The Legal First Steps when Selling Your Business

Do you want to sell your business? The process of selling your business can be legally complex and challenging. This article gives a broad overview of initial legal issues to consider before negotiating or signing a final agreement to sell your business.

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1. Choose the Right Lawyer

The most important decision you will make in selling your business is choosing the right advisors. The most important advisors to you during this process will be an experienced mergers and acquisitions (“M&A”) financial advisor and an experienced M&A lawyer. The M&A financial advisor will help you get the most money for the business. The M&A lawyer will help you keep that money. Yes, that’s right – once you get money from the sale of your business, you could lose some or all of it from legal claims by the purchaser and/or taxes. You should find a lawyer who focuses on M&A and has years of experience in that area. Generally, a lawyer who primarily focuses on other practice areas, such as handling car accidents or divorces, will not have experience in M&A. Nevertheless, these lawyers may be able to refer you to an experienced M&A lawyer. Keep asking for referrals until you find someone with whom you would be comfortable working.

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2. Conduct Seller “Due Diligence”

It would be best to take some time to examine your contracts, regulatory requirements and other potential legal issues with your M&A lawyer to understand any matters about which a potential buyer may have concerns. By performing this exercise before a sale, you may be able to resolve certain issues and thus avoid delays in completing the sale. Here are some examples of questions that you should ask:

• Does anyone else have a right, or claim a right, to the profits or equity of your business?
• Are your financial statements accurate and up to date?
• Are there any third parties, such as a customer or a vendor, who may have a contractual right to object to the sale of your business?
• Do you have copies of the contracts that are important to your business?
• Does your business use any permits that may require approval from the issuing authority for a new owner to purchase your business?
• Are there any unresolved issues with taxes?

A potential buyer will expect you to answer these questions and many more during the potential buyer’s “due diligence” process. Additionally, you will be required to attest to the accuracy of certain statements regarding your business in the final agreement for the sale of your business in what are called “representations and warranties.” If you make a “representation and warranty” that is inaccurate, the buyer could later make a claim against you to be compensated for any financial loss caused by the inaccuracy. Thus, it is best to have your M&A lawyer help you identify these issues in advance to avoid a last-minute rush in which you may be more prone to making a mistake.

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3. Sign a Confidentiality Agreement

Before sharing any information with a potential buyer about your business, you will both sign an agreement that requires the potential buyer to keep confidential all information that you share.  This is typically called a “confidentiality agreement” or a “non-disclosure agreement” and your M&A lawyer will help you negotiate this document.  Often, potential buyers or brokers will try to get you to sign a mutual confidentiality agreement that also requires you to keep confidential any information they may share with you.  However, a potential buyer is unlikely to share material information about its business with you, so it is preferable that you sign a confidentiality agreement that focuses on best protecting your interests, or a “unilateral” confidentiality agreement.  Nevertheless, there are cases where it is appropriate to sign a mutual confidentiality agreement.  For example, if you are receiving equity in the potential buyer as part of the purchase price for your business, you will want to receive detailed information about the potential buyer’s business and the potential buyer will want you to keep that information confidential.

Note that signing a confidentiality agreement with a potential buyer does not allow you to share with the potential buyer those of your contracts or any other information that are subject to confidentiality obligations with third parties, such as customers or vendors.  An experienced M&A lawyer should be able to guide you through dealing with such a situation and other sensitive confidentiality issues.

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4. Determine the Appropriate Structure for the Transaction

When selling your business, you will generally be selling either the equity or the assets. Typically, as a seller, you may find it tax advantageous to sell the equity.  However, buyers often prefer to purchase assets and leave you with the equity because asset transactions can be more tax advantageous to the buyer.  Thus, to fully understand the impact on you of different transaction structures, it is imperative that you and your M&A lawyer consult with a qualified tax professional, such as your certified public accountant or a tax lawyer.  

Buyers also prefer asset transactions because if the buyer purchases the equity of your business, the buyer will generally assume all liabilities of the business.  An asset transaction allows the buyer to pick and choose the liabilities the buyer will assume.  Thus, asset transactions are more common in sales of small businesses.

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5. Negotiate a Term Sheet

You and your M&A lawyer should also negotiate a list of the most important terms of the sale with your potential buyer.  This might be called a term sheet, a letter of intent, an indication of interest or a proposal.  This document will allow your M&A lawyer to identify structural issues with the transaction and ensure the terms are non-binding prior to advancing to the stage of drafting a final agreement to sell your business.  Sometimes, the term sheet can contain binding provisions.  For example, the potential buyer may insist on an exclusive negotiating period during which you can only work with that potential buyer.  

Some believe that it is not important to involve a lawyer at the term sheet stage.  However, this can be a mistake because the term sheet can highlight issues with your potential buyer or the transaction that might cause you to look for a different potential buyer.  For example, the tax structure of a transaction can materially affect the amount of the purchase price that you keep.  If you later discover that your “high bidder” turned out to be a “low bidder” due to the tax impact of the proposed transaction structure, it may be difficult later to re-engage with another bidder.

After going through the above initial steps, you will be ready to focus on the next step of negotiating a final agreement to sell your business.

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Author

Tom Leslie, Leslie Law PLLC

Tom Leslie is a former chief legal officer of public and private companies and previously practiced at two top-50 international law firms. He has extensive experience in mergers & acquisitions, commercial transactions, joint ventures, finance, securities laws and general corporate law across a broad range of industries, including construction, consumer products, e-commerce, energy and healthcare.

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This article does not, and is not intended to, constitute legal advice or tax advice and should be used for general informational purposes only.  This article does not address all issues arising with respect to the topics covered by this article or all possible solutions to such issues.  Readers of this article should contact their attorney or tax advisor to request and receive advice with respect to the issues covered by this article and any other legal matter.  This article does not create an attorney-client relationship between the reader and its author or the law firm of which the author is a part, and no such relationship is being solicited by this article.