Buy it, Use it, Break it, Fix it
Marks Gray P.A. Aug 19, 2020 in News
Owning your own business doesn’t always have to start from the ground up. For many, owning their own business is not a “forever” plan; the goal is to build that business up and sell it once they are ready to move on. Buying or selling a business is an involved transaction but here are some of the important things to consider from both sides of the table.
Who’s the Bank?
The more substantial the business, the less likely the sale is happening without some sort of financing. The two most common forms of financing are traditional lenders and seller financing. There are pros and cons to each. Traditional lenders will want to verify the business’s financial records to confirm the loan isn’t too risky, and for sellers who haven’t kept those types of records, this can become a nightmare of spreadsheets and bank statements. But all of that headache generally translates into a higher asking price on the sale. Seller financing does not have the same rigorous review of the business because there is no third-party lender. Instead, the seller takes the promissory note on the balance of the purchase price secured either by the ownership interest in the business or the assets of the business. But where the seller gets paid in full as of closing on traditional financing, the seller merely has the payments under the note on the seller-financed transaction.
Buy the Entity vs. Buy the Assets
From a legal standpoint, the business is normally either transferred via the entity or via its assets. With the transfer of an entity, the seller transfers their ownership interest through stocks or membership units of the currently operating corporation or limited liability company. The business continues on and the only change is the identity of the owner. The benefits are that there is no disruption to the operations or any need to obtain new contracts with landlords, vendors, customers, or others. While the entity transfer is smooth, it also carries all outstanding liabilities that the business may have from prior operations. If a lurking lawsuit comes up after you’ve purchased the entity, “that was a different owner” isn’t a defense. So when parties are more concerned about cutting off that potential liability, the asset transfer is used.
In an asset transfer, all of the assets of the seller’s business are transferred to the buyer’s business. Done correctly, this process cuts off all liability that would attach to the prior business allowing the buyer to have a fresh start. The downside is transferring all of the contracts, accounts, vendor agreements, customer information, websites, phone numbers, etc. This is why asset sales are typically very detail-oriented with listings of each category of asset.
This section started from the legal standpoint, and it’s important to note that isn’t the only standpoint. There are a number of accounting and financial objectives that are affected or even achieved through one transfer method over another. These are substantial transactions and there is no reason not to have an accountant or CPA be part of your decision making.
Confirming the Intangibles
Every business is going to have both tangible (physical) property and intangible (not physical) property. The great thing about tangible property is how straightforward verification can be. The equipment, inventory, or machinery is either there or it isn’t. Intangible property requires a different mind-set when wanting to verify. The typical process is to itemize with as much identifying information as possible each of the intangibles being included in the transaction. These itemizations are exhibits or addenda to the closing paperwork and can be exhausting. But these are where you will find a substantial number of post-closing disputes if they are not addressed adequately. Transfers of “goodwill” are normally part of an intellectual property catch-all provision with little to no detail. Does that include website domains? Social media accounts? Trademark registrations? Copyright registrations? Prior marketing materials? Phone numbers? Trade secrets? Can the buyer keep using the seller’s commercials in which the seller appeared in-person? These are just examples where buyers and sellers, by not addressing the details in their contracts, set themselves up for fights later on. Confirming the actual inventory of intangibles and how those will be dealt with in the transaction is important to put those disputes to bed before they ever get up.
The concern over intangibles is almost exclusive to asset transfers because the legal ownership of each piece of property is changing hands. In an entity transfer, all of the property is and will continue to be owned by the same entity; only ownership in the entity itself is changing. For those transactions, verification is needed to confirm that the authority for each of those is properly transferred as part of the closing. The person identified as having authority on behalf of the business entity is changing and that has to be updated with everyone else the entity does business with. This includes, but is not limited to:
- bank accounts
- employer identification numbers with the IRS
- credit cards and credit accounts
- state, federal, and local business licenses
- vendor accounts
- utility accounts
- state business registrations
- trademark/copyright registrations
- insurance providers
- tax collectors
- professional licensing boards
Nothing can burn bridges between buyers and sellers more than trying to retcon these transfers months after closing because they were overlooked.
To Compete or Not to Compete
When the business relies heavily upon the acumen and relationships of the seller, buyers typically want to protect themselves from a bum deal by including a non-compete for the seller as part of the transaction. These clauses need to not only be thoroughly discussed and agreed to, but vetted by someone with a law license. Non-compete agreements are very situation specific and the line between enforceable and overbroad is very thin. Sometimes non-competes are not pursued because the seller presents little risk of competing, or more often because seller financing is being used (if the buyer’s business doesn’t get paid, the seller doesn’t get paid). The need for a non-compete is not hard and fast; it’s more a consideration of risk allocation and every transaction is different.
If the business requires any type of specific licensing beyond general county and municipal business licensing, that is going to dictate aspects of the transaction. Is the license transferrable? What are the processes for transferring the license? What is the timeline for transferring? For businesses that require particular licensing, a transfer of the license normally puts much of the onus on the buyer to take those steps to confirm they can receive the license. But where the business will require the buyer to obtain a new license after the transfer, the seller can expect some hand-holding since the buyer is trying to replicate what the seller has already done.
Where is the Value?
This is one of the most important aspects overlooked by both buyers and sellers in terms of what their contracts say versus the reality they operate in. Every business has financial records and spreadsheets and both sides can argue why the purchase price should be higher or lower, but those are meaningless if neither party can identify where the value is coming from. Is the value key personnel such as long-term sales staff with extensive relationships? Or is it business practices that allow the business to operate for considerably cheaper than the competition? Is there proprietary software or trade secrets that give the business its edge? Consumer goodwill? More effective advertising? Without knowing where the value comes from, the buyer is set up to fail should there be any major changes during the transition that affect it. If the seller does not know where the value comes from, then they are negotiating against themselves assigning a purchase price to the business.
There are a myriad of considerations for the purchase or sale of a business and each transaction is different. Not every consideration will impact every transaction, but it’s important to leave no stone unturned in such a substantial decision. The attorneys at Marks Gray, P.A. have decades of experience advising clients on purchasing and selling their businesses and would be happy to discuss yours with you.
Logan K. McEwen is an associate who practices in the areas of intellectual property, commercial litigation, tort liability, and real estate. He assists businesses in navigating registration and licensing of intellectual property, regulatory compliance, consumer relations, business-to-business agreements, and litigation. He advises on a wide array of topics from transactional reassessment, operating contracts, insurance coverage, premises liability, to corporate internal governance disputes and mergers and acquisitions. A native of Pensacola, Florida Mr. McEwen resides in Jacksonville with his wife, Darci, and two daughters. When not practicing law, he enjoys reading, playing music, and woodworking.Share