The four phases of selling your business [Transcript]

 

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[Plan Your Future Today]

 

[Laurie M. Lee, Business Attorney, CEO]
[ELEVATE Business Law, PA]

 

Laurie M. Lee:

So, you’re thinking about selling your business, or you want to know what the process is like. I’m going to talk about the mechanics of selling your business. There’s four general stages to selling your business, and these don’t all have to be in this order. But the first stage is usually the letter of intent. And the letter of intent stage is the introduction with the seller and the buyer.

 

Generally, if you have brokers involved, the brokers will be transferring communications back and forth. They’ll be representing the seller and maybe there’ll be a broker representing the buyer. And the buyer will reach out to the seller and say, “I want to know more about your business.” Usually there’s a nondisclosure agreement signed by the buyer at this stage, so that the buyer can get more information that might be confidential about the business. Then what happens, the buyer will submit a letter of intent and the negotiations take off from there.

 

Stage two is what’s called due diligence. And this is when the buyer gets to know the business a little bit better. Looks under the hood, checks different things that they’re concerned about. Stage three is actually where the purchase agreement comes into play. And this is where the documents get signed or negotiated, the further deal terms. And then stage four is actually the closing. And this is where title actually gets transferred, the ownership of the business gets transferred.

 

So let’s first talk about the stage one, letter of intent. It’s often called an LOI. And if you are using a broker at this stage, sometimes a purchase agreement can be used as the letter of intent. But the general purpose of the letter of intent is to say, “Are we close enough in terms to move forward with this deal?” The seller has thought about what the seller wants out of the deal: the purchase price, the terms, the timing what’s actually being sold.

 

The buyer has come in knowing what the buyer’s wanting, what kind of business, generally speaking, what kind of price they’re willing to pay, how they’re willing to pay it. And so the letter of intent process is to see if these two match and you’re negotiating the deal terms as you go. So maybe the seller has advertised the business for sale at a certain price, and the buyer comes in and offers a slightly lower price. There be several rounds of back and forth talking about the price.

 

There could be other terms. For example, one very common term is how long is the seller going to hang around and help the buyer transition into the business? And so this is sometimes a consulting issue. Sometimes, the buyer wants to actually employ the seller after the sale to make sure that they’re around and can help and educate them, make a smooth transition with employees and clients.

 

The brokers are involved at this stage. Sometimes, if two businesses, a seller and a buyer don’t have a broker involved, they negotiate directly with each other. This is not as common with small businesses, but it does happen. Having a broker does help the process. It allows for there to be separation between the buyer and the seller so that there’s not as much emotion involved in the decision making. The broker is the interface. Maybe it’s one broker, maybe it’s two brokers, one on each side. They do have a role to play in the process and they are very valuable in their skills and finding a good one can help the deal run very smooth. This is also the time where the seller looks at the buyer and says, “Is this a serious buyer? Are they qualified? Is this someone I want to transfer my business to?”

 

And keep in mind, there’s an emotional component to this. Sellers have spent a lot of time, money, energy, commitment, sacrifice in building their business. And they don’t want to just pass it off to anybody. They want to see who this person is. Do they have the same values as I have? Will they take care of the business? Will they keep it running? Will they take care of the employees and treat the customers right? So that’s a big issue during the state age. And then the financing arrangements.

 

Obviously the big ticket item in the room is how much money will you pay me, and how fast will you pay me? So there’s several different arrangements, of course, for financing. And sometimes we get very creative with this. Sometimes a buyer comes to the table with a cash deal and they’ll give the seller the full purchase price in cash. Other things times, which is more common, there’s some sort of a financing arrangement.

 

Either the buyer is financing it through a bank, through the seller. Sometimes the seller will accept payments instead of one lump sum. Sometimes they’ll accept payments over time from the buyer. And of course that’s a debt represented by a promissory note with interest attached. And so there’s different arrangements, whether the seller will accept those arrangements is determined at this stage. So let’s say now you’ve got the deal terms all negotiated, the big ticket deal terms, the price, how it’s going to be paid, the seller likes the buyer, the buyer likes the business.

 

The big ticket items are settled at this stage. Now we go into due diligence. And due diligence is the period, it’s a term of art. And if you hear it, what it means is an investigation period. It just means that the buyer gets to come in and really dig into the business. Most of the time they look at financials. They’ll look at contracts with customers or clients. If it’s a product-based business, they’ll look at how the product is actually made. If it’s a service-based business, they’ll look at the employees.

 

There’s all kinds of things that go on during due diligence. And sometimes attorneys are involved in this stage, sometimes they’re not depending on the size of the business, the type of the business, the personalities of the buyer and the seller. But some of the big pitfalls during this stage is to make sure that the seller is providing the buyer with enough information to make an educated decision. The seller at this stage should never hold back any documents, never hold back information for fear that it will scare the buyer off. Everything needs to be put on the table at this stage because there are legal repercussions later down the line if the seller has held back some information.

 

So it’s very important to be honest and direct, be responsible with your communications at this stage. There are deadlines, this stage doesn’t go on forever. There has to be a time that it ends. And this is determined, usually in the letter of intent stage that the buyer might have two weeks of due diligence, three weeks, two months. It depends on the business how long due diligence is, but there is a definite cutoff for due diligence. And once that cutoff happens, once that date occurs, the buyer then has to decide, is he or she going forward with the deal? Have they seen everything that they feel comfortable with? Have there been any red flags? Are there any dangers? Are they uncertain? At this point, the buyer has to decide they’re moving forward. If the buyer is still good, it goes into the next stage.

 

If the buyer is not good after due diligence, there can be two things that happen. One is the deal just dies. The buyer walks away and says, “I’ve seen things I don’t like. This is not for me.” The second thing that could happen is the buyer comes back to the seller and says, “You know what? When we negotiated in stage one, I didn’t know these facts. I didn’t know these things. Now that I do, the deal has changed for me. I may be willing to go forward, but we’re going to change a couple of these deal terms to make me feel comfortable.”

 

And so there may be price negotiations at this stage, that rarely happens. Sometimes there’s a little bit of financing negotiations that might happen at this stage. And any other matter of items that the buyer might feel uncertain about. Now, there is a difference in due diligence between the two types of sale. There’s two ways to sell your business. You can sell the assets of your business, or you can sell the interest in an LLC or the stock in a corporation.

 

The difference in due diligence for these two types is in an asset sale, the buyer is going to look at the holistic picture of the business. They’re going to look at pretty much everything. The interest stock sale goes deeper. They’re going to look at past behavior of the business, because they are going to be taking on more liabilities than they would be in an asset sale. So the interest stock sale, the due diligence for that type of sale goes much deeper. And it tends to take longer because they’re looking at past loans, they’re looking at past employees, they’re looking at any past lawsuits, other liabilities that could sneak up on them two, three, four years down the road and be a surprise.

 

So then if we get through the due diligence stage, we move into the purchase agreement stage. If the purchase agreement has been used as a letter of intent, and this is the case most of the time if you’re using a broker, the purchase agreement then comes back into play. And at this point in time, if it needs to be revised from the due diligence negotiations, that’s done at the stage. If you use a true letter of intent during stage one, during this stage, the purchase agreement would actually be drafted, and this is when the attorneys start getting really involved. They draft the agreements to match the terms that have been negotiated between the buyer and the seller. The buyer should have his or her own attorney. The seller should have his or her own attorney. These attorneys represent each party separately and look out for their interests.

 

And during this time, things such as the asset sale come into play. There are certain documents that are produced and drafted for the asset sale. One of which is, what are the assets? You have to define the assets and you have to be very specific sometimes on what is being sold and what is being kept. If you’re doing an interest or stock sale, there’s actually official action that has to be taken by that business entity. And some of those internal documents need to be drafted. You have to take into account certain title transfers. How are we going to transfer title? If there’s vehicles in the business, if there’s real estate in the business. At this stage, all of those things are starting to get ironed out, and you’re working through and you’re making a plan for how those transfers will occur. Also, during the stage there’s representations and warranties.

 

This relates back to what I mentioned on the due diligence stage. The seller represents and warrants to the buyer certain very key provisions. One of which is, the seller says, “I promise you that everything I’ve told you and provided to you is accurate and valid. If it’s not, I will be responsible for the repercussions, any damages that flow from that. I also promise you that the assets are in good condition, that all my employees are happy and won’t sue you.” The list goes on and on. “I’ve paid all my taxes. I’ve done all these things right.” And if the seller cannot make those representations and warranties, it’s disclosed at this as well. The indemnification is partnered very closely with the reps and warranties and basically the seller says, “If you buyer, suffer any damages or losses because of something I have done, I will indemnify you. I will pay you for those losses.”

 

Those are two provisions in this deal and almost every deal that are highly negotiated, because those are the big ticket liabilities that could come out for the buyer in the future, but also for the seller in the future. And then if there’s other documents that need to be prepared for closing, it’s done at this stage.

 

And then stage four is closing. Most of the time, you’re sitting at a table, buyer and seller come to the table and they pass the papers around the table and everyone signs. The key to closing is timing. So usually either in the letter of intent stage, or even sometimes in the purchase agreement stage, the date of closing will be set. And it will either say no sooner than a particular date, or it’ll say no later than a particular date, or it could even say the parties agree that it’s going to be on or around a date.

 

So you’ve got a couple of three days before, three days after kind of a window. Sometimes closing dates get moved. Sometime they get moved up, more often they get moved back, because things have to be prepared. Documents have to be prepared. Title has to be investigated. There’s other things that go on to make closing happen. Usually the buyer and the seller physically present, and they sign the documents. And when they get up from the table, the ownership is transferred. It is no longer owned by the seller. It is now owned by the buyer.

 

The receipt of funds is done at that point as well. Most of the time it’s done by wire transfer. Sometimes it can be done by check. Sometimes the funds can be held in escrow. Sometimes the bank is cutting the check. It can be a different way of paying, but at this point in time, funds are paid. Then, and this is very important, not only is ownership important to transfer, the operation of the business is very important to transfer. So please keep in mind considerations, such as keys, keys to the office, keys to storage, passwords, where you have things located, your filing system, passwords for online accounts. All types of things have to be transferred to make the operation runs smoothly, the seller and the buyer. And again, that’s an important piece of why the seller stays on afterward for a period of days to help the buyer transition. And there you have the mechanics of a sale.

 

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