The buyer has done their due diligence and you’ve done yours. Terms of the transaction have been broadly agreed to — including the price.
Next up: The closing. You’ve gotten this far; what could go wrong?
Hold my beer…
There’s no such thing as a perfect closing but we can come close. This article addresses some of the potential landmines that can detonate in the final stages of a transaction and how to mitigate them — for both buyers and sellers.
Table of Contents
- Tips for a Successful Closing
- Buyer’s Obligations for the Closing
- Before the Closing
- Purchase Agreement
- Escrow and the Closing Process
- Days Before the Closing
- Signing and the Official ‘Closing’
- Immediately After Signing
- After Closing
- Months After the Closing
Tips for a Successful Closing
Expect last-minute problems: The sale or purchase of a business never goes as smoothly as expected. Problems often remain even after the closing. For this reason, it’s best that the seller and buyer maintain an excellent working relationship so they can easily cooperate to solve such problems.
Keep the agreements simple: Legal documents that are simple, direct, and straight to the point are more easily understood and are more likely to be useful. If the documents and the entire sales process are easy to understand, problems are avoided, and litigation is less likely to occur. The faster the transaction, the lower the transaction costs for all parties involved. The plainer the document, the less chance of misunderstanding or misinterpretation, and the less chance of any conflict or recrimination later on. In the unfortunate event that a document needs to undergo litigation, a court, a jury, or an arbitrator can comprehend the document more quickly. The faster they understand its meaning, the faster the proceeding and the lower the legal costs. We recommend the following:
- Avoid the elaborate conventions of traditional legal documents: “whereas,” “aforesaid,” “heretofore,” and so on.
- Do not use legalese, jargon, or technical legal terms, except when absolutely necessary.
- Avoid long-winded enumeration and redundancy.
- Focus on the essential provisions. It is impossible and impractical to cover every possible contingency.
Buyer’s Obligations for the Closing
There are several important actions the buyer should take as early in the process as possible:
- Form a new entity: The buyer should form a new entity, such as a corporation or LLC, as early in the process as possible. The promptness of this is critical because the transaction can be significantly delayed when the buyer doesn’t form their entity in a timely manner. The transaction cannot close if the buyer’s entity is not active at the closing.
- Employer Identification Number (EIN): The EIN is often required by third parties, such as an escrow agent, when opening a bank account and obtaining licenses, and the buyer should obtain an EIN as soon as possible in the process.
- Obtain a business license: The business license must be transferred as part of the sale process. In some jurisdictions, the buyer can apply for a license prior to closing. In other jurisdictions, the license can be transferred only after the closing.
- Obtain licenses and permits: The seller should create a list of permits and licenses for the buyer to apply for and obtain. Again, timing is important here because the buyer needs to coordinate this with other closing tasks, such as opening a bank account.
- Obtain DBA (“doing business as”): If the buyer wishes to operate under the same trade name, the buyer must obtain a DBA by filing a fictitious business name statement (FBNS). In some jurisdictions, the seller must terminate the DBA and transfer it to the buyer. Other jurisdictions allow simultaneous filings.
- Business bank account: The buyer should open a bank account before the closing. Most banks require that the buyer have the proper licenses, such as a DBA and business license, and form an entity prior to opening a bank account in the business’s name.
- Set up merchant accounts: The buyer must be properly licensed and have bank accounts and other licenses in place before they can apply for a new merchant account.
Before the Closing
Here is a summary of essential actions that both the buyer and seller should take before the closing:
Allocation of 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 regarding how the price is allocated.
Calculate work in progress (WIP): The parties should prepare a spreadsheet to calculate WIP so it can be prorated at closing.
Equipment inspection: The parties should inspect the equipment well before the closing to eliminate last-minute surprises and allow the seller ample time to repair or replace any equipment, if necessary.
Preliminary inventory count: The parties should conduct a preliminary inventory count as early in the process as possible to eliminate any surprises.
Seller’s entity: The seller should check the status of their entity to ensure it is in good standing. Closing cannot occur if the seller’s entity is not in good standing, and the closing can be significantly delayed as a result.
Tax clearances: The parties should obtain the following tax clearances before the closing:
- Payroll tax clearance: Ensures the seller’s payroll taxes are paid and current before closing.
- Sales tax clearance: If the business collects sales tax, the seller must obtain a clearance certificate prior to the closing. Failure to do so could expose the buyer to unpaid taxes.
- Other tax clearance certificates: Clearance may often be required from other state agencies for other taxes.
- Financing documents, if applicable: 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 escrow conduct the closing.
- Franchisor approval: The franchisor must approve the sale, if applicable, and the buyer must usually attend training and sign the franchise agreement before the closing.
- Lease assignment: If the landlord must approve a transfer of the lease, we recommend contacting the landlord as early in the process as possible to eliminate potential surprises.
The purchase agreement can consist of the following schedules and exhibits:
Assignment of contracts: Any contracts included in the sale must be assigned.
Bill of sale: The bill of sale transfers possession of the assets at the closing, if the sale is structured as an asset sale.
Buyer’s disclosure statement: This provides the buyer with the opportunity to make any necessary disclosures in writing.
Consulting agreements: This is necessary if the seller will remain to assist the buyer with the transition for an extended period of time.
Corporate resolution: Both the buyer and seller must sign a corporate resolution authorizing them to sign on behalf of their entity.
Equipment list: A list of the assets included in the price must be attached to the bill of sale.
Holdback agreement: Holdbacks are common in all-cash deals and require a third party to hold back a portion of the purchase price to reimburse the buyer for any covered items until the holdback period has expired.
Intellectual property transfer: Any intellectual property included in the sale, such as patents, copyrights, or trademarks, must be documented and transferred to the buyer at closing.
Non-compete agreement: The seller often signs a non-competition agreement at closing, agreeing not to compete with the buyer of the business for a period of time.
Promissory note: A promissory note is necessary if seller financing is involved. The promissory note is often personally guaranteed by the buyer for smaller transactions.
Security agreement: The security agreement enables the buyer to offer the assets of the business as security (collateral) for the seller note until the seller is paid in full. This allows the seller to place a lien on the assets of the business and prevents the buyer from selling the business or further encumbering the assets of the business without the seller’s permission.
Seller’s disclosure statement: This provides the seller with the opportunity to make any necessary disclosures in writing.
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. We recommend using an escrow agent to assist with the closing of smaller transactions.
Multiple adjustments and prorations must often be made (lease payments, utilities, property taxes, accounts receivable, etc.) at the closing to account for timing differences between when bills are paid and when a change of possession occurs. Escrow can assist in making these closing adjustments and prorations.
Escrow is often required if third-party (e.g., bank) financing is involved. Escrow serves several important functions in the sale of a business. The primary duties of the escrow agent include:
- Holding the earnest money deposit. Earnest money deposits are commonly provided by individual buyers, but not corporate buyers.
- Ensuring clear title of assets is transferred at closing by performing UCC and other searches
- Filing a notice to creditors (required in 13 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
The seller and buyer should do the following several days before the closing:
Final Inventory Count: If the business has a substantial amount of inventory, an inventory count should be performed on the day before closing by both the buyer and the seller, or an inventory valuation service can be hired to perform the count. The buyer usually pays the seller for inventory, based on the original cost of inventory, in cash at closing. The seller may liquidate or dispose of any obsolete inventory as long as the buyer’s approval is obtained.
Final walk-through: The buyer and seller should perform a final walk-through of the business and ensure there are no surprises at closing.
Transfer funds to escrow by wire or certified check three business days before closing: If the parties are using escrow, the buyer should transfer their closing funds to escrow via a cashier’s check or wire transfer three full business days before the closing. There are often delays with wire transfers, which can delay a sale if the wire is made on the day of closing. To prevent problems, we suggest wiring the money to escrow at least three days before closing. Wire transfers should be paid to the selling entity, not to the seller personally. 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 are not accepted by escrow companies due to numerous recent fraudulent issues. If the parties are not using escrow, the buyer can wire funds the day before or the day of closing.
Signing and the Official ‘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, but this is becoming more common with advancements in technology.
Signers: All owners do not need to sign the purchase agreement and all exhibits and schedules, but they should sign a consent authorizing the “signer” to sign on the other parties’ behalf. If the business is solely owned by a married person and is located in a state or jurisdiction that follows community property laws, both spouses should sign all closing documents. It is also recommended that all officers sign the closing documents. If all officers are not available, then a corporate resolution can be used.
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 a hard copy. 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. Most escrow companies today still require physical signatures.
When does the actual closing occur? The purchase agreement represents the parties’ binding commitment to the sale. “Closing” occurs when the sale actually takes effect, or in other words, when the business transfers ownership from the seller to the buyer. This happens when 1) the seller and buyer sign the bill of sale (in the case of an asset sale) and 2) when the buyer wires or transfers payment to the seller. Only when both have occurred can the sale be said to have “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? 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 definitive 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 seller to buyer. Note that while the buyer gains legal ownership of the vehicle at the moment of signing the deed 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 has not been registered, third parties can continue to treat the seller as 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 the seller as owner, the seller must give any resulting benefit to the buyer.
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 definitive purchase agreement (DPA). 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 (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 only transfer to the buyer when the bill of sale is signed. Typically, the seller 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. The seller remains the owner of the business and is entirely responsible for the company until the closing.
Immediately After Signing
The seller and buyer should do the following immediately after the closing:
Client List: The seller should provide the buyer with a list of their customers or clients and assist with the transition of these relationships.
Employee Meeting: The buyer and the seller should meet to inform employees regarding the change in ownership. The guidelines for telling employees vary widely and largely revolve around the dynamics of the seller’s current relationship with employees. We recommend that the buyer present a solid and persuasive vision of the company moving forward and ensure employees of their continued employment. The meeting should be positive, upbeat, and reassure all employees of their futures.
The seller and buyer should address the following after the closing:
Accounts Receivable: The seller typically retains ownership of the accounts receivable in most transactions. If the seller is retaining ownership of the accounts receivable, then the seller should keep their entity (Corporation, LLC, etc.) and bank account open so they can collect any outstanding accounts receivable post-closing. The buyer and the seller should also meet to discuss how to collect the accounts receivable post-closing and the possibility of notifying customers. Typically, the seller continues to invoice the customers using the business address, and the buyer receives the payments and hands them over to the seller. This can often be simplified in situations when the parties are together at the business performing the training during the same period.
Telephone Service: An arrangement should be made to transfer telephone services before closing.
Training: The buyer and the seller should work together to complete the training and transition period. Both the buyer and the seller should document the completion of the training in the training log to minimize the possibility of disputes in the future regarding whether or not the training was successfully conducted.
Transfer key assets: The seller should provide the buyer with the following at closing:
- 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
Transfer of equipment leases: Any equipment leases that are to be assumed must be properly transferred from seller to buyer.
Transfer of any third-party contracts: These include advertising contracts, equipment leases, etc.
Transfer relationships with key customers, vendors, and other relationships: The buyer and the seller should jointly meet with all key relationships following the closing and assure them that the transition will be a smooth, seamless process.
Transfer of telephone service: An arrangement should be made to transfer telephone services at the closing.
Transfer of utilities: The parties should contact the utility providers to transfer the utilities from the seller to the buyer.
Transfer vendor accounts: The buyer and the seller should contact all vendors and suppliers after the closing to notify them of the ownership change.
Transfer of websites, domain names, phone numbers, and other asset transfers: The buyer and seller should work together to transfer all technology to the buyer.
Uniform Commercial Code (UCC) financing statement: The seller should file a notice or a lien with the appropriate filing office if there is a seller note.
Months After the Closing
The seller and buyer should address the following in the months following the closing:
Allocation of purchase price: The parties must file IRS 8594 at the end of the tax year.
IRS checklist: The seller should contact their accountant to assist in closing the entity once all accounts receivable have been collected.