Selling business takes cautious consideration
Lawyer raises questions that should be pondered prior to sale, acquisitionApril 13th, 2023
So you’re thinking about selling your business. First off, congrats. If you’re selling your business, then a chapter—or more like a novel—is coming to an end.
However, as much as acquisitions are exciting for both the buyer and seller, acquisitions also can become overwhelming. This is especially true in the early stages of a potential acquisition, when the “what if” and “what about” considerations are endless.
Regardless of deal size, the acquisition process is, well, a process. However, during the early stages there are questions you can start to consider prior to hiring an attorney that will save you both time and money and will set you up for an efficient acquisition process. Where do you begin when selling your business? By first considering some important questions.
Will the transaction be structured as an asset purchase or a stock purchase?
As the names imply, in an asset purchase, the buyer acquires certain assets directly from the seller, resulting in the buyer’s legal entity becoming the new owner of the purchased assets. In a stock purchase, the buyer acquires the seller’s stock, resulting in the buyer becoming the new owner of seller’s legal entity.
Both asset purchases and stock purchases have their pros and cons. For example, one major pro of an asset purchase is it allows the buyer to limit liability to only those assumed in the asset-purchase agreement. The limitation of liability is a pro for sellers too, because once the assets are sold, sellers can generally move on to whatever is next.
In stock purchases, the buyer assumes all the liabilities of the entity it acquired, albeit you can limit the assumed liabilities, but the clean break is not quite the same.
One of the downsides with an asset purchase is it can be more complex due to having to identify and then transfer or assign the purchased assets to the buyer, as well as having to identify the value of the various assets for appropriate tax treatment. In a stock purchase, it is relatively straightforward for the buyer to purchase seller’s stock almost turnkey.
Asset purchases and stock purchases also both have their own tax implications, which are dependent on the parties’ entity structure, the specific assets or property involved, as well as how payment of the purchase price is structured. Therefore, it’s important to consult with certified public accountants and attorneys when deciding which structure is best for you.
How is payment of the purchase price going to be structured?
In an ideal world, every acquisition would proceed as follows: The parties agree on the purchase price; the seller wants cash; the buyer has the cash. At closing, the buyer hands the seller a briefcase full of cash—or more realistically, initiates a wire transfer—for the full purchase price.
However, sometimes the buyer doesn’t have liquidity, the parties don’t agree on a final purchase price, or if they do agree, it often makes more sense for the buyer to pay the seller later. Regardless, when cash isn’t used to pay the purchase price, another method of payment structure is needed.
Often, when the purchase price isn’t paid at closing, a structure in which the seller accepts a payment plan, either in full or in part, is common. One option is seller financing, in which the seller effectively loans the buyer either all or a portion of the purchase price in the form of a promissory note—a legally binding IOU. The buyer then makes payments to the seller until the promissory note plus any interest is paid back in full. This is one of the more common options used when cash is not paid in full. The seller gets their desired purchase price plus interest paid out over time, and the buyer makes monthly payments as they grow.
Another option is called earnout payments, in which the buyer agrees to pay the seller a portion of the purchase price now, with the remainder contingent upon further metrics or events. This typically occurs when the buyer and seller don’t agree on the final purchase price for a specific reason or want a way to incentivize the seller-owner to support the transition.
These are just some examples. There is a laundry list of creative ways to structure payment, including an installment purchase agreement or the buyer using its stock akin to cash. As with everything, what option is best and how to specifically structure the terms will be unique to your situation. However, at a minimum, having a high-level understanding of potential payment structures will save you both time and money during the acquisition process.
Is the transaction reliant on third parties?
Third parties play a significant role in acquisitions but often are overlooked. A seller is likely a party to numerous contracts with third parties that play an integral role in the acquisition. This may include landlords, suppliers, or customers and clients. In addition, most of these contracts likely will contain a provision that prevents a seller from assigning the contract to a new entity or new ownership without notice or the express consent of the third party. Such language may read something like: “(Seller) may not assign this agreement or any rights or obligations hereunder in the event of an acquisition, merger, or other transfer of substantially all of its assets without the written consent of (third party).”
Depending on the situation, a third party’s failure to consent could significantly impact the acquisition.
In this hypothetical example, a seller has a successful bakery. For the past 20 years, the seller has leased a large building that acts as the bakery and brick-and-mortar shop. The seller also has a long-term agreement with a supplier for the specific flour it uses. In addition, the seller has agreements with 10 local restaurants and five local grocery stores for its baked goods.
In this simple example, there are likely contracts in place between the seller and the landlord, vendor, the restaurants, and the grocery stores. Most of those contracts likely will contain an assignment provision like in this example. If a restaurant or two don’t consent, that may not significantly impact the deal. However, if either the landlord or supplier don’t consent, that will likely impact the deal.
Third parties will be discovered during due diligence. However, thinking about the parties involved and the role they play in the acquisition will help ensure a smooth transition.
The takeaway here is: If you’ve considered the three questions above prior to contacting an attorney, you’ll be in a great position entering an acquisition. You’ll understand what you’re selling and be able to have a productive conversation on how the purchase price will be structured. Lastly, you’ll have thought about and identified a crucial, yet often overlooked, variable in any acquisition—third parties.
To sellers, congrats on successfully building a company and selling it. To buyers, best of luck in your future endeavors.
Asif Lundstrom is a business attorney at the Spokane office of Foundry Law Group. Reach him at email@example.com.