When you go to sell your business, there is a certain legal process involved that must be followed. It’s not like you can just have the buyer write you a check and then let them take over your business. There are a few legal steps to closing the sale of your business which ensures that it will be a successful transaction for both parties. Otherwise, you run the risk of facing legal ramifications after the sale if the buyer becomes unhappy with some aspect of the business that they purchased from you.
Below are the 6 legal steps that you need to concern yourself with when you’re ready to close the sale of your business.
1) Declaration of Intentions
When you find a buyer that is ready to purchase your business, there are 2 initial steps that must be taken before the purchase agreement is signed. The buyer can legally back out of the general agreement that you have with them until they actually sign the purchase agreement. These first few steps will protect both you and the buyer in various ways.
The first initial step is to form a Letter of Intent. This is a legal document that summarizes all the conditions and terms of the transaction, such as the purchase price, due diligence terms, deposit amount, and so on. Some buyers will create their own Letter of Intent and then submit it to you for approval. If you need to make edits, then you would form your own Letter of Intent (also known as Term Sheet) with the edits and have the buyer sign off on it.
Either way, a Letter of Intent is usually a nonbinding agreement and does not guarantee that any sale will take place. Instead, it guarantees that the seller will not advertise their business for sale while active negotiations are being conducted with the buyer. To make sure that you’re dealing with a serious buyer, they will be required to pay a deposit to you during these negotiations. This helps ward off any deadbeat buyers who don’t have any money to spend on a business. But if negotiations don’t amount to a purchase agreement, then you would refund the deposit back to the buyer.
After the Letter of Intent is signed by you and the buyer, they can now use this legal document to show to lenders for the purpose of securing a loan to purchase the business. They may also take the letter to their accountant or lawyer and have them decide what terms should go in the purchase agreement if they decide to purchase your business. Overall, the Letter of Intent is more for the buyer’s benefit than for your own.
The only thing you must worry about during these negotiations is keeping the sensitive information about your business confidential. Since the buyer will be doing their due diligence and looking into your company’s financial and customer information, you don’t want them walking away from the deal and then using this information for their own personal gain. That is why a Letter of Intent should have a confidentiality agreement which prevents the buyer from using your information or revealing it to another source if the sale does not occur. This is the best protection you can give yourself as a seller while you’re trying to secure a purchase agreement with a buyer.
2) Buyer’s Due Diligence
Due diligence is a term you often see in real estate documents but they also apply to the documents which pertain to selling a business. As mentioned in the first step, the terms of due diligence are outlined in the Letter of Intent. Due diligence is when the buyer does their own research into all aspects of your business. They will want to look at your financial records, customer records, sales reports, profit & loss statements, expense statements, leases, business loans, business contracts and so on. All this information will help them decide whether they want to purchase your business.
For a seller, it is important to let the buyer perform their own due diligence because it will help protect you if a sale is made. For example, if the buyer were to purchase your business and then sue you because they claimed you weren’t honest about the number of customers your business gets per month, the due diligence clause will protect you in court. Basically, if the buyer acknowledges in a legal contract that they performed their own due diligence and are still willing to proceed with the purchase of the business, they cannot come back later and claim they didn’t know certain information about the business. As long as you provide them with accurate documents about your business during their due diligence process, then they have no legal grounds to sue you.
All your company’s paperwork should be made readily available to any serious buyer that has signed a Letter of Intent. Don’t wait until you get a buyer to prepare this information because then they might walk away from the deal. You should also prepare reports which pertain to the operation of your organization. This includes inventory reports, employee records, maintenance reports, asset portfolio, marketing tools, organizational chart, and property list. Just think about what you would want to see if you were the buyer and have it ready for them.
Once the buyer reviews all these documents, they may ask you if they can personally inspect your company’s facilities. This is a big part of their due diligence investigation because it allows them to see the business in action and how the organization is managed. This may slow down productivity a little bit for your employees but you should still let the buyer do this. Otherwise, they will get suspicious if you tell them they cannot inspect the facility.
If everything checks out from their inspection, the buyer will want to know if there are any outstanding legal or financial disputes with your business. This may be a pending tax audit, insurance claim, lawsuit, or anything else that may affect the profitability or reputation of your business. Be honest and provide them with all the details about this if they exist.
3) Purchase Agreement
By now, a Letter of Intent has been signed and your buyer has performed their due diligence on your business. If they are still interested in proceeding with the purchase of your company, then you need to create a purchase agreement to officially start the transaction. Unlike the Letter of Intent, the purchase agreement is a binding contract that will obligate the buyer to purchase your property for the price and terms agreed upon in the document.
At this point, you should have an attorney create this purchase agreement for you. Sometimes the buyer will have their own attorney do it. Either way, your attorney should at least write the clauses that protect your interests and then share them with your buyer’s attorney. Be aware that a purchase agreement is not some 2-page document. Depending on the size of your business and the number of terms outlined, it could have hundreds of pages to it. That is why it is best to have an attorney who is experienced in contractual law to handle the agreement and review it for you.
Related: Legal Templates at ExitAdviser
To protect yourself the most, do not include any guarantees in the agreement. You need to outline the liabilities that the buyer will be undertaking and how you as the seller will not be held responsible for them after the sale. Since the buyer has done their own due diligence, they should not have a problem agreeing to these terms if they are satisfied with the outcome of their investigation.
In some cases, if the buyer’s investigation found disputes or problems with the business, their attorney may want to include a provision in the agreement where you agree to settle these issues prior to the sale. This is not unreasonable because the buyer would still be willing to purchase the business even though it has these problems. You may even want to agree to help the buyer with certain expenses in running the business during their first couple of years of owning it. However, only do this if they are expenses which affect the value or operation of the business as you hand it over to someone new.
Your agreement should have a provision which outlines the expenses that you are willing to pay for the buyer. Just be sure they don’t total to more than 25% of the total sales price of your business. Otherwise, you’ll be giving back a majority of the profits that you’re making from selling the business. With that being said, product liability is one particular liability that sellers take with them. This refers to the liability on products that you have already sold to customers up until the point where you transfer ownership of your business to the buyer. Therefore, keep your product liability insurance active in case a previous customer tries to come after you in court.
4) Buyer’s Method of Payment
The buyer’s method of payment is something you need to find out right away. If you are fortunate enough to find a cash buyer for your business, then it will be a very smooth transaction. However, most of the time, buyers will either try to obtain financing from a bank or they will ask you to give them a seller financing deal. This is where you agree to accept monthly payments from them in exchange for letting them own the business. Unless you are really desperate to sell or you’re confident that the buyer will follow through with the deal, it is best to avoid seller financing. Otherwise, if your buyer defaults, then you must go through a legal procedure to reclaim ownership of your business. By that time, the buyer could have driven your business into ruins. It is best to consult with your attorney about which type of payment is best to accept from the buyer.
5) Pay Attention to Local and State Laws
There are specific laws in every state which regulate the sale of a business within its jurisdiction. These laws outline which actions the buyer and seller must take prior to the closing of the sale. It is important that you understand what these rules are because if they are broken, you could face a fine or a halt in the sale of the business.
If you’re selling a public company with shareholders, they may have certain rights under your state’s laws. In most states, you can only sell a corporation if you get approval from its board of directors. Sometimes the corporate charter of your company may require this too, even if you live in a state without this legal requirement. If you are only selling business assets and not the stock of your corporation, then your major shareholders will have to vote on approving the sale first. As for the minority shareholders, after they are informed that your company is going to be sold, they are allowed to find out the company’s value through an appraisal. Based on these results, they can cash out their shares on the closing day when the company is finally sold.
As far as the buyer is concerned, they may want to perform a lien search on the real estate property or other assets of your business. Even though you might have already told them there are no liens, they’ll still want to make sure themselves. This means the buyer or their lawyer will be searching the public court and/or clerk records for the state and/or county. If everything checks out on their end, you will be deeding and/or recording documents to transfer these real estate properties and/or assets in the buyer’s name. However, if the real estate and assets are in the company’s name, you don’t have to transfer them to anyone. After all, the buyer is taking over ownership of the company so whatever assets are in the company’s name will become the buyer’s assets anyway.
There are certain states that require you to prove to your buyer that there are no sales taxes due by your customers. If you live in one of these states, you need to go to your local taxing authorities and have them give you a tax certificate as proof of having no taxes owed to them. If there are taxes currently owed, a portion of the purchase price will have to go toward paying those taxes off before the business can be transferred to the buyer. This can all take place on or before the closing day. Also, don’t forget that the actual sale of the business will likely be subjected to sales and/or transfer taxes too. Some states charge these taxes for selling the business, its assets, and/or the securities of the company like stocks.
There are states which require you to notify your company’s creditors in the event that you sell a majority of its assets, such as inventory and supplies. This must be done within 10 days of the closing day. If you fail to notify your creditors within that timeframe, they will legally be able to claim these assets from your buyer after they’ve taken ownership of them. As a result, your buyer will come back and sue you for what they lost. However, it rarely comes to this because the lien search that the buyer conducts prior to the sale will usually discover any liens or debts still owed on these assets.
To save yourself the trouble and inconvenience of having this happen after the sale, just give your buyer a list of all the liens and creditors associated with the company and its assets. The information should include the amount of the liens, the address of the creditors who hold the liens, and the names of the creditors. This will save a lot of hassle down the road and it will ensure that you are doing honest business with your buyer. Furthermore, your state may require that you provide this information to your buyer anyway.
Be aware that some creditors may not approve your buyer for the same extended credit they gave you. Since creditors tend to award business loans based on the personal credit history of the owner, a buyer with a bad credit score may not be accepted by these creditors after the ownership of your company changes hands. This could mean that you’ll have to pay the creditors back at the time of the sale.
Related: Selling a Business with Debt
6) Transfer Ownership
When all the agreements, due diligence, and financing are over with and you’ve complied with state laws, the last step is closing the deal and transferring ownership of the business to the buyer. This will involve signing a plethora of legal contracts which grant the buyer ownership of various aspects of the business. If you’ve followed all the steps listed above, then you should have no problems from this point forward.
Disclaimer: This article is not a substitute for professional legal advice.