Business owners wishing to sell their business typically use one of two types of agreements when selling their business. Asset purchase agreements provide for the sale of the business by selling all, or substantially all, of the businesses’ individual assets to the purchaser. Stock or equity purchase agreements allow the assets of the business to remain with the business but ownership of the business itself is transferred.
Asset purchase agreements are more commonly utilized than stock or equity purchase agreements because liabilities of the business typically do not transfer to the purchaser of the assets under an asset purchase agreement. In contrast, liabilities, such as environmental, legal, safety, product or employee liabilities (even if they are unknown at the time of sale of the business) remain a risk for the purchaser of a business purchased pursuant to a stock or equity purchase agreement because the business entity remains in tact after the sale.
Regardless of how the sales transaction is structured, the following issues should be addressed in any agreement to sell your business.
- Identification of Parties. The agreement should clearly identify who is bound by the terms of the agreement. This is especially important if there are obligations of both individuals and the company. Attention will need to be given to ensure that the appropriate individuals and entities are parties to the agreement.
- Description of Assets. The parties should be specific with respect to the assets being conveyed. In the event of an asset purchase agreement, typically a schedule or bill of sale will provide an itemization of the assets being purchased. It is also prudent to specifically identify any assets that will remain as property of the seller after the closing.
- Price. Fundamental pricing terms and payment methods should be included in the document. Such terms may include seller financing provisions and earn-outs. The parties should also consider adjustments to the purchase price and relevant pro-rations for sales commissions and items such as work-in-progress as of the closing date. An allocation of purchase price among items such as tangible personal property, goodwill, inventory, land must be negotiated so that the transaction is treated uniformly by both parties for tax purposes. The document should be clear with respect to the purchaser’s ability to hold back any payments due or any right of set-off with respect to future payments due under any note as part of any seller financed transaction.
- Closing. The agreement should provide where and when the closing of the sale will take place and how, and under what circumstances, the closing date can be extended. Typically, the agreement will also provide that if the closing does not occur by a specific date, then the agreement terminates. This “drop dead date” provides the seller with some certainty regarding when the business can be offered or sold to another party. The closing provisions should also include the items to be delivered by each party at the closing such as the purchase price, bills of sale, assignments, executed ancillary agreements, etc.
- Assumption of Liabilities. In the case of an asset purchase agreement, if any contracts or other liabilities are to be assumed by the purchaser, such contracts or liabilities should be expressly identified. The parties will have to review third party agreements with respect to their ability to be assigned or assumed. The agreement should also spell out what recourse the seller has in the event the purchaser does not satisfy any outstanding obligations that the purchaser has assumed, but for which the seller may still be liable. This is especially important if there are outstanding obligations which are personally guaranteed by the seller.
- Representations and Warranties. These provisions allow the parties to provide certain assurances to each other. For example, typical representations and warranties provide that each party has all necessary consents and approvals to consummate the transaction contemplated by the sales agreement. Representations and warranties commonly requested by the purchaser include : the business has been operating in compliance with applicable laws, there is no pending or threatened litigation involving the business, the business will operate in its historic manner prior to the closing, there is no outstanding debt encumbering the assets being purchased, and due diligence information provided by the seller is accurate and not misleading.
- Due Diligence. Sales documents typically include a time frame after the signing of the sales agreement but before the closing which allows the purchaser to look into the affairs of the business. Confidential information such as financial statements and customer lists are commonly provided to the purchaser for review. Limitations surrounding such due diligence should be clearly spelled out in the transaction documents. For example, can the purchaser interview existing clients and employees of the business? These due diligence provisions should outline how long the materials will be made available, what will be made available, which representatives of the prospective purchaser will have access to the information, how confidential information will be treated, and what happens to such information if the transaction does not close. Such issues are often addressed in a separate confidentially and non-disclosure agreement that is incorporated into the sales document.
- Indemnification. To indemnify is to guarantee against loss that another may suffer. Sales agreements typically provide indemnification for various items. For example, the agreement may provide that the seller will indemnify the buyer for any losses the purchaser suffers as a result of a breach of any of the representations or warranties in the agreement. In the event the seller represents and warrants that there is no outstanding debt encumbering the assets and it turns out after the closing that some of the assets purchased are, in fact, subject to loans and associated liens, the seller would be responsible for the cost of paying off those loans and obtaining releases of the associated liens. The purchaser will generally request broad and comprehensive indemnification provisions whereas the seller will want to narrowly define indemnification obligations.
- Termination. The parties will need to address what happens in the event the transaction does not close. For example, what happens to any purchase price deposit and confidential information? Also, when can the selling party offer the business to a third party and can the selling party entertain back-up offers while the transaction is pending?
- Ancillary Agreements. If, as part of the transaction, the parties have bargained for the selling party to refrain from competing with the company or from contacting customers or employees, agreements will need to be drafted outlining the terms of such agreement. The sales documents will reference these documents as part of the sales transactions and the ancillary agreements are typically attached as exhibits to the asset purchase agreement or stock/equity purchase agreement. Confidentiality agreements, assumption agreements, non-competition agreements, and consulting agreements are common ancillary agreements.
If you would like more information regarding asset purchase agreements/stock purchase agreements, or if you would like us to review your sale documents, please contact our Business Law Group partner, David A. Closson at [email protected].