Legal Issues That May Arise When Selling A Business

Q: I am selling my business and have a buyer. After the buyer found some problems with the business, we are now having issues with the sale. Can we participate in dispute resolution or mediation? How can we avoid litigation?

A: While I am always willing to litigate any dispute, it is in the best interest of all parties to work together to reach an amicable resolution. Alternative dispute resolution, especially mediation, is highly recommended. Such a forum is an excellent opportunity for the parties to present and discuss all issues of concern before an impartial third party, specifically a third party who has experience with the particular issues that are involved. When all parties come to the table with a desire to engage in active listening and to resolve the issues, either method (but preferably mediation) quite frequently resolves all pending issues. The best method to ensure alternative dispute resolution is used is to incorporate such a requirement into the discussions leading up to the execution of the contract, as well as included in the final contract document.

Q: I am buying a business. We are scheduled for closing this week, and there was a fire in the business. It was not a major fire, but there was some minor damage and the insurance company will have to come in to assess the damage and determine repair costs. Do I still have to go through with the sale?

A: Generally, the simple answer is yes; however, I would recommend a review of the contract for sale to determine if it contains any contingency for factors impacting the sale and/or closing when such an unforeseen circumstance arises. I would further recommend you review the following to verify the fire does not interfere with the operation of the business nor cause you any additional financial exposure: 1) the fire did not damage the structural integrity of the building or leasehold space which the business occupies; 2) the fire will not delay your being able to assume operation of the business as originally contemplated by the contract for sale and any related closing documents; 3) the insurance company for the current owner will fully pay for all damages, and if there is any deductible to be paid, that cost is borne by the current owner. If the fire causes greater damage than you originally thought, such that numbers 1 and/or 2 become factors, then the contract language becomes important relative to the contingency I described, especially if the cause of the fire is due to the negligence of the current owner.

Q: Should I tell my landlord that I am considering selling my business? Am I legally required to inform him of the sale?

A: The option as to whether to share this information with your landlord depends upon two important factors: the terms of the lease and your relationship with the landlord. Often the terms of a commercial lease will contain language that requires the tenant to provide notice as to change of ownership. In the absence of any language that prohibits such a change during the terms of the lease, simply complying with the notice requirements as specified will be sufficient. However, if a lease prohibits a change of ownership during the term of the lease or, more frequently, prohibits a sub-lease from being executed, a potential change of ownership can be problematic. It is for these reasons that your relationship with the landlord is important. If you have a good relationship, the landlord will be more willing to waive any restrictions in the existing lease and simply re-negotiate a new lease with the new owner. Therefore, you should review the terms of the lease prior to contemplating selling your business.

Q: How do I ensure that key customers stay after I buy a business? Can I address this with a contract?

A: There is never an absolute guarantee that key customers will remain with the new ownership. The best option to try and ensure such continuity is to be proactive in the negotiations. It is important that all customer lists be provided, as well as proprietary information that is critical to the operation of the business. It would be important to allow you or your key employees to become familiar with the operation of the business and key customers by incorporating such an integration into the due diligence and negotiations part of the transaction. It would also be important to incorporate into an agreement a requirement that the former owner remain as a consultant, so the continuity is evident to the customer base.

Q: I am buying a business that is currently a sole proprietorship. However, I am buying the business with two others, and we want to know whether we should create a partnership, Limited Liability Company, or a Corporation. Do you have any advice?

A: I would recommend either a Limited Liability Company or Corporation. The primary advantage of both are, as corporate entities, you and the other owners/principals are typically protected from potential personal liability. Additional benefits are that a corporate entity provides for continuity in the event of the death of a shareholder and makes transfer of ownership, through stock sale, much easier. One detriment is on the tax side. That is, a corporation is deemed a “person” under the law, and, thus the corporate income is taxed. You would also be paying tax on your personal income (wages) received from the corporation. Ultimately, the benefits of a corporate entity as described outweigh the potential tax related considerations.

Q: I am selling my business this year. I do not have any documentation for my employees. Is it too late to properly document their employment?

A: Now that you have decided it is time to sell, you have an opportunity to review the records of your business to determine what information is missing or incomplete, especially information that you will need to provide. This information would include employee information such as basic personnel files. You will want to make certain this information is complete prior to formally putting the business up for sale, especially if your employees are expected to continue with the company once the new owners have assumed control. Other information that you should verify is complete includes accounting records, sales records, and tax returns, all for a minimum of a 5-year period. All of this information is in addition to the customer list.

Q: I am selling my franchised business. I signed a franchise agreement, but the business is not producing any revenue. Do I need an attorney to help with this transaction?

A: It is very important for you to have an experienced attorney whose practice is concentrated in business law and litigation review the franchise agreement. The terms of the franchise agreement are extremely important, including any restrictions on your ability to sell. It is also likely that if a sale of the franchise is permitted, the franchisor must be provided with notice and consent to the sale. Assuming the franchise can be sold, then you will also want to work with the attorney to review the details and history of your business. You will also want to verify all necessary corporate books and records pertaining to the business are proper and in good order to draft the contract for sale and to make certain that your interests are fully protected. It will also be necessary to work with a CPA so a full financial analysis can be performed to properly value your business. Once your due diligence has been completed, the attorney can assist with the negotiations and then participate in drafting a contract that will fully protect your interests.

Q: What would you, as my attorney, provide business owners like me, besides legal advice?

A: I have represented many small- and medium-sized businesses during my career. In developing a relationship with my client, I learn about the owners and principals as individuals along with the details of the business. This knowledge is invaluable because learning about the details of a business and its owners provides a foundation for me to provide general business advice and counseling. For example, I have often reviewed and suggested re-writes or revisions to existing forms or regularly used contracts to better protect the interests of my client. I also have provided advice and recommendations regarding insurance coverage issues and for my contractor clients, given safety advice and improved safety practice recommendations. My ability to provide good advice avoids problems before they occur.

Q: Do you have any other tips or advice for anyone buying, selling, or appraising a business?

A: The most important factor is preparation and due diligence. When selling a business, it is essential that all books and records of the business are in good order. The list includes the following, which will vary depending on the business: 1) accounting/bookkeeping; 2) personnel; 3) sales; 4) tax returns; 5) customer lists; 6) leases if applicable or alternatively title to real estate that would be transferred; 7) necessary UCC documentation for any equipment; and 7) title to vehicles. Additionally, it is very important to make certain your business valuation has been completed. I emphasize to my clients the importance of transparency so that all issues that might impact a potential sale are disclosed. From the buyer’s perspective, review of all the documentation noted above is important, as is making certain that financing is, if not in place, will not be an issue within a potential time frame to close the deal.

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