We often receive communications with regard to the purchase and sale of a business. This Article provides a general overview of the steps involved in this process, especially for those who have not bought or sold a business previously.
Step 1: Determine a Reasonable Value
I have previously posted an article dealing with determining the value of a closely held business. If you are the Seller, you will need to figure out a reasonable value for your business. This may be determined by a variety of methods as previously pointed out. It is important to remember that the value of your business does not include its sentimental value to you, rather its reasonable value on the open market.
If you are the Buyer, you will need to do your due diligence and employ a reasonable valuation method to determine a fair offer. Before you can obtain the financial books and records of the Seller’s business the Seller will probably insist that you execute a Confidentiality and Non-Disclosure Agreement (“NDA”) which is necessary to protect the Seller’s data.
It is important to remember that the Buyer’s determination of value may be greatly influenced by the financing available to make the purchase. The Buyer should have a good advance understanding of what its lender is willing to lend, the terms of the loan, and how the lender may be valuing the business as well as the percentage of value that the lender is willing lend. The Buyer should also understand the lender’s loan approval process, especially how long it will take to obtain a formal loan commitment. If the transaction is to be Seller financed (in whole or in part), the parameters of such should be determined in advance of further negotiations.
Step 2: Negotiate the Basic Terms
If the parties have at least a general agreement as to a purchase price, the next step will be to negotiate the basic terms of the deal. These basic terms should include: the type of purchase and sale (i.e. a sale of equity or an asset purchase), what assets are included and excluded from the deal, what liabilities are to be assumed by the Buyer, if any, the time for any remaining due diligence and any contingencies connected to the transaction (including third party approvals), warranties, Seller provided training or time available for transition, noncompetes, any adjustments that are to be made to the purchase price (such as inventory, works in progress, and on account of receivables), and the closing date.
When basic terms have been agreed to in principal, it is time to document these in a Letter of Intent (“LOI”). LOI’s are of two types: binding and nonbinding. A nonbinding letter of intent simply provides that neither party must proceed with the transaction, but if it does go forward, then the terms stated in the LOI will reflect in the final deal. By contrast, a binding LOI legally obligates the parties to proceed with the deal (subject to any preconditions or contingencies) and the terms of the LOI will be included in the Purchase and Sale Agreement. It is useful for you to prepare a “point sheet” of your understanding of the deal to take to your lawyer to prepare or review the LOI.
Step 3: Document the Deal
Based on the LOI, the deal will be governed by a formal document usually called a Purchase and Sale Agreement. Note that if a new company needs to be established by the Buyer to receive the purchased business or its assets, this should be formed at this stage or before. Also a lien and judgment search should be completed before closing by the Buyer to assure that it will be purchasing the business “free and clear.”
Purchase and Sale Agreements are usually technical documents and it is best to proceed at this stage with professional guidance from a qualified attorney. The party receiving a draft of a Purchase and Sale Agreement should have its own attorney review it and negotiate any further changes to be made.
Step 4: Closing
With all of the predicates out of the way, it is time to prepare the closing documents, close the deal, and exchange considerations. Typical closing documents include: a bill of sale and/or deeds to any real property, company enabling resolutions, financing instruments, noncompetes, express warranties, employment contracts, etc.
This Article hopefully has supplied you with a roadmap of the basic process of buying or selling a business. As experienced business counsel, we would be pleased to help you navigate the journey to closing.