The Necessary Legal Steps of a Business Transaction

Harry J. DiDonato

Esq. LL.M. The Necessary Legal Steps of a Business Transaction

In this interview, Harry DiDonato,  transactional attorney and business advisor at MacElree and Harvey Law Firm, utilizes his 25 years of legal experience to discuss topics, such as: business aquisition and sales, corporate matters, real estate transactions and tax planning. Mr. DiDonato also explains the unique advantage that you will gain with the assistance of a seasoned mergers and acquisitions attorney during the purchase or sale of your business.

Key Points from our Conversation

  • Generally, unless otherwise specifically negotiated at the commencement of the lease, most leases prohibit an assignment of a lease from the existing tenant to a new tenant.

  • Each situation is different and an analysis must be performed of each transaction prior to entering into a letter of intent or other agreement to sell or purchase a business.

  • It is best to hire competent advisors that have extensive experience in the business sale process to provide objective advice and guidance throughout the appraisal and sale process.

Interview

Tina: I am considering selling my business. What does an attorney provide business owners like me, besides legal advice?

Harry:  An attorney experienced in mergers and acquisitions is a tremendous resource for business owners considering selling their business. Attorneys will provide business owners with an overview of the process and educate the owners on what to expect at the various stages of their business sale. A seasoned attorney will also provide valuable information on how to prepare the business for sale and will provide insight on what buyers will focus on in a sale. An attorney with M&A experience will also have connections to the better business brokers and advisors and can help make appropriate recommendations.

 

Tina: I own a small business and I think I am ready to sell my business. At what point do I hire an attorney and what parts of the selling process do they handle?

Harry: It is best to hire an attorney as early in the process as possible, but certainly before discussions occur with any potential buyers. Initially, an M&A attorney will ensure that a confidentiality agreement is in place with any party that may receive the seller’s confidential information. The attorney will work with your other advisors to structure a sale transaction with an emphasis on tax efficiency and liability protection. He or she will also provide valuable guidance preparing your business for sale, and be able to point out potential landmines and pitfalls that can kill a deal.

 

Tina: I am buying a business. Should I buy the assets or entity?

Harry: The choice to purchase assets or an entity will vary by transaction. Most small to mid-size market deals are asset sales. In an asset sale, the buyer is able to reduce liability exposure from the selling business by forming a new entity to acquire the assets and selecting what assets and liabilities to purchase from the existing business. Liabilities that the buyer does not want to assume will remain with the selling business. The buyer will also be able to achieve a step up in basis in the purchased assets to allow for a tax advantage of depreciating the purchase price of the purchased assets. In a purchase of the stock or other ownership interest in an entity, the buyer will be assuming any and all obligations and liabilities of the seller. Due diligence is always critical, however, it is particularly critical in a purchase of the ownership interest in an entity, given the after sale liability exposure. However, sometimes circumstances dictate that a purchase of the ownership interest in an entity is the only way to achieve a deal or to transfer desirable contracts in the existing business entity. Each situation is different and an analysis must be performed of each transaction prior to entering into a letter of intent or other agreement to sell or purchase a business.

The choice to purchase assets or an entity will vary by transaction. Most small to mid-size market deals are asset sales.

Tina: I own a business and lease the space I am using to operate the business. Legally, am I required to tell my landlord that I am considering selling my business?

Harry: Generally, unless otherwise specifically negotiated at the commencement of the lease, most leases prohibit an assignment of a lease from the existing tenant to a new tenant. Most leases also restrict a change of control or transfer of any ownership in a tenant without the consent of the landlord. As such, although a landlord does not need to know that you are in the process of selling your business from the beginning, there will often be a contingency in any purchase agreement whereby the seller will need to obtain the landlord’s consent to the transfer of the lease to the buyer prior to closing of the transaction.

 

Tina: How do I ensure that key customers stay after I buy a business? Can I address this with a contract?

Harry: One of the biggest issues confronting small to mid-market companies in a sale event is allowing a buyer contact with key customers. As can be appreciated, the seller desires to restrict access to key customers until a deal becomes definitive, while a buyer seldom wants to purchase a business without speaking to key customers to determine whether they will stay with the business after the sale. Generally, contact with key customers is addressed in the purchase agreement and is often negotiated to be achieved after most due diligence has been performed and other contingencies satisfied. That way, the seller has more confidence that the transaction will close and the buyer will be able to confirm with key customers their intentions to stay with the business after the sale.

One of the biggest issues confronting small to mid-market companies in a sale event is allowing a buyer contact with key customers.

Tina: I own a small business and I have employees that have been with my company since I opened. I have a buyer that wants to buy the business, but only if he can keep the employees. Can we agree to this? If he buys the business and then the employees quit, will I be liable for breach of contract?

Harry:  In general, the treatment of key employees is dealt with in the purchase agreement between the seller and the buyer. A buyer will often insist, as a condition of purchase of a business, that certain key employees will remain with the business. Often, this comes in the form of employment agreements for those key employees, which are negotiated prior to closing of the sale. Most times, a seller cannot guarantee the continued employment of employees with the buyer after the sale, therefore, the seller under a business sale contract will generally not be liable for breach of contract in the event the employees do not work for the new business or quit shortly after the sale. However, a seller will generally be required to sign a non-solicitation agreement which will prohibit the seller from soliciting its former employees or otherwise interfering with their employment relationship with the buyer.

 

Tina: What is escrow? It is necessary?

Harry: Escrow is a fund of money that is taken from the sale proceeds and placed with a third party escrow agent to hold for a certain period of time after closing to secure the obligations of the seller under the purchase contract. Because, in a sale, the seller will generally cease doing business after the sale, the buyer will need security for the obligations of the seller under the contract. In the event of a breach of the contract after closing, if the business no longer exists, often there will be no money available from the seller to make the buyer whole. As such, the escrow fund will exist for a period of time after closing and will be available to the buyer in the event of a breach of the contract by the seller.

 

Tina: What are the reporting requirements for selling my business? Do I need to report the sale to the state or federal government? Or do I only have to report the sale for tax purposes?

Harry: Different states have different reporting requirements in connection with the sale of a business. In addition, reporting requirements vary depending on the size of the sale transaction. Often, in small to mid-market transactions, there are reporting requirements to a state’s department of labor and department of revenue. In larger transactions, there may also be federal reporting requirements. It is best to seek advice on a jurisdiction-by-jurisdiction basis to determine the specific reporting requirements based upon the location of the business and the size of the transaction.

Different states have different reporting requirements in connection with the sale of a business.

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

Harry: The best tip I can provide when selling or buying a business is to not get emotionally involved or become “married” to a sale or purchase. Most small to mid-market companies were formed, started and grown by either one or a small number of owners. The business, rightfully so, is a large part of their life. In a sale event, it is often easy for the owners to become emotionally involved in the sale or attached to the thought of a sale. When the owners become emotionally involved, it can often lead to unrealistic expectations with respect to the value of the business, or, worse yet, undermine negotiations, whereby an emotionally involved seller leaves money on the table or a buyer pays too much for the business. It is best to hire competent advisors that have extensive experience in the business sale process to provide objective advice and guidance throughout the appraisal and sale process.