How the Closing Works
The buyer has done their due diligence, and you’ve done yours. All the terms of the transaction have been agreed to. The purchase agreement is ready to be signed.
Next up: The closing.
You’ve gotten this far, so what could go wrong? Hold my beer …
There’s no such thing as a perfect closing, but we can come close. This chapter addresses some of the potential landmines that can detonate in the final stages of a transaction and how to mitigate them – for both you and the buyer.
Before the Closing
Here is a summary of essential actions that both you and the buyer should take before the closing:
- Allocate the Purchase Price: The parties should agree on the allocation of the purchase price as early in the process as possible to eliminate any delays due to disagreements.
- Calculate Net Working Capital (NWC): The parties should prepare a spreadsheet to track any changes in net working capital.
- Inspect Equipment: The parties should inspect the equipment well before the closing to eliminate last-minute surprises and allow you ample time to repair or replace any equipment, if necessary.
- Do a Preliminary Inventory Count: The parties should conduct a preliminary inventory count as early in the process as possible to prevent any surprises.
- Check Seller’s Entity: You should check the status of your entity to ensure it’s in good standing. The closing can’t occur if your entity isn’t in good standing, and the closing can be significantly delayed as a result.
- Obtain Tax Clearances: The parties should obtain the following tax clearances before the closing. Note that these can be obtained by an escrow agent if they are coordinating the closing:
- Payroll Tax Clearance: This ensures your payroll taxes are paid and current before closing.
- Sales Tax Clearance: If your business collects sales tax, you must obtain a clearance certificate prior to the closing. Failure to do so could expose the buyer to unpaid taxes.
- Other Tax Clearance Certificates: Clearances may often be required from other state agencies for other taxes.
- Coordinate With Third Parties: You and the buyer must coordinate with third parties regarding the following:
- Financing Documents: If third-party financing is involved, multiple additional documents must often be completed, such as business plans, projections, and others. Many third-party lenders also require that an escrow agent conduct the closing.
- Lease Assignment: If the landlord must approve a transfer of the lease, I recommend contacting the landlord as early in the process as possible to eliminate potential surprises.
Escrow and the Closing Process
An escrow agent is a third party charged with the responsibility of holding all monies and papers until all conditions of the escrow are observed.
Multiple adjustments and prorations must often be made to various bills at the closing to account for timing differences between when bills are paid and when a change of possession occurs. For example, lease payments, utilities, property taxes, and accounts receivables may all be impacted due to their billing cycles. Escrow can assist in making these closing adjustments and prorations.
Escrow is often required if bank or other third-party financing is involved. Escrow serves several important functions in the sale of a business. The primary duties of the escrow agent include:
- Ensuring clear title of assets is transferred at closing by performing UCC and other searches
- Filing a notice to creditors, which is required in a minority of states
- Prorating expenses, such as property taxes and other expenses
- Acting as a third-party clearinghouse for payment of liens, debts, or other bills
- Holding and releasing funds
Days Before the Closing
You and the buyer should do the following several days before the closing:
- Final Inventory Count: If your business has a substantial amount of inventory, an inventory count should be performed on the day before closing by both you and the buyer, or by an inventory-valuation service. You may liquidate or dispose of any obsolete inventory if you obtain the buyer’s approval.
- Final Walk-Through: You and the buyer should perform a final walk-through of the business to ensure there are no surprises at closing.
- Transfer Funds to Escrow: There are often delays with wire transfers, which can impede a sale if a wire is made on the day of closing. To prevent problems, I suggest the buyer wire the money to escrow at least three days before closing. The buyer should check with their bank beforehand to ensure no daily wire transfer limits exist since banks sometimes maintain restrictions on the amount of wire transfers that can be made per day. Cashier’s checks usually aren’t accepted by most escrow companies due to numerous recent fraudulent issues. If the parties aren’t using escrow, the buyer can wire funds the day before or the day of closing.
Signing and the Official Closing
Here are some common questions about the closing:
How are most closings handled?
The parties may conduct the closing virtually or meet around a table on the closing date. Most closings today occur virtually. In this situation, the closing documents are often mailed to the parties via courier for signatures and then sent back to the escrow agent for release on the closing date, or the documents are signed electronically. A virtual closing is uneventful for most and is becoming more common with advancements in technology.
Who needs to sign?
All owners don’t need to sign the purchase agreement and all exhibits and schedules, but they should sign a consent authorizing the “signer” to sign on their behalf. If the business is solely owned by a married person and is in a state or jurisdiction that follows community property laws, both spouses should sign all closing documents.
Are hard copies required?
The Uniform Commercial Code (UCC) used to require that a security agreement be in writing and signed, which was usually interpreted to mean that a hard copy was involved. Now, the UCC merely requires the security agreement to be a “record,” which is interpreted to allow electronic documents. However, individual county clerks or secretaries of state offices may maintain the traditional hard-copy requirement. It’s important to confirm in advance with lenders, escrow agents, and other parties to the closing if hard copies are required or if a secure electronic signature is acceptable.
When does the actual closing occur?
The purchase agreement represents the parties’ binding commitment to the sale. Closing occurs when the sale takes effect, or in other words, when the business transfers ownership from the seller to the buyer. This happens when these two actions take place:
- The seller and buyer sign the bill of sale – in the case of an asset sale, or the stock certificates – in the case of a stock sale.
- The buyer wires or transfers payment to the seller.
Only when both have occurred can the sale be said to have officially closed. If payment and the signing of the bill of sale occur on different days, the sale will close on the day of the later action.
When does the actual transfer of possession occur?
In an asset sale, the signing of the bill of sale by both parties, not the bill’s delivery, constitutes the passing of the title. When the bill of sale is signed, the parties have, by mutual consent, transferred ownership, even if the bill of sale is not yet delivered or handed over to one of the parties.
How are vehicles transferred?
The parties should include any vehicles and titled property in the asset list, which will be attached to the purchase agreement. When the parties sign the bill of sale, legal ownership of all property in the asset list – including any vehicles listed – transfers from you to the buyer. It’s important to note that while the buyer gains legal ownership of the vehicle at the moment of signing the bill of sale, the parties must still arrange for the registration of the transfer with the DMV, which may happen days or weeks later. In certain instances, the law may provide that if the sale hasn’t been registered, third parties can continue to treat you as the owner with respect to the vehicle. In this regard, the purchase agreement’s “beneficial ownership clause” addresses this situation. According to this clause, if for any reason third parties continue to treat you as the owner, you must give any resulting benefit to the buyer.
Which documents are signed at closing?
The following documents must be signed before or at the closing:
- Purchase Agreement: The purchase agreement can be signed before closing or at closing. The purchase agreement and schedules become effective and binding when signed, but the business’s legal ownership will transfer only upon signing of the bill of sale – if the sale is structured as an asset sale, or upon signing the stock certificates – if the sale is structured as a stock sale.
- Schedules: These are signed at the same time as the purchase agreement. The purchase agreement and schedules become effective and binding when signed, but the business’s legal ownership will transfer only upon the signing of the bill of sale.
- Exhibits or Bill of Sale: The bill of sale and assignment of the lease, if applicable, are attached to the purchase agreement and signed only at closing. Legal ownership and possession of the business transfer to the buyer only when the bill of sale is signed. Typically, you will sign the bill of sale only after the buyer has transmitted payment as agreed upon, and if any contingencies have been fulfilled or waived to the parties’ satisfaction. You remain the owner of your business and are entirely responsible for the company until the closing.
Immediately After Signing
You and the buyer should do the following immediately after the closing:
- Provide a Client List: You should provide the buyer with a list of your customers or clients and assist with the transition of these relationships.
- Inform Employees: You and the buyer should meet to inform employees regarding the change in ownership, if they haven’t already been informed. The meeting should be positive, upbeat, and reassure all employees of their futures. The guidelines for telling employees vary widely and largely revolve around the dynamics of your relationship with employees. I recommend that the buyer present a solid and persuasive vision of the company moving forward and ensure employees of their continued employment.
After Closing
You should transfer the following after the closing:
- Key Assets: At closing, you should provide the buyer with these important items:
- Computer access codes, safe combinations, and alarm codes
- Keys to file cabinets, premises, and vehicles
- Owner’s manuals, instruction manuals, and information on any warranties
- Equipment Leases: Any equipment leases that are to be assumed must be properly transferred from you to the buyer.
- Any Third-Party Contracts: These include advertising contracts, equipment leases, and others.
- Key Customers and Other Relationships: You and the buyer should jointly meet with all important relationships following the closing and assure them that the transition will be a smooth, seamless process.
- Telephone Service: An arrangement should be made to transfer telephone services at the closing.
- Utilities: The parties should contact the utility providers to transfer the utilities to the buyer.
- Vendor and Supplier Accounts: You and the buyer should contact all vendors and suppliers after the closing to notify them of the ownership change.
- Websites, Domain Names, Phone Numbers, and Other Assets: You and the buyer should work together to transfer all technology to the buyer.
- Uniform Commercial Code (UCC) Financing Statement: You should file a notice or a lien with the appropriate filing office if there is a seller note.
Months After the Closing
You and the buyer should address the following in the months following the closing:
- Allocation of Purchase Price: The parties must file IRS Form 8594 at the end of the tax year.
- IRS Checklist: You should contact your accountant to assist in closing your entity sometime after the sale.
Conclusion
Selling a company sends emotional shockwaves through many business owners, ranking right up there with stressors such as the death of a loved one, divorce, and going to jail. Okay, well, maybe not jail.
But the reality is that most entrepreneurs are lifelong “go-getters” who feel empty when there’s nothing more to “get.” To say, “I will be retired” isn’t enough for these business owners. As a wanna-be ex-owner, you’ll likely need to direct your energy toward a new passion. After all, grandkids don’t stay little and cute forever.
The trick, of course, is to keep anxiety and stress to a minimum before and after the sale. You don’t necessarily need to have a detailed Plan B in place before you sell your business. But you should at least address the question of what you hope to be doing in 5 years, 10 years, and beyond.
And then there’s the sales process itself. As you’ve seen, it can be complex and time-consuming.
But if you’ve made it this far, to the doorstep of the closing, congratulations – the end is in sight. By following the suggestions in this chapter – including maintaining a good relationship with the buyer, keeping the agreements simple, and doing the necessary prep work – you’ll be cashing in or out with confidence and peace of mind.