As part of our Buying and Selling a Business Blog Series, we have discussed important steps in preparing for the transaction and the importance of due diligence. We will now dive into the process of executing the deal. In a business sale, once due diligence is complete and both parties are ready to move forward, the next step is to “paper the deal”. With money, future profits, and significant assets at stake, this critical step shouldn’t be reduced to a handshake. Whether you’re the party buying or selling the business, understanding and implementing the proper legal documents will help you plan critical components of the transaction, avoid disputes, and prepare for a smooth transition.
This blog will cover the key elements of papering the deal, including selecting the transaction structure (asset purchase vs. equity purchase), drafting the purchase agreement, and preparing ancillary documents like employment agreements, bills of sale, and more.
Selecting a Transaction Structure: Asset Purchase vs. Equity Purchase
Choosing between an asset purchase and an equity (or stock) purchase is a fundamental decision in a business sale, each with its advantages and disadvantages. In an asset purchase, the buyer acquires specific assets (potentially all) and usually none of the liabilities of the business rather than the on-going business operation and entity itself. In an equity purchase, the buyer acquires ownership by purchasing the seller’s shares or membership interests in the on-going business, taking on all assets and liabilities.
Asset purchases are often preferred by buyers because they can “cherry-pick” valuable assets and leave behind unwanted liabilities. This reduces the buyer’s liability exposure and can result in other tax benefits through asset depreciation. This structure may be less favorable for sellers, as they may be left with liabilities and may need to dissolve the entity post-sale.
Equity purchases tend to result in a cleaner exit for the seller, as the seller transfers all liabilities and obligations to the buyer with the company. When a sale is structured this way, buyers should be aware that they are taking on all liabilities belonging to the company, including hidden risks. Comprehensive due diligence is always important, but it is vital for the buyer in equity purchases.
Deciding on a structure often depends on tax implications, liability management, and both parties’ goals for the transaction. A significant consideration in whether an asset purchase or equity sale is chosen may often turn on the transferability of existing customer contracts and retention of employees. Each party to the transaction should engage and consult with legal and financial advisors to identify which structure best fits each party’s needs and then negotiate a path forward that works for both parties to get the deal done.
Drafting the Purchase Agreement
The purchase agreement is the primary legal document in a business sale. It specifies the terms and conditions of the transaction, setting out rights, responsibilities, and protections for both buyer and seller.
Key components of the purchase agreement include:
- Purchase Price and Payment Terms: This section outlines the purchase price, the payment structure (e.g., lump sum or installments), and any contingencies that might impact the final payment amount.
- Representations and Warranties: For sellers, representations and warranties provide assurances about the business’s condition and performance, some of which survive the sale of the business and can provide a claim against the seller by the buyer if such statements are false. Buyers rely in part on the representations and warranties of the seller in making their final determinations to, complete the transaction.
- Indemnification Provisions: These provisions specify each party’s responsibility for damages or liabilities post-transaction, offering recourse if unexpected issues arise. They can also limit the seller’s liability, particularly in an asset purchase.
- Closing Conditions: This section lays out the conditions that must be met before the transaction closes, including approvals, permits, or regulatory requirements.
A well-drafted purchase agreement clarifies expectations, mitigates risks, and protects both parties’ interests. It is essential for buyers and sellers to consult their legal advisors to ensure the agreement is comprehensive and accurately reflects the agreed upon terms.
Key Ancillary Documents in a Business Sale
In addition to the purchase agreement, several ancillary documents are needed to support the transition and provide legal protection.
Some of the most common ancillary documents in a business sale include:
- Bill of Sale: This document transfers ownership of tangible assets (e.g., equipment, inventory) from the seller to the buyer. It provides evidence of the transaction and ensures the buyer’s legal ownership of assets.
- Assignment and Assumption Agreement: This agreement is necessary in asset purchases to formally assign assets and liabilities being transferred. It also outlines which party assumes responsibility for each obligation, which is critical in delineating post-sale responsibilities.
- Intellectual Property (IP) Assignment: If the sale involves transferring IP (e.g., trademarks, patents, or copyrights), this document formally assigns ownership to the buyer. It is crucial for businesses where IP is a core part of the business’s value.
- Non-Compete and Non-Solicitation Agreements: These agreements protect the buyer from competition by the seller. In a non-compete, the seller agrees not to start or work for a competing business within a certain time frame and geographic area. Non-solicitation agreements prevent the seller from poaching employees or clients.
- Employment or Consulting Agreements: In many business sales, especially those involving key personnel, the buyer may require the seller or certain employees to stay on temporarily to ensure a smooth transition. Employment agreements outline terms, roles, and compensation for these arrangements.
- Escrow Agreement: Sometimes, a portion of the purchase price is held in escrow to cover unforeseen liabilities or indemnification claims. This document outlines the conditions for release of funds held in escrow and any contingencies.
Each ancillary document serves to protect interests, manage risks, and facilitate a seamless ownership transition.
Regulatory and Compliance Considerations
Compliance with regulatory requirements is essential when structuring a business sale, as failure to do so can lead to penalties or delays.
Some of the key regulatory considerations include:
- State and Local Approvals: Depending on the business type and location, there may be state or local approvals required, especially if the business holds specific licenses or permits.
- Tax Filings and Clearances: Both parties may need to file with tax authorities to handle any taxes due at closing or to request clearances indicating no back taxes are owed. In some cases, a buyer may request tax indemnity provisions.
- Notification of Stakeholders: In certain cases, shareholders, partners, or other stakeholders must be informed of the sale. For example, equity purchases may trigger rights of first refusal or other notice obligations.
Finalizing the Deal and Post-Closing Obligations
Closing the sale is a major milestone, but both parties should be aware of any remaining post-closing obligations:
- Payment and Release of Funds: Depending on the payment terms, funds may be released over time or held in escrow until specific conditions are met. An escrow agreement must clearly outline release conditions.
- Transfer of Records: The seller is often required to transfer specific records, including financial documents, employee files, and customer information, to the buyer as specifically set froth in the terms of the purchase agreement. For businesses with extensive records, consider data protection measures to ensure sensitive information remains secure.
- Transition Planning and Handover: A clear transition plan is essential, especially for buyers who may require assistance from the seller or key employees. Consulting or employment agreements often formalize these arrangements, ensuring continuity and stability for the business.
Proper performance of all post-closing obligations is crucial for a seamless handover and for protecting the interests of both parties and may be tied to the final payment to be made to the seller.
Conclusion
Papering the deal is a critical phase in the business sale process, requiring thorough planning, documentation, and compliance to protect the interests of both buyer and seller. By selecting the appropriate transaction structure, drafting a clear and detailed purchase agreement, and preparing essential ancillary documents, both parties can pave the way for a clear and successful transition that is legally binding on both parties as to the performance of all their obligations.
Understanding these steps allows business owners to enter the transaction with confidence, knowing they are well-prepared for a successful closing and the new chapter that follows. Whether you are buying or selling, having a clear roadmap and skilled advisors at your side ensures that everything that needs to be completed is known, covered, and enforceable pursuant to the terms of the legal documents such that business is smooth and beneficial to both parties.
Contact Skufca Law at (704) 376-3030 today for more information or to discuss buying or selling a business.