Exclusive Interview with Chris Cali, Attorney

Chris Cali

Legal Aspects to Consider When Buying and Selling a Business

In this interview, we have the opportunity to discuss wth attorney Chris Cali the legal aspects buyers and sellers should consider when buying and selling a business. Mr. Cali offers excellent insight on an array of topics, including: third-party contracts, due diligence, working with an attorney and attorney's fees.

 

Key Points from our Conversation

  • "A seller desperate to sell his business and retire, or a buyer who is terrified of losing out on what he perceives to be a great opportunity will almost always regret the deal terms he strikes without having a drop dead limit."
  • "The best precautions to take are to make sure that all agreements are spelled out clearly in writing, and that when advertising the business for sale, there are no unintentional (or intentional) misrepresentations regarding the business and the desired terms of the sale."
  • "The due diligence phase, particularly when buying a business, is the most critical point of the transaction."
  • "A key reality in legal services is that it is less expensive for an attorney to prevent a problem than it is to solve one."
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Interview

Tina: I have accepted an offer from a buyer. Can the buyer cancel the purchase at any time?

Chris: If an offer has been accepted, thereby creating a valid contract, the only way a buyer can cancel is if a contingency provision in the contract allows a buyer to terminate.  There will often be contingencies to allow the buyer to perform due diligence on the company and its records, inventories and other aspects of the business. Sometimes there is a contingency for the buyer to secure financing to complete the transaction. The contingency language will indicate under what circumstances a buyer (or seller for that matter), may cancel the contract.    

 

Tina: How are third-party contracts affected by the sale of my business? Are they automatically transferred to the buyer?

Chris: Third party contracts with employees, service providers and vendors do not get cancelled just because the business is being sold (unless there is a provision in the third party contract that provides for that).  Typically these contracts are assigned from the seller to the buyer at the closing of the business sale.

Most times, buyers will want to continue working with the seller’s third parties so they will expect those contracts be assigned to them in the sale.  A seller will want to make sure that the third party vendors and service providers sign off on the assignment and release the seller from their liability under the third party contract after assignment.

 

Tina: Can I use a “standard” non-disclosure agreement with buyers when selling my business?

Chris: The term “standard” is a dangerous term because what is standard for one type of business may not be standard for another type.  That being said, typically, for most businesses, a nondisclosure agreement will contain the same key terms:

  1. A description of the parties and the transaction being contemplated;
  2. A definition of what constitutes confidential information that is being shared between the parties;
  3. Instructions on how confidential information must be handled and with whom it can be shared;
  4. Instructions on when and how to return or destroy confidential information; and
  5. Consequences for a party breaching the agreement.

A business owner should speak with an attorney about the specifics of their transaction to determine if any special provisions should be included in a non-disclosure agreement for their specific business type.

The term “standard” is a dangerous term because what is standard for one type of business may not be standard for another type.

Tina: I am selling a business and the buyer has requested to contact employees and customers during due diligence. Is this normal practice and should I allow the buyer to do this?

Chris: It is not necessarily normal practice for potential buyers to be contacting employees and customers during due diligence.  Most times a seller will not want employees or customers to know that a sale is being contemplated until it is ready to close (or after it has already closed). 

Unless there is a unique set of circumstances to the contrary, the buyer should be able to complete thorough due diligence without speaking with employees or customers.   If employees find out about an impending or possible sale, it could lead to confusion, uncertainty and anxiety among the employees.  It is better that employees, as well as customers, find out once the deal is already done, because this provides certainty and will cause the least amount of disruption. 

 

Tina: I bought a business and recently found out that the seller lied to me about the income the business was generating. I found out he falsified the financial records. I am making monthly payments to him on the note. Should I stop paying him? How should I handle this?

Chris: The only advice I can provide here is to see an attorney right away.  The remedies that a buyer has been a seller has defaulted or misrepresented information will vary depending on the contract, business type, and governmental regulations. 

 

Tina: As a business owner preparing to sell my business, what precautions can I take to avoid being sued?

Chris: The best precautions to take are to make sure that all agreements are spelled out clearly in writing, and that when advertising the business for sale, there are no unintentional (or intentional) misrepresentations regarding the business and the desired terms of the sale. 

Of course when trying to sell, a business owner wants to make the business look as attractive as possible to a potential buyer.   While there is nothing wrong with putting the best spin possible on the business, if a seller goes too far by inflating revenue statistics or offering “projections” which are not factually supported by the business history or market trends, a seller could find himself with a buyer who will feel that he has been cheated.  Even a relatively minor misrepresentation can destroy the buyer’s trust in closing the transaction or, worse, lead to a post-closing lawsuit. 

 

Tina: Do I need an attorney to help with due diligence if I am buying or selling a business?

Chris: The due diligence phase, particularly when buying a business, is the most critical point of the transaction.  This is where the buyer gets to investigate what exactly it is that they are buying.  If something problematic is missed during the due diligence phase and the transaction closes, the buyer is stuck with it (assuming that there was no intentional deceit on the Seller’s behalf).  This can potentially lead to catastrophic consequences for the buyer, who might have absolutely walked from the deal if the issue was caught and objected to during the due diligence period.

When selling a business, an attorney can help to pinpoint and solve problems that might delay a closing.  Business brokers, unless they are licensed attorneys, cannot practice law or solve legal problems.  Therefore by foregoing legal representation, a seller is leaving a large void in the due diligence phase.

 

Tina: I am selling my business, at what point do you recommend hiring an attorney and what role do they play in the process?

Chris: A business owner should get their attorney involved right away when contemplating a business sale.  A key reality in legal services is that it is less expensive for an attorney to prevent a problem than it is to solve one.

The main role of the seller’s attorney is to help negotiate the legal terms of the contract between the parties and to help execute the transaction.   By getting an attorney involved from the beginning, the attorney can look for and help to solve potential problems before they cause an issue which could harm negotiations.  An attorney can also help advise a seller on certain matters that should or should not be agreed to in negotiations.  If a seller agrees to something problematic before the attorney gets involved, it could be impossible, and definitely expensive, to fix it.  

Additionally, the seller’s attorney will be in charge of preparing the items needed for closing (closing documents, schedules, certifications, lien releases, etc.)  By getting the attorney involved early in the process, it will give him plenty of time to deal with issues that need to be resolved to consummate the transaction.  For example, if a selling entity was administratively dissolved because the seller hasn’t filed annual reports in two years; it is better the attorney reinstate the corporation right away rather than try to expedite the reinstatement a week or two before closing and potentially delay the sale.    

By getting an attorney involved from the beginning, the attorney can look for and help to solve potential problems before they cause an issue which could harm negotiations.

Tina: How would a business owner get the most out of working with an attorney? What tips do you have for working with an attorney when selling a business?

Chris: As previously mentioned, getting the attorney involved early in the transaction is key to getting the smoothest possible closing in the sale of a business.

 

Tina: As an owner looking to sell my business, how can I minimize fees when working with an attorney?

Chris: To minimize fees when working with an attorney, a client first needs to understand what it is that an attorney is ultimately providing to it.   An attorney’s stock in trade is his time and experience

The way to minimize legal fees is to make the most efficient use of the attorney’s time.  This does not mean cutting corners or impairing the attorney’s ability to do his job.  However, if a client has questions for his attorney, then create a list and set up a time to discuss them, rather than send them piecemeal over several calls or emails. If the attorney has several action items for the client to complete, the client should complete them timely to avoid unnecessary follow up correspondence on the status of completion.  Also, the client should organize financial documents and other schedules prior to sending them to his attorney.  Efficiency is the way to minimize legal services without taking away from the substantive tasks an attorney needs to complete in order to fully represent the client. 

 

Tina: I am selling my business for $5M. What are typical legal fees for a transaction of this size?

Chris: This is a common way for business owners to approach the cost of legal services, but they are asking the wrong question (and worse they could ask it to the wrong lawyer).  It is true that generally speaking the higher the transaction price, typically the more complicated the legal work.  However, that is not always necessarily the case.   You might have a $5M transaction that is actually very straightforward despite the transaction price.  On the other hand, you might have a transaction that is only worth $120K, but there might be significant issues and obstacles that an attorney has to deal with to get the transaction to close.

So if a business owner approaches a lawyer and says, “I am selling my business for $5M.”  The lawyer says “Sure, a $5M transaction is going to cost $12,000 in legal fees.”  The client might think, that’s less than half of one percent of the entire transaction, I am getting a deal!  But it might be that this transaction is so straightforward, $6,000 is a fair price for the legal work involved.

Therefore, the more applicable question is “I am selling my restaurant with a liquor license” or “I am selling my gas station that I own with two other partners.”  The type of transaction will give the attorney a much better idea of what the legal costs will be, independent of the purchase price.    

 

Tina: How can an attorney and business broker work together as a team to ensure a successful transaction?

Chris: Ideally, the attorney and business broker should both be involved in the negotiation of the final terms of the contract. Attorneys tend to be risk adverse while business professionals tend to be risk acceptant.  Each party therefore brings a separate perspective to the transaction and by working together the attorney and business broker can ensure that the contract is offering the most attractive terms for their client, and is structured in such a way that it is likely to smoothly and successfully close.

 

Tina: What are the most common legal mistakes buyers and sellers of businesses make and what advice can you offer to help them avoid these pitfalls?

Chris: The most common mistake in general that buyers and sellers make is approaching the negotiation of a business without the proper mindset and preparation.  While there are many negotiation philosophies that one can utilize, I tell each client that they should never enter into a negotiation that they are not willing to say no and walk from a deal that he is uncomfortable with.   A seller desperate to sell his business and retire, or a buyer who is terrified of losing out on what he perceives to be a great opportunity will almost always regret the deal terms he strikes without having a drop dead limit.

While there is nothing wrong with putting the best spin possible on the business, if a seller goes too far by inflating revenue statistics or offering “projections” which are not factually supported by the business history or market trends, a seller could find himself with a buyer who will feel that he has been cheated.

As far as legal pitfalls, for sellers it is definitely whey they get into situations where the buyer is going to pay all or part of the purchase price over time (seller financing).   While sellers often accept promissory notes and security agreements to secure payment, it exposes a number of potential headaches for the seller.  If a buyer is unsuccessful in operating the business, gets buyer’s remorse, or something else happens to negatively impact the buyer’s ability or desire to pay the seller, a buyer may look for ways to blame the seller and justify their non-payment.  If selling, you prefer a clean break if possible and when the deal is closed, it’s closed.

For a buyer, not paying enough attention to the “fine print” of the transaction can be problematic.  Buyers tend to be very focused on the end game of the transaction, i.e. dreams of how successful they will be at operating their new business post-closing.  But even if something is a good financial opportunity, there may be other risks involved with a particular business or with a particular seller which are not readily apparent and could be overlooked in due diligence.  Buyers should pay attention to the limitations that sellers attempt to impose in the agreement as to what is being guaranteed. Often, it can be a red flag.

Tina: Do you have any other tips of advice for anyone buying, selling or appraising a business?

Chris: My advice is to make sure you search for competent legal professional advice, an attorney who knows what he is doing and has significant experience doing it.  Selling a business is not the same as selling real estate or prosecuting a divorce case.  There are nuances involved. Business owners should take the time to interview potential legal professionals and determine their experience, particularly in dealing with their specific type of business.

 
 
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