Business attorneys have a breadth of knowledge that we as business owners can use to our advantage. However, it’s important to make sure you have the right attorney on your team before you sell your business. Whether you own your own privately held company or a franchise, you need to know who to talk to and what questions to ask to find a lawyer who will have your best interests at heart. M. Blen Gee Jr. is a business lawyer specializing in commercial law, contracts, corporate law, business litigation and mergers & acquisitions. He has helped hundreds of business owners, and agreed to share some of his legal tips with you on this edition of “Deal Talk.”
In the 21st century, if you know that someone is thinking about suing, you have to preserve all digital records.
- Blen Gee
Blen: Well, thank you. I appreciate it. In terms of reading, increasingly, the practice of law is the practice of learning new stuff. It changes every day. Very little that I learned in law school is that germane anymore, other than fundamental principles. You really have to constantly keep up.
In terms of reading, increasingly, the practice of law is the practice of learning new stuff. It changes every day.
Jeff: So basically, what you're saying is you've never left school. You're always going to school and always being educated in some regard.
Blen: The 21st century lawyer is a professional learner, that’s absolutely true.
Jeff: [Laughter] That's right. Very, very good. Again, it's good to have you on the program. There's a lot to talk about and probably too much to cover in the scope of one program, Blen. So, just to let you know in advance, we may be asking you to come back at some point in the future. That all depends on how happy you are with the program when we're done with it. But let's go ahead and we'll dive right into it just to start.
Just out of curiosity, there may be some business owners or even future buyers listening to the show who've done all their homework, and they keep outstanding records. They have a CPA and a tax attorney and a professional business appraiser ready. They've contracted with an agent. Why do they need an attorney to sell or buy a business?
Blen: Every business transaction, every purchase, and every sale has a huge number of issues. Everyone is different. You have employment law issues. You have environmental issues. You have real estate issues. Does the person, in fact, own the real estate? We purchased a car dealership a couple of years ago, and there was an extremely favorable lease that was part of the deal but part of the transaction was making sure that lease was valid, that it was going to be valid five years from now and ten years from now.
If you are selling, you want to do two basic things. You want to make as few representations and warranties as you can about your business. You will be required to make some, but you want to keep that to a minimum. And you want to get paid. That's not always as easy as it sounds. A cash deal is obviously preferable. If you are buying or you're buying others’ representations and warranties that the seller is making, are they adequate? Is he going to give you a proper warranty about the status of the profitability of the business over several years? Is he going to tell you about a labor issue that has come up? Or are there hazardous chemicals on flight that weren't handled properly? A huge number of practical issues there. If it's a company that's a closely held company, just a few owners, have all the owners signed off on it? Has the Board of Directors signed off on it? If the major shareholder agrees to the sale and close and you find out that there was three other shareholders who weren't informed or were not adequately informed and there was never a vote of the Board of Directors approving the sale, your lawyer has a big, big problem. If you don't have a lawyer, you have a big, big problem. Those are just a few of the infinite number of things that can go wrong.
If you don't have a lawyer, you have a big, big problem.
Jeff: And the list goes on, Blen, as they say. Now, let's say a business owner who is contemplating the sale of their business came to you and said, "You know, Blen, I'm done. I'm ready to sell my company, ready to move on, ready to retire,” whatever the case may be. "What do I need to do first? Who should I call?” What would you say to them?
Blen: If it's the owner of the business who wants to sell out, he's got tax issues, that's number one, and valuation issues, number two. What is his business really worth? Some industries, there's fairly rapid turnover, and people in the industry know what the dealership's worth. Car dealers are good example. Most car dealers know what their dealership is worth, and they know what their competitor's dealership will be worth if somebody wanted to buy it.
Other businesses, you may have no idea how much you're company is really worth. You may have an over-inflated view of it or it may be worth much more than you realize, and there are lots of different factors: earnings in the past, earnings potential in the future, tangible assets. Many companies’ only real valuable assets are the goodwill, the business relationships that they've built up over the years, a name recognition they’ve built up over the years. Other businesses may have tangible assets that are important part of their businesses: furniture fixtures and equipment, especially manufacturing equipment. They could be a major aspect of the business.
An example would be a restaurant. A restaurant will have a great deal of goodwill associated with its location, the customer stream and the reputation in the community. It will also have spent a whole lot of money on equipment, such as tables and chairs. Restaurant equipment can be very expensive. And if you sell that restaurant right there in that location, you get maximum value. If you had to close it down and just sell off the equipment, you would find that that very expensive restaurant equipment is essentially useless, nobody wants it. So, the value in place with a going concern, name recognition, equipment, if somebody doesn't have to come in and repurchase and install, no downtime, all of those things have value. As a lawyer, I can't put a price on that. And you, as the owner, you can't put a price on that. You really need a valuation expert to help you do that in most cases.
Jeff: Let's jump into the franchise question if we can, Mr. Gee, because I know that this is an area where you really have a very deep level of expertise. How are things different when a franchise business is involved? I mean, are there certain issues with a franchise? You just talked about a restaurant, for example, which is a very, very common type of franchise business. Are there certain issues that are unique that come into play in the transaction of a franchise from one owner to another that may not be as critical for wholly-owned and operated private businesses?
Blen: Yes. Franchising, as you know, is a hugely successful business model, and it is also an area that has huge risks. Initially, 40-50 years ago as franchising took off, there was a great deal of dissatisfaction among people who purchased franchises. The Federal Trade Commission came in and started regulating the disclosures that have to be made, and today, if you buy a franchise business, not only do you have to deal with the buyer, you have to deal with the franchisor and that franchisor's going to give you a wad of documents about an inch thick. It may come to you on the internet but if you print it out, it's going to be about an inch thick. Every word in there has been scrutinized by a team of franchise lawyers who are highly sophisticated and stay current with every single case, every single change in the regulations. If you're buying that franchise, you need a lawyer who can look at the franchise disclosure document and more importantly, the franchise agreement that you will be living with for five to ten years at a minimum and tell you what it really says and what your risks are.
One of the things that I emphasize to people who are buying a franchise being is the exit strategy. If you're buying a McDonald's and you put it on a location that you think is wonderful and for whatever reason it doesn't work out, you're not making money, you can sell that McDonald's. Somebody will want to buy it. They will take over your lease, that's a long-term obligation. They will buy your equipment. You may lose some money, but it wouldn't be a catastrophe. So, that's one exit strategy on the high-end. If you're buying a franchise that's lesser known, it's a start-up, or it's a just not a huge franchise, you may not be able to sell that franchise if it doesn't go right. And no matter how well you plan, sometimes it just doesn’t go right.
We represent a chain of pubs, and they probably have opened 15-18 very successful pubs and two or three, the same management team, the same decor, the same staffing procedures, never made money. And your location might seem ideal, you may do everything right and for some intangible reason, you don't make money. If you're locked into a ten-year franchise that has a provision in it that if you terminate early, you will owe the entire royalties that remain in eight years, reduced to the present value, but that's a big number, you will also have a lease that might be three or more years. Certainly, you don't have a good exit strategy. So, that's one of the things that you have to look at with a restaurant or really any franchise: what is your exit strategy?
The business community is livid with franchises that have crashed and burned. So, you need a lawyer to look at that agreement. I always tell people, the very first thing to do is inspect, check out the franchise system carefully yourself. There are lots of resources on the web. There's a group called Blue Mau Mau that gives a lot of information about franchises that are out there. When you get your franchise disclosure document, you'll get the list of the franchisees, call as many franchisees as you can. Go visit their stores. Talk to the people who have done well. Talk to the people who haven't done well. Check out as much as you possibly can.
If you talk to some former franchisees and they tell you they're under a confidentiality agreement, they can't discuss it with you, well, that's a red flag.
Franchising, as you know, is a hugely successful business model, and it is also an area that has huge risks...one of the things that you have to look at with a restaurant or really any franchise: what is your exit strategy?
Jeff: Blen, let me ask you a question here. As you indicated, there are so many different types of franchises out there regardless of industry and opportunities. Is there an industry—whether it be hospitality or the dry cleaning or personal services, restaurants—that has a particular reputation for being, I don't know what word you used, dicey or challenging for a business owner or an entrepreneur to come in and take ownership?
Blen: Cleaning franchises have a terrible reputation. You go in and you buy a franchise. The franchisor tells you they're going to give you leads for cleaning opportunities in your city, and very, very frequently, they're just not what they are advertised as. That's the one that I've seen the most abuse in.
Other things to look at, look for, if you're buying a smaller or start-up franchise, you want to, again, look at the exit strategy. If you're buying one where your financial risks are high, you want to think long and hard about that. There are franchises for daycare and those sorts of things which require people to either invest in a substantial long-term lease for the facility or build a facility for that daycare system. You better check that one out really carefully because you may have a white elephant of a building sitting there that you can't use. Typically, they're non-competition provisions where you can't de-identify or change the brand and start your own daycare system. So, cleaning franchises and daycare systems have a lot of risk. Anything where you have to build, if it's a franchise, you have a lot of risk. You want to check it out very, very carefully.
Jeff: He's Attorney Blen Gee, Jr., and he's in Raleigh, North Carolina. My name is Jeff Allen. You're listening to the Morgan & Westfield podcast and we're talking about things that you need to keep in mind when you're selling a business, even buying a business, really why you should want to get the advice of a business attorney in order to help keep things on the legal side legal and to be very careful, quite frankly, there are a lot of mistakes that are made by people who might be involved in transacting a business from the first time. This is one of those things that you probably don't want to go at it alone, quite honestly. And Blen is able to give us some insight into some of the things we really need to be mindful of.
What is one of the most common mistakes, Blen, that a business seller makes and what do you tell sellers in order to help them avoid making this mistake?
Blen: Probably the mistake that can have the worst consequences and that has the greatest risk is where you do owner financing. A bank has underwriting requirements where they check out those buyers' financials. They have minimum asset requirements. They may require the spouse's guarantee, and the banks still suffer losses. You're not a banker if you're a seller. You are not going to have the same expertise in checking out the buyer's finances. You will not have the same system set up for credit checking, for maintaining that payment, for pursuing the person legally if they default, that a bank has. You should not be a bank. But people do. I rarely have been asked to act as an expert witness, but I was asked to act as an expert witness on a dealer transaction, probably a decade and a half ago. The lawyer had been sued, had a malpractice suit. What had happened was the seller had taken almost all of the sales price as owner financing. And there was a default. The person that bought the business went into bankruptcy. The seller had a huge, huge financial loss and blamed the lawyer, and the lawyer didn't really do anything wrong. The seller just took too much risk, you know.
You can get a lot more money in principle with owner financing because the buyer may not be able to get a bank loan, but if the buyer can't get a bank loan, why are you acting like the bank?
Jeff: Yes, why would I? I'm just wondering why would a business owner, someone who's trying to sell their business, take on that kind of risk. I mean, maybe it's just a kind-hearted act on their part. They're anxious to get out. They want to see that it works and that their business is profitable and that the new owner coming in is going to be able to make a good positive go of it, but why else would someone take on that kind of risk? I'm just kind of wondering out loud.
Blen: Well, it may be someone who has health issues. They've reached a certain age, and they really want to just get out of it. But if it's a risk, then, what you could do is you could ask for the majority of the money upfront, and then, another 20% or so in owner financing then, your risk is a lot less. It might ultimately end up with a bigger return on the sale, but it's a risk. That is probably the number one issue for sellers to avoid.
If it's the owner of the business who wants to sell out, he's got tax issues, that's number one, and valuation issues, number two.
Jeff: So, let's flip it around then. Let's talk to the buyers now who might be listening. Is there one particular pitfall that you've seen time and time again that buyers can avoid with some careful planning?
Blen: Well, the one thing that I see is the seller who has the "My way or the highway" attitude. “This is the deal, take it or leave it.” I'm even seeing sellers who are wanting non-refundable down payments or deposits before the contract is drafted.
What happens is you find that they use that as a leverage to keep changing the deal, to keep making new demands, and you find that you're negotiating position continually gets eroded. And what I will recommend to my clients is at the very beginning, when you get one of these—when you see "take it or leave it" or some unreasonable demands—and sometimes it's the lawyer, sometimes it's the seller, sometimes it's both of them, but what I recommend to the client is at that point, you should be willing to say "no" and be willing to walk away from the deal. And one or two things will happen. Either you'll say "No" and they'll say, "Alright, the deal's off," and you'd saved a whole lot of attorney's fees. Or they'll cave, and they know that you're serious. You want a good deal, you want to buy the business, but you're not going to be taken advantage of.
So, from the buyer's point of view, the "my way or the highway" seller or the lawyer that takes that position, say "No" early and mean it.
Jeff: There you go. It’s the same way that you would treat buying a car, going to shop for a car that just seems to be way out of range, and it's not what you went in there for. You'd handle it much the same way, so in this particular case, take the same kind of approach that you would when you're investing. But when you're buying a new car, the same kind of deal, just basically stand up for yourself there, and you may end up at the end of the day getting a better deal when the guy comes back and chases you down and said, "Okay. I'm ready to talk."
Blen: Or, instead of spending $50,000 and have the deal fall through, you spend $2,000.
From the buyer's point of view, the "my way or the highway" seller or the lawyer that takes that position, say "No" early and mean it.
Jeff: There you go. Now, to the meat of our chat, and I guess maybe we've saved the best part for last on our discussion here, but it really is worth it that we kind of build it up to that. It may not be possible to be lawsuit-proof, especially in our capitalistic environment in this country, Blen. As you know, you've been in the business, you've been an attorney for such a long time, and indeed, you've had the chance to see a number of different scenarios play out and been involved in many cases. But what should business owners do, regardless of the size of their business, to help lessen the chance of litigation, to help keep them out of court?
Blen: I tell people that their first defense is doing things right. If it's a well-run business, you get into trouble less. Your second defense is insurance, and sometimes insurance is magic. You have this horrible situation, and you call up your insurer. They say "Yes, there's coverage," and it goes away as a business problem. You may end up testifying in court but in the practical matter, the distraction of that litigation goes away so. Insurance can be magic. You can have a contract dispute that may have a negligence claim phoned in to the other contract clients. Contact your insurance broker and say, "This has come up. Is there a possible coverage for this lawsuit even though it's mainly a contract suit?” and sometimes, there will be coverage because there is a negligence claim. So, doing things right, insurance are the first two lines of defense.
The corporate shield, the reason you set up a corporation or a limited liability company is you put up a reasonable investment in the company but not everything that you have. And that corporate shield can protect you. If it's done right, if you have a corporation you need to have a lawyer set up the corporation, you need to have initial minutes and by-laws and to do your annual minutes, just like the lawyer's going to tell you in that cover letter that he sends you with your corporate minute book, and so many people don't do that. But do your annual minute, they don't have to be a work of art. I've seen typewritten corporate minutes that are half a page long, hunt-and-pecked typed, that's wonderful. That just make sure your litigation lawyer is so happy if somebody's trying to pierce the corporate veil that you have all those corporate minutes.
When with liability companies, the same thing. You should have your operating agreement in place, signed by all owners. And that corporate shield can be invaluable if the worst happens, and there's a huge judgment against you.
Other things to be alert to that many people forget about, especially if you have a larger organization, you want to make sure that you promptly receive that lawsuit. You don't want to end up in a situation where it is found on the corner of somebody's desk and not been dealt with, and you're in the fault position. You're already starting from a difficult situation. In the olden days, at least in North Carolina, you had the sheriff come to your office to you have the sheriff come to your office to deliver the suit papers or you got a certified letter with the suit papers and hopefully, whoever got that certified letter would get it to the proper department. But today, in North Carolina and also in the federal courts, you can get a lawsuit by FedEx. And if you have that FedEx sitting on somebody's desk, especially in federal court which has a 20-day time period for answering, 22 days later you may have a very difficult situation that you have to dig out of.
Bankruptcy notices. You may have a claim against the bankrupt company that is very valuable, and the notice may come in regular US mail. If that sits on somebody's desk, passed the deadline and bankruptcy courts are very unforgiving with missing deadlines, you might be out of luck. So, that's a very important thing that sometimes people overlook. You want to make sure that any official government or lawsuit gets to the right person as quickly as possible. If you have claims, statutes of limitation varies from jurisdiction to jurisdiction so don't sit on a potential suit if you've been treated badly. Arbitration claims, time limits could be shorter. You may go in North Carolina where there's a three-year statute of limitations, but you may find other estates have a shorter statute of limitations for a breach of contract claims. So, those are issues to be alert to.
In the 21st century, if you know that someone is thinking about suing, you have to preserve all digital records. That's just the rule these days. If you know that it's possible you will get sued, you need to put the word out, all right? Don't delete anything related to this file. If you have some old computers that have potentially digital information about that particular subject, you got to put them in a backroom, you can't throw them away. The 21st century is different, and you've got to be preserving all the digital avenues, not only because of the fact that it may turn out to be beneficial for you but, if it's destroyed or lost, you may find some federal district court judge very upset with you and sanctioning you for not preserving that evidence. So, that's an important thing that most people don't even think about these days.
I tell people that their first defense is doing things right. If it's a well-run business, you get into trouble less. Your second defense is insurance, and sometimes insurance is magic.
Jeff: Very, very quickly, Blen, if someone would like to get in touch with you at your office, they have questions or maybe they're seeking representation or seeking your advice and guidance and counsel, who can they call?
Blen: Well, we’re on the internet, of course. My direct telephone number is 919-645-4503 in Raleigh. Typically, we’ll chat with someone on the phone off the clock to see if there is a fit, if this is something that we can help them with, and if not, frequently, I can make recommendations.
Jeff: There you have it. Blen Gee, once again, we've ran out of time on this segment. Thanks very much for joining us. I hope that we can visit with you again soon here on the Morgan & Westfield podcast.
Blen: I appreciate it very much.
Jeff: Thank you again to Blen Gee, Jr. from Johnson, Hearn, Vinegar, and Gee PLLC in Raleigh, North Carolina for joining us today.
The Morgan & Westfield podcasts are presented by Morgan & Westfield, a nationwide leader in business sales and appraisals. Now, if you'd like more information about buying or selling a business, call Morgan & Westfield at 888-693-7834. Again, that's 888-693-7834 or visit morganandwestfield.com. 'Til next time! I'm Jeff Allen. I'll see you again.