The Deal Structure
- Deal Structure – asset sales versus stock sales
- Deal Structure – earn-outs and seller financing
- Letters of Intent Negotiation
- Due Diligence Investigation
- Negotiation of the Purchase Agreement, including Representations and Warranties
- Conditions to Closing
- Ancillary Agreements – employment, consulting, and non-competition agreements etc.
Asset Versus Stock Sales – Do You Want the Business, or Just the Assets?
One major consideration is whether you want to buy, the entire company or just the company’s assets. The buyer’s preference tends to be an asset purchase due to certain tax advantages, that is, the buyers tax basis in the purchased assets can be amortized over several years. On the other hand, in a stock sale, the buyer will get basis in its stock, which can’t be amortized, but the buyer won’t necessarily get increased basis in all of the purchased assets
Generally, a buyer is not liable for any unknown or unconsented to liabilities, barring any exceptions based on successor liability theories. If the seller is a C corporation, then it would not prefer an asset deal as it would result in double tax – one level of tax at the entity level and another tax hit once distributions are made – which could make a deal less profitable.
On the other hand, the seller would prefer a stock sale because the buyer inherits all the liabilities of the business. For our purposes, the term “stock” refers to any equity interest in any entity (e.g., membership interests in a limited liability company, stock in a “C” or “S” corporation, or partnership interests in a general or limited partnership), and the term “stock sale” to refer to the sale of any such equity interest. Under such circumstances, a buyer would typically look to protect himself against any unknown liabilities through indemnification. Clearly state the purchase price and payment terms; include basic terms of any seller financing or earn-outs, if applicable.
Earn Outs vs. Seller Financing
Seller financing allows the buyer to make a down payment of the purchase price, with the remainder to be paid via a promissory note in certain installments over time. From the seller’s perspective, there can be significant risk associated with not receiving payment of the entire purchase price when seller financing is involved. To minimize this risk, sellers should consider some of the following factors:
- Creditworthiness – how creditworthy is the buyer? Check public records for liens, bankruptcies, tax issues, and litigation concerning the buyer. You might also evaluate prior transactions done by the buyer to understand how those transactions were structured and confirm that all notes payable by your buyer were paid in full.
- Security – will the promissory note be secured or unsecured? Generally, the note will be secured, or collateralized by the assets or stock being sold and perhaps other assets of the buyer.
- Guaranties – consider asking for personal guaranties, either from a parent entity or from individual owners. This is particularly important if the buyer is setting up a new entity to affect the purchase.
- Covenants – with respect to covenants, consider typical covenants in a bank loan agreement and think through what can reasonably be required in the context of seller financing in a sale of business. You should also include terms giving you ongoing access to financial statements and other information while your note remains outstanding.
Conversely, the Earn-Out deal structure makes a part of the purchase price contingent on the purchased business achieving some pre-determined goal after closing. Generally, such a deal structure would be conditioned on the business attaining certain revenues, or EBITA, in the year or two after closing. This structure comes into play when the parties disagree on valuation.
Negotiating the Letter of Intent
It is vitally important for the parties to clearly state whether the LOI is binding or non-binding. Some factors to consider include
- Clearly state the purchase price and payment terms; include basic terms of any seller financing or earn-outs, if applicable;
- In an asset deal, include a generic list of assets being sold and list any significant excluded assets;
- Provide a general framework for how the diligence process will proceed
This is the most important step in purchasing the business, and probably the most time-consuming step. Due diligence is performed by the buyer to determine if it wants to go through with the purchase of the business. As the seller, you know all sorts of information that the buyer doesn’t have and due diligence is the primary way the buyer has of acquiring such information. It is important for the buyer to ensure that he has examined the businesses financial and tax records to ensure that the financial state of the business is indeed what the seller represents it to be.
Ancillary Agreements – Employment, Consulting, and Non-Competition Agreements
Generally, noncompete agreements are a part and parcel of most business purchases and sales because the buyer may not necessarily want the seller to start competing with him after the sale of the business. Moreover, buyers often have to deal and negotiate employment or consulting agreements to retain key employees of the seller who may know a lot about the operations of the business and help with the transition process. Buyers must be aware of certain key issues before negotiating such agreements, including but not limited to, the term and scope of the restrictive covenants or non-compete agreements, the term of the employment agreements and the benefits to be given to the employees.
Get started on your case today by calling our Fairfax office at 703-652-5506, or reach out online to schedule your initial consultation. Our business attorneys take purchase and sale agreements very seriously, and will carefully guide you through the process from start to finish.