SELLING A BUSINESS is a major decision. Business owners typically wrestle with this question when they ponder retirement or wish to pursue different business opportunities and interests. This article highlights the legal aspects and potential pitfalls of various stages of the business sale process.
Sale vs. Dissolution
Rather than selling the company, a business owner could, of course, wind-up and dissolve the company. However, in doing so, the business owner will not be able to fully realize the value of the company’s goodwill. In essence, goodwill consists of a business’ reputation, patronage and other intangible assets. Typically, a successful business develops these attributes over a period of time. A buyer will benefit by acquiring a company with some level of “ready-made” business and, accordingly, the seller can demand a price “premium” for this additional value.
The early stages of any business sale will entail some preliminary negotiations between the proposed buyer and seller. It is this stage where the parties will begin to explore the broad issues and characteristics of the transaction such as price, payment terms, and the legal structure of the sale (e.g. stock sale, asset sale, etc.). The parties typically converse and may exchange correspondence as well as other informal documents. It is here where the parties may unwittingly encounter their first legal land mine. There subtle differences between negotiation and words that give rise to a contract. If oral expressions are sufficiently definite as to the essential terms and demonstrates an intent to bound, a legally binding contract can arise, despite the fact that the parties planned to later formalize the agreement or address other issues in a written contract.
Letters of Intent
In some cases, a letter of intent (LOI) can facilitate negotiations. LOIs are often misunderstood and can represent significant legal risks. Many times, people wrongly view LOIs as documents that are “somewhat binding.” LOIs can have binding and/or nonbinding provisions— but there is no middle ground. LOIs must be drafted with care. If a purportedly “nonbinding” LOI is sufficiently definite as to the essential terms and demonstrate an intent to be bound, courts may construe it as a binding contract, despite the document being labeled “Letter of Intent.”
Due diligence is the care and investigation undertaken to assess the legal, financial and market risks of a proposed transaction. Although due diligence is typically a greater concern to buyers, sellers may wish to investigate the financial wherewithal, experience, and credibility of a potential buyer.
Consulting and Employment Relationships
A seller may wish to offer, or the buyer may request, the seller’s business advice after the transaction closes. After all, a seller will have a wealth of knowledge about the company’s industry, customers, vendors, employees, landlord, lenders, etc. Of course, the seller is entitled to be compensated for conveying such advice. The seller should consider exploring either an independent contractor (i.e., consultant) relationship or a classic employment relationship with the buyer.
Collecting the Sale Price
A chief concern of the seller is, as it should be, getting paid. If the sale is an “all cash” deal, the seller has little concern in this regard. However, the buyer often lacks the capital needed for an “all cash” deal. In such cases, the buyer will typically ask the seller to allow some or all of the price to be paid over a period of time. At minimum, such agreements should be documented with appropriate loan agreements and promissory notes. The seller should consider additional measures to reduce risk. For example, the seller may want the buyer to offer “collateral” to secure the loan. If the buyer is a limited liability entity (e.g. corporation or LLC), the seller should ask the principals of the entity to personally guarantee payment. The seller should also consider requesting the personal guarantee of the principals’ spouses to avoid the dissipation of the principals’ assets through asset transfers (whether “legitimate” or fraudulent).
In conclusion, selling a business implicates numerous legal issues. Entrepreneurs will be well served by obtaining professional advice regarding such transactions. Please contact the author if you wish to discuss this article or his practice areas.
This article is provided solely for the general interest of the reader. The article and its contents are neither intended as, nor should be construed as, legal advice or opinion. Legal advice and opinion are provided by the firm only upon engagement with respect to specific factual situations.
Barry F. Gartenberg, L.L.C.
Attorney at Law
505 Morris Avenue, 1st Floor
Springfield, New Jersey 07081