Business Sales - Legal Factors to Consider in Selling Or Buying a Small Business

Understanding the business sale process will help the business owner prepare for the sale and realize increased value from the business. In the process of the purchase and sale of a business, there are four phases: preliminary negotiations result in the execution of a letter or memorandum of intent; an investigation of the business by the buyer commonly referred to as "due diligence;" the negotiation and execution of a contract; and the closing of the transaction. The key to realizing the highest possible value for the business is to be prepared for the due diligence phase.
The process often begins with a letter of intent or memorandum of understanding, frequently prepared by the buyer, which is a term sheet or outline of the conceptual terms of the transaction. When accepted and signed by the seller, it indicates that both parties wish to move forward, but often there is language in the document to indicate that it is not legally enforceable. The letter of intent may be accompanied by a deposit towards the purchase price, which might be forfeited under certain circumstances. At this stage of the process, the focus has usually been more on the business and financial aspects of the prospective transaction, rather than on its legal aspects.
Either as part of the Letter of Intent or as a separate document, a confidentiality agreement is executed. This is an essential element of the diligence process due to the nature of the information and documents that will be disclosed between the parties. The goal is to protect the misuse of confidential or proprietary information during the due diligence phase, and thereafter if the transaction should not be consummated. Litigation over misappropriation of trade secrets, proprietary and confidential information can be extremely costly and may come too late to be of significant benefit. Once the confidentiality agreement is in place, the due diligence process may proceed. The process of diligence begins with the designation of the persons who have authority and knowledge to make inquiries for the buyer and disclosures for the seller. In addition, especially in the case of the buyer, a person should be designated who can be contacted if in the course of the diligence process there is a party who is not responsive. It is helpful to establish a time line for the completion of certain tasks, as well as assigning responsibility for the various tasks.
The sequence of these phases may be influenced by a number of factors. The seller may wish to have an enforceable contract prior to allowing diligence, and in that case the contract for sale would be executed but provide for a period of diligence and that the purchaser's performance is contingent upon acceptable investigation results. A diligence investigation may precede preliminary negotiations, especially where the buyer may be in a position to access the diligence information (such as where the buyer is a minority owner of the business). It is not unusual to perform diligence on seller's disclosures as contemplated by the schedules to be attached to the contract. Frequently, the contract is executed at the time of closing, even though there are a number of reasons why this practice may not be advisable.
Regardless of sequence, the due diligence phase creates the integrity of the transaction. Due diligence is understood by the legal, financial and business communities to mean the disclosure and assimilation of public and proprietary information related to the assets and liabilities of the business being purchased. This information includes financial, human resources, tax, environmental and legal matters. From the perspective of the buyer, information provided by the seller is confirmed and additional information about the business is directly obtained. From the perspective of the seller, accounting and appraisal information is directly communicated to the buyer confirming issues of value and identifying potential obstacles to closing.
The contract will provide for the seller to make certain covenants and warranties based on schedules of information attached to the contract. The accuracy of these disclosures is established by the diligence process. There will be, however, certain aspects of the business, such as unknown liabilities or future revenues, that cannot be confirmed. On these items, buyer and seller will make certain agreements which will have the effect of allocating risk between the parties.
The nature of the diligence inquiry lends itself to a checklist approach. The checklist is a starting point - if followed blindly it will lead to unreasonable and redundant requests, which will antagonize the seller. Certainly if the diligence inquiries are not carefully drafted to be reasonable and appropriate to the business, the seller is well within reason to object to the diligence request. On the other hand, if the approach is not thorough and coordinated between the various experts conducting diligence, there will be oversights in the buyer's diligence inquiry. Moreover, there will be issues of confidentiality such that the process must comply Business broker Tri Cities WA with confidentiality concerns of the seller, especially if the transaction is not closed. All of this contemplates a diligence effort that is the product of cooperation between buyer and seller.
The contract will include the schedules agreed upon by the buyer and seller in the diligence process and will contain the terms of the agreement between them, including requirements of performance such as elimination of certain liabilities by the seller and payment of the purchase price by the seller. The closing indicates that all preliminary actions or contingencies have been satisfied and that all of the parties agreements will merge into the written contract of sale, which will control the relationship of the parties after the closing when the buyer will own the business.
The buyer will project the future operation of the business after closing. The buyer will be concerned whether after closing the buyer have to keep the services of the selling owner to have the business operate appropriately after the sale. If so, the buyer will pay less for the business. The primary step to obtaining maximum value for a business is to install non-owner management so owner-managers are not essential to the business.
A review of the due diligence checklist is indicative of the work involved in selling and buying a business. To prepare for sale, use the due diligence checklist and conduct a diligence investigation on your own business. If you were a buyer looking at this business, would you buy it, or if not, why not? This will be a guide for preparing your business for sale and deriving more value from your business when you do sell.

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