This article outlines the basics of buying or selling a small business in Texas. While the process is often times complex, buying or selling a company is sometimes necessary or desirable to conduct business. While this article highlights key aspects of the buying and selling process, it is by no means comprehensive.
Assets versus Entity
A business owner first needs to decide whether to sell the business entity (e.g. stock in a corporation or membership interest in a limited liability company) along with all of the assets and liabilities, or the business assets alone. In an asset sale, the assets transferred are specifically listed in the asset purchase agreement, as are the assets that are excluded. Ownership of the entity remains with the seller, as do the entity’s debts and liabilities, unless otherwise negotiated and agreed upon in writing in the transaction documents. Buyers will typically favor an asset sale because they can itemize and limit the purchased assets without assuming undisclosed liabilities.
Conversely, in the sale of an entire entity, the seller’s stock or membership interest, for a corporation or limited liability company respectively, is assigned, transferred, and sold to the buyer. Since ownership of assets remains with the entity, a bill of sale for the assets is not usually required. Sellers generally prefer this method because it is a more streamlined process, and it allows the owner to release himself from the company’s associated liabilities. Advantages to acquiring an entity may include obtaining established branding and goodwill, an existing credit rating, established vendor accounts, or lines of credit. However, the due diligence a buyer must perform will be significantly greater and thus becomes a more expensive acquisition.
The Sales Price
The sales price is a key negotiating point in most transactions. Obviously, potential buyers will likely try to negotiate a lower price from the seller’s asking price. To establish credibility to your asking price, it is imperative that a seller have a business appraiser evaluate the value of his or her business. The company’s existing assets and indebtedness must be taken into consideration. A buyer should perform research to discover any existing tax liens, debts, or other encumbrances associate with the entity and any of the assets to be acquired. A buyer can request any debts be paid and liens lifted as a contingency to closing or merely have the total value subtracted from total purchase price.
Letter of Intent
The letter of intent is an initial agreement that outlines the terms of negotiation between parties currently in negotiation to purchase a business. While the letter of intent is not a binding contract to purchase the business, it contains several binding and non-binding terms that protect both the buyer and the seller while each side evaluates the transaction. Its purpose is to allow the buyer sufficient access to the seller’s business so that he can evaluate the merits of the deal while also ensuring the seller that confidential information will remain secure.
The letter of intent commonly contains statements of intent; the basic terms and method of the transaction; an exclusivity clause; a confidentiality clause; and a closing date. The exclusivity clause prevents the seller from promoting or advertising the business to other potential buyers for a limited amount of time, while the potential buyer performs due diligence into the company’s value and operations. This protects the potential buyer from spending large sums of money in inspecting the business only to be out-bid during this process. Finally, the closing date provides finality to the ending of negotiations and forces the purchaser to make a decision by a certain date or agree to an extension with the seller.
The purchase agreement s the definitive agreement that finalizes all terms and conditions related to the purchase and sale of the company. These documents may be referred to as asset purchase agreements or share sale agreements, depending whether the entire business or merely the assets are for sale. The purchase agreement outlines all of the details of the sale and contains the same terms as the letter of intent. However, unlike a letter of intent, these terms are binding upon the closing of the sale. Depending on the nature and extent of the sale, the transaction may also require other documentation such as a bill of sale, promissory note, security agreement, deeds, stock transfer certificate, employment agreements, and assignment and assumption agreements.
The purchase agreement must identify parties and the business to be sold; state whether the sale is a transfer of a company as an entity or of assets only, and then list those assets; specify the sales price and how it will be paid; provide for earnest money; include a period of due diligence and inspection; contain representations and warranties by both seller and buyer; provide protections for confidential information; specify conditions precedent that must be met for the transaction to close; and provide remedies in the event either party defaults. If you have a lease on office space, the buyer will be able to take over the lease through a sub-lease arrangement negotiated among all parties. Otherwise the buyer must negotiate a new lease with the landlord.
The purchase agreement should contain non-competition and confidentiality agreements. A buyer has a legitimate concern that the seller may establish a new business in a relatively close geographic proximity and continue in the same line of work. Courts have upheld non-competes so long as they are reasonable in duration and in geographical scope. Further, the purchase agreement should contain a non-solicitation clause, to prevent the seller from soliciting the buyer’s customers and employees. Additionally, confidential information about the business will likely be revealed during the course of the buyer’s due diligence, and the seller has a right to keep this information private. As a result, the purchase agreement should include a strict covenant on the part of the buyer not to reveal confidential information at any time to third parties. This covenant should apply whether or not the deal eventually closes. It should also prohibit the buyer from utilizing the information in order to compete with the seller in the future.
The purchase agreement should also contain representations and warranties by the buyer and seller, the breach of which may be a basis for terminating the agreement. Since many of these representations and warranties can become a basis for the bargain, it comes as no surprise that they generally become another negotiating point. Buyers want the seller’s representations and warranties to be broad and extensive in time and scope; sellers naturally want to limit their ongoing liability, preferring that reps and warranties expire at closing and merge into the closing documents, thereby putting a period on liability. Representations and warranties can be made to survive closing, survive closing for a limited period of time, or not survive closing at all.
Due Diligence and the Inspection Period
Due diligence is the process by which the buyer investigates all aspects of the company to evaluate its overall value. One the buyer has signed a confidentiality agreement and a letter of intent, buyer should take time to fully perform prudent due diligence to ensure that no surprises arise after closing. A due diligence period allows the buyer to walk away from the deal if the business is unsuitable for the buyer’s purpose.
Due diligence and inspection may include, examination of the company books and records; physical inspection of the premises; inventory inspection; determining whether there are any taxes outstanding; annual and quarterly tax returns as well as ad valorem tax records; history of lawsuits or whether any suits are pending; utilities usage; employment and independent contractor agreements; vendor agreements; credit reports; and industry evaluations, just to make a few issues. If the buyer chooses to terminate negotiations, he will generally receive return of the earnest money less the inspection costs.
Eventually, negotiations must be resolved, and the sale needs to close. The date should be scheduled for when all parties are available and preferably during a morning hour so you can reach banks and government offices. Closing dates near the last day of the quarter, month or pay period may simplify the transaction through proration for monthly expenses that transfer with the sale. The purchase agreement, its attachments, and all other relevant documentation must be complete and ready for signatures. Government and tax forms that need to be prepared may include Texas Secretary of State forms; transfer documents for vehicles included in the sale; transfer documents for intellectual property; and IRS Form 8594, which the seller and the buyer need to complete showing an identical allocation of the purchase price.
After the transaction is complete, a number of activities may still need to occur, depending on the nature of the sale. If real estate was transferred, deeds and mortgages must be recorded. Money must be wired to escrow. Any business or operating licenses must be transferred, if possible. Otherwise the new owner may be required to apply for a new license or otherwise have it re-issued.
Again, this article addresses only the principal elements of the transaction. Acquisition of a business, whether merely selling its assets or the entire entity, is a multi-faceted process. A business entrepreneur should not attempt to undertake this endeavor without competent representation. A knowledgeable attorney will assist in making the transaction as quick and efficient a process as possible.