Selling Your Business: Key Terms to Focus On
SELLING YOUR BUSINESS: KEY TERMS TO FOCUS ON
There may be business deals you can safely write up on a restaurant place-mat – but the sale of your business isn’t one of them. The “keep-it-simple” principle has its limits. To protect your legal and financial interests, you need to put together a detailed sales contract for you and the buyer to sign.
Here are some items to consider for inclusion in your sales contract.
1. What the buyer is buying. Usually the buyer will buy the business assets. These typically include the furniture, fixtures and equipment and, in a wholesale or retail business, the inventory of goods. The assets also may include lease rights, phone numbers, the business name – and a catchall called goodwill. While buyers prefer to buy assets, if your business is a corporation there’s another way to go: you can sell the corporate stock. The buyer will then own the corporation which, in turn, owns the assets. There can be some tax advantages for you if you sell the stock rather than the assets. See your CPA for details.
2. The buyer’s investigation. The buyer may want some time after signing the sales contract to further check out the business – for example, looking into financial statements and tax returns. That’s usually no problem. But protect yourself by keeping the check-out period short. If the buyer decides to walk away, you want to be able to quickly resume your marketing of the business. And have the buyer acknowledge in writing that your business information is confidential and won’t be divulged to others without your permission.
3. The down payment. Seller financing is common. The buyer makes a down payment and then pays you the balance (with interest) over the next three to five years. The more the buyer has invested in the business, the more likely you’ll get paid on time; the buyer won’t want to lose what’s been invested. So try for a down payment of at least 25%. One-third is even better. Of course, before you agree to terms other than 100% cash, you’ll want to see the buyer’s financial statement and get a credit report.
4. Security for the balance. You should retain a security interest in the assets until the full balance is paid. That way, if the buyer gets behind in paying you, you can take back the assets you sold. Another way to protect yourself is to have the buyer’s spouse cosign for the debt so you can reach their jointly-owned assets if the buyer doesn’t pay. If you’re really nervous about being paid – and the buyer is willing – see if you can further protect yourself by having the buyer give you a mortgage or deed of trust on the buyer’s house.
5. Allocation of the purchase price. Different assets receive different tax treatment. It will smooth things out with the IRS if you and the buyer can agree in the sales contract on how the purchase price will be allocated among the different types of assets. In other words, if you’re selling the business for $500,000.00, how much of that amount is for equipment? How much for the lease rights? How much for inventory? How much for goodwill? This is another area where your CPA can help.
6. Your lease. If your lease for your business space will last past the date you close on the sale, see if you can assign the lease to the buyer. You may need the landlord’s permission to do that. Consider, as well, asking your landlord to release you from any further responsibility for rent after the buyer takes over. You may want to say in the sales contract that the deal is contingent on your getting the landlord to let you off the hook for future rent.
7. Warranties. In almost any sales contract, you’ll be asked to make warranties – that is, guarantees that certain facts and statements are true. If it turns out you were wrong, the buyer may sue you or use it as an excuse make big deductions from what’s owed to you. Read the warranties very carefully. If you’re not absolutely sure of the facts, protect yourself by adding the words, “to the best of sellers’ knowledge . . . ” That way, if the facts aren’t as you thought they were, you can’t be held responsible. Your existing insurance policies may also protect you, but some types only provide protection for "claims made" during the policy period and require you to buy "tail coverage" for any claims made after you stop paying premiums.
8. Non-compete clause. The buyer won’t want to pay you for a business, only to find out that you’ve become a competitor. Chances are the buyer will want you to agree not to compete for a certain number of years within a designated geographical area. Make sure the area isn’t too big and that the restrictions are reasonably needed to protect the buyer. You may still need to earn a living in a related field.
9. Prepaid items. If you’ve paid property taxes or rent in advance, it’s smart to provide that those items will be prorated at the closing. In other words, the buyer will reimburse you for the portion that will benefit the buyer.
10. Liabilities. The buyer will want you to assume liability for any debts or other legal obligations (such as an accident claim) that relate to the time when you owned the business. That’s fair. But it’s also fair for the buyer to assume liability for debts and other legal obligations that come up after the closing. Sometimes these matters are handled through clauses using the words “save harmless” or “indemnify.”
11. Consultant. You and the buyer may agree that you’ll be available for six months or so after the closing as a consultant or advisor. This can make for a smooth transition – and also give you the chance to earn a bit of money. Make sure, however, that you spell out what your duties will be, how much time you’re committing and how much you’ll be paid.
One final point: Some buyers and sellers are anxious to put something in writing early in the deal. They agree to sign a “letter of intent” before the details of sale have been worked out. Why? Because they want to show their mutual good faith in moving ahead.
There’s nothing wrong with that, but be careful. If the letter of intent isn’t worded carefully, a judge may treat it as a binding contract – even though crucial items are missing. It’s best if you and the buyer are bound only by the sales contract itself. Your lawyer can put the right words in the letter of intent so it’s not binding.
This article was authored by Fred S. Steingold, a member of the Michigan Bar, who is with the Law Firm of Fred S. Steingold, with an office at 320 N. Main in Ann Arbor, MI 48104, Phone (734) 665-0635. Copyright by Fred S. Steingold, 1999.