Minimizing Negative Tax Implications When Selling a Business – Post #30April 26, 2018
Outlining the Business Purchase Agreement: A Simple GuideMay 10, 2018
The last step, the closing of your business sale, hinges upon acceptance of a purchase agreement by both buying and selling agents, and many sellers gloss over the details within it to get to the closing table as quickly as possible. But now is not the time to become lax. This article is designed to give you some of the many things to look out for as you review the hundreds of pages of legal “mumbo-jumbo.” After all, the wording in the purchase agreement protects you from legal or financial risk after the sale of the business.
Podcast Time Index for “The Sale Documents and the Terms Found in a Purchase Agreement”
- 00:31 – The Documents and the Terms
- 01:53 – Tying up loose ends
- 03:04 – Questions to ask yourself
- 04:32 – What is a Release?
- 05:08 – Indemnification Clauses
- 05:23 – Insurance
- 06:32 – The Non-Compete Agreement
- 08:50 – The Non-Solicit Agreement
- 09:45 – The Indemnification Agreement
- 10:14 – The Confidentiality Agreement
- 11:32 – The Intellectual Property Agreement
- 12:38 – How to keep it all straight
When I was 18 years old I purchased my first business, a small landscaping company. Since the purchase price was relatively low, I thought I could close the deal without having a lawyer review the terms of the deal. Yeah, rookie mistake. I know. At the time, though, the legal costs seemed insurmountable compared to the low purchase price.
Fast forward. Eighteen months after purchasing the company, I received a letter from the state of Georgia. The previous owner had not paid the last portion of the unemployment taxes, and I was now the person responsible. Clearly, I didn’t have good counsel when I bought the company, but the seller did. And his attorney made sure that he was protected in the event that we had overlooked something. And we did.
The seller wasn’t trying to be nefarious. He just had a good lawyer who used the purchase agreement to protect his client from future liabilities or claims against his company or him.
An attorney is important in keeping an eye out for any of these kinds of loose ends. Maybe you’ve overlooked a tax or insurance liability. Perhaps you’ve forgotten a personal guarantee you made on a lease agreement. Due to confusion during the closing process, maybe you didn’t realize you owed one more month of expenses to a vendor. Or perhaps an employee has filed a harassment suit against one of your business managers. Whatever your particular “loose ends” are, you want to use the purchase agreement to tie them up.
When your team is drafting up terms and conditions within the purchase agreement, you’ll need to build a list of liabilities that could come back to bite you after closing. Now don’t worry. If you have a powerhouse transition team, they’re going to help you. They’ll ask you directed questions to identify any recurring, existing, or upcoming problems in your company. In the meantime, you need to go ahead and dig through the closets to see if there are any skeletons in there.
7 Common Final Issues That Must Be Resolved (or Be Added to a Purchase Agreement):
- What agreements have you signed that are still in force?
- Have you made agreements with outside consultants?
- Are you carrying loans on a piece of equipment?
- Did you make any personal guarantees with landlords, vendors, or advertisers?
- Do you have any looming liabilities (angry customers, disgruntled former employees, product failures, lawsuits) that could cause you problems?
- Who owns copyrights to your logo?
- Do you have current contracts on your management systems or websites?
Ways a Purchase Agreement Protects the Seller
I realize this is not the happiest topic. Yes, it’s even depressing. But you want to dig up ALL of the skeletons. In meetings with your transition team, be transparent. Get everything out and on the table so that your team can help you. NOW is the time for you to take inventory and take action. If you wait until after the sale, your team cannot protect you. However, before the sale, your legal team can add releases, clauses, and requirements to the purchase agreement which can shield you from known and unknown liabilities after the sale. Specifically, your razor-sharp attorney can add one or all of the following terms and conditions within the purchase agreement.
1. A Release
Just what it sounds like, this clause releases the seller from specific and/or general liabilities or obligations that could arise after the sale. The more specific the release, the better protected a seller becomes.
2. An Indemnification Clause
Also called a Hold Harmless Clause, this condition protects the seller from any lawsuits that arise after the sale. Anna Wang of ShakeLaw.com defines this best. She explains, “An indemnity clause typically states that one party agrees to ‘indemnify’ (and often also to ‘hold harmless’ and ‘defend’) the other party. To indemnify someone is to absorb the losses caused by that party, rather than seeking compensation from that party, or to compensate that party if something you do (or fail to do) causes them to experience loss, damages, or a lawsuit from a third party.”
If the seller’s skeletons require releases or indemnifications, attorneys might require buyers to purchase and carry liability insurance to cover potential obligations if they should arise. That way, if a situation comes up, the insurance company could deal with the legal and financial ramifications.
Ways a Purchase Agreement Protects the Buyer
While the release, indemnification, and insurance help provide you with some peace of mind, buyers might ask you to sign certain agreements that could come back to haunt you. If you sign these agreements without reading through them, you could strip away all of the protections you just put in place in the terms and conditions. So look for these common agreements in the purchase agreement. Have your exit team review them and write-in conditions that protect you before you sign.
1. Non-Compete Agreement
In the case of a business sale, you’re going to have to sign this agreement. A buyer usually enforces it to prevent you from going to work for a competitor’s company or from opening up a new competing business. If a seller is buying your trade secrets, patents, formulas, and more, he has the right to ask you to leave that information in his hands and no one else’s, at least for a certain amount of time.
However, you’ll want to rely on your team to add protective terms and conditions to the purchase agreement. While you cannot work for competitors, make sure you maintain the right to work with businesses who don’t compete.
Also, make sure you specify a realistic time limit around the non-compete. Typically, 12, 18, 24, or 36 months allow the buyer to make the company his own so that if you decide to compete, he can withstand your competition.
Lastly, you want to make sure the non-compete terminates in the event of a breach of contract. If the buyer doesn’t pay his obligations to you the seller, stipulate the dissolution of the agreement so that you can attempt to take back his customers and the industry niche if you so choose.
2. Non-Solicit Agreement
Most likely, you’re also going to have to sign a non-solicit agreement. Once again, this document governs you, the seller. Essentially, it prevents you from poaching current employees, customers, and vendors from the company once you sell it.
If you want to operate a non-competing business after the sale, you may have your attorney include certain conditions within this agreement. For instance, you may request the right to hire an employee if the buyer fires him or her. Or, if you want to take an employee with you, stipulate that within this agreement so that the buyer knows about it and agrees to it. Just remember, if you take a key employee with you, the buyer has the right to lower his purchase price for your company.
3. Indemnification Agreement
We dealt with indemnification clauses earlier that protects you, the seller. In this part of an indemnification agreement, the buyer will ask for protection for him. By signing this agreement, you indemnify the buyer if someone claims that you did something wrong while operating the company.
Obviously, it’s fair to protect the buyer from any illegal activity done during your tenure in the business, like fraud, tax evasion, or infringement. However, you shouldn’t have to indemnify the buyer for everyday, legal operating procedures that were done during your ownership of the business. Again, your attorney will be able to help determine what is fair and what’s not.
4. Confidentiality Agreement
Basically, you and the buyer agree to keep your secrets secret. The buyer’s already asked you not to compete with him, but now, he has the right to ask you to keep your trade secrets from competitors as well.
Confidentiality agreements are pretty standard, but make sure you maintain the right to speak with your legal and financial teams about any pertinent circumstances and situations. You’ve got to be able to talk to your team about how you’re getting compensated for the sale of your business. So keep your trade secrets secret, but use common sense when you define other terms within the confidentiality agreement.
5. Intellectual Property Agreement
Another agreement that you may have to sign is the Intellectual Property Agreement. If you have patents, copyrights, or trademarks on products or systems within your company, you agree to give the buyer rights to use them. You are not giving away your intellectual property. Rather, you’re giving the buyer permission to use it.
If you worked with an outside consultant on that particular patent or design, the buyer will need that third party to sign this agreement as well. All parties who created the property must give the buyer permission to use it, or the buyer has the right to walk away from the deal or lower his offer price.
4 Ways to Determine Whether or Not the Purchase Agreement Protects You
Whew. That’s a lot of documents for you to review, and I haven’t even given you an exhaustive list of terms, conditions, gotchas, etc, etc, etc, within the purchase agreement. I’ve just hit some highlights! So as you’re reading through the dozens or hundreds of pages within the agreement, how do you identify potentially harmful clauses? How do you protect yourself while allowing the buyer to protect himself?
- Listen to your advisors. – You pay your team to think about worst-case scenarios. They are here to protect you from financial and emotional harm, and they are familiar with the legal terminology in purchase agreements. Listen to what they say. They know what they’re doing.
- Take inventory. – No one knows your business better than you do at this time. You know what skeletons you’ve buried, so write down everything you can think of that could come back to haunt you. Then, let your advisors determine the risk those skeletons could pose to you or the buyer.
- Prepare to negotiate the details. – There will be some give and take through the negotiations over the terms and conditions within the purchase agreement. If you know your business has problems, be prepared to negotiate. Don’t give in to all of the buyer’s demands because your business has some ugly spots. Get creative, and let your team help you negotiate.
- Don’t forget about the team you’re leaving behind. – More than likely, you have employees that will remain with the company. They will be exposed to liabilities if there are any, so put conditions in place that will take care of your former team.
So, friends, we’ve discussed how to tie-up business loose ends before finalizing the purchase agreement. These clauses and agreements can protect you and the buyer from legal and financial retribution after the sale of the company.
Now that you know how a purchase agreement can protect and hurt you, we’ll look at the general information and sections included within purchase agreements in article #32.