stock versions)
This is the crucial document in the business sale process.
It’s signed at closure time by the buyer and seller and any other required signatories or notaries. It builds on and amends the content originally seen in the Letter of Intent or Term Sheet.
There are two possible document versions depending on the type of sale, namely a Business Asset Sale Agreement or Corporation Stock Sale Agreement. There are many similarities in the content, but crucially the items being traded are quite different. In the case of a stock sale, applicable to a corporation, transfer of business ownership is done through shares rather than specified assets.
Video: David Barnett explains what's the difference between selling company's assets versus its shares.
The template document examples of both types given in Exit Adviser are for illustration purposes only. These documents are typically drawn up by one of the attorneys involved in the deal for subsequent review and checking by both buyer and seller teams.
An asset sale is far more common, indeed obligatory should you be a sole proprietor as there are no shares involved. This means that certain assets are included in the deal whilst others, subject to negotiation, will be excluded.
Tax reporting requires an agreed apportionment of the Purchase Price between asset classifications that include inventory, tangible, intangible and property leasehold. There are more details of this in the How-to Guide on preparing for deal closure.
Either way it’s important to agree a fair market value for the shares or assets that will stand up to the scrutiny of an IRS tax official.
Some of the named sections in these agreements are:
- Agreement date and names of the parties involved in it
- Purchase Price
- Terms of the agreement, which usually involves: some form of cash deposit, which you may decide is best held with a 3rd party escrow agent; a cash sum payable at deal closure; and (often) a Promissory Note summary where seller financing is offered
- Representation and warranties, including statements that: the Agreement supersedes all previous understandings whether written or oral; all titles will be transferred free of liens and encumbrances; the individuals party to the Agreement have the right and authority to transfer and receive the assets or shares; agreed actions in the event of a dispute
- Business continuity, confirming the responsibility of the seller to maintain business as usual up to the closure date, and the terms of service should the seller agree to carry on in the business in some capacity for a period following closure
- Non-compete and confidentiality, statements whereby the seller agrees not to compete in a similar business activity within a defined geographical territory, as well as a re-statement of confidentiality by both parties
- Contingencies, for example concerning successful transfer of leases or licenses
- Laws governing the agreement, in particular which state laws shall apply
- Closure date, when and where the documents are signed
- Signatures, of whoever needs to sign, with a notary witness
- Schedule attachments, with the supporting documentary evidence
With less complex, lower value business sales, the documentation is usually simpler. The detail needed all depends on the specific circumstances of the business.
For example, extra documents will be required for real estate sale or lease, the Settlement Sheet can have a long list of entries, and a detailed Promissory Note may be required with suitable accompanying security documentation.
Other aspects of the Business Sale Agreements that benefit from legal or accounting advice, or both, include the Asset Acquisition Statement for the IRS (using Form 8594) detailing the asset breakdown, and a Universal Commercial Code Statement to register a Promissory Note that has been securitized.
4. Bill of Sale
This is more straightforward.
It’s the legal proof of sale.
No buyer will want to pay for, or take possession of, any business assets or shares without a paper Bill of Sale receipt provided by you, the seller.
The buyer will also want clear proof that you’re the true, legal owner of the items being sold.
The basic content of a Bill of Sale includes:
- your name as the seller, including address
- the dollar amount paid, written in full, then repeated in figures
- the buyer’s name
- acknowledgment of payment receipt from the buyer
- granting of sale, transfer and delivery of the items, forever, to the buyer and any heirs, successors, executors or administrators
- description of the assets or shares involved
- statement of your lawful ownership, the right to sell the items, free from all encumbrances, and a warrant that you'll speak up for the buyer should there be any subsequent legal ownership claims
- signatures, including that of a witness to notarize
The Bill of Sale, usually drawn up by your lawyer, is handed over to the buyer on the day the deal is closed, as set in the Business Sale Agreement.
This How-to Guide can be summarized with the reminder that you can sleep much easier if you engage professional help when authoring legal documentation, so that it's tailored to your specific business circumstances.
Crucial members of your sale team are a lawyer, an accountant specializing in tax matters, and a business broker should you choose to use one.
The earlier you involve them in the sale process the better.