While today’s financial headlines are highlighting the slowdown in the type of large company mergers and acquisitions that were so prevalent during the booming economy and low interest rate environment in 2021, there is still plenty of transaction activity among small and medium sized businesses.
In fact, for many buyers, a downturn offers advantages such as the opportunity to acquire undervalued businesses and assets. Because there are buyers in the market, that means sellers looking to cash out or consolidate their operations have options available to them.
Regardless of whether you’re a buyer or seller, it’s important to know what’s ahead of you to complete a successful transaction. While it would be great to seal the deal with a handshake, that’s not how things work in the real world. Every transaction should proceed through a diligent process of evaluation, negotiation and documentation. The last, in particular, is critical, and it’s important to have a thorough understanding of the types of documents that are needed to buy or sell a business.
In order to engage in a process of buying and selling a business, it’s necessary for the buyer to review the operations and finances of the business being sold. However, sellers shouldn’t reveal the inner workings of their business to just anyone without some protections in place, particularly given that many of the prospective buyers for a business will be its competitors.
A Non-Disclosure Agreement (“NDA”), also referred to as a Confidentiality Agreement, can protect a seller against the unauthorized disclosure of confidential information during a sale process.
An effective NDA should include terms such as:
- Clear definition of the parties covered by the NDA
- The meaning and scope of “confidentiality” and what information and documents are covered
- Any exceptions to confidentiality (such as information that already exists in the public domain)
- The period of enforcement of confidentiality provisions
- The consequences, including the respective rights and obligations, of the covered parties
Having an NDA in place allows the parties to engage in open discussions and negotiations, and decide whether to move forward with the next step in a potential transaction, which is the documentation of a letter of intent.
Letter of Intent
Once a buyer and seller come to terms on the major points of a transaction, such as purchase price and scope of assets, these terms are documented in a Letter of Intent (“LOI”) or Term Sheet.
An LOI is a written, non-binding document which outlines key aspects of an agreement. Both parties sign the LOI, which is typically the precursor to the process of the buyer engaging in comprehensive due diligence of the business.
A key aspect of an LOI is the timeline for due diligence and closing, which allows the buyer to investigate whether there are risks that may cause the buyer to back out of the transaction, as well as time line up financing for the transaction, as necessary. Another common provision in an LOI is an exclusivity period for the buyer during which the seller cannot shop the business to other potential buyers.
Creating a Purchase Agreement is the next step after an LOI has been signed. The purchase agreement is a legally binding contract that locks in the buyer to the price and other agreed-upon terms.
The structure of a Purchase Agreement is dependent on whether a buyer is purchasing the stock of a business from the seller or specific assets of the business.
The sale of a business as a going concern to a new owner is done via a stock sale. In a stock sale, the purchaser buys the stock of the company and assumes all assets and liabilities. In short, the stock sale purchaser steps into the shoes of the prior owner(s).
In an asset sale, the business’ assets, such as equipment, property, customer lists, and goodwill is sold. The purchaser then uses the assets for an existing business or operates under a new entity using the purchased assets. The purchaser does not assume the liabilities of the seller unless specifically agreed upon.
Click here to learn more about the relative pros and cons of doing a stock versus asset purchase/sale.
The Purchase Agreement differs from an LOI in that it obligates the parties to close on the transaction, subject to any specific terms and conditions of the purchase/sale built into the agreement.
In addition to defining the price being paid for the stock or other assets being purchased, as well as identifying the parties to the transaction, a Purchase Agreement typically includes financial terms such as the timing of payment (at the time of closing or payments over time), covenants related to the parties’ obligations during and after the transaction, if any, assumption of liabilities, and warranties, such as warranties to the condition of assets.
In any transaction, the parties should use a Purchase Agreement to define the terms of the purchase/sale and ensure both parties’ rights are enforceable.
Get the Help You Need to Buy or Sell a Business in Michigan
There are a number of steps involved in buying or selling a business. A lot is at stake for both buyers and sellers, so it’s critical to utilize the right documents, and the right business lawyer, to make sure your rights and your investment are protected.
To discuss your objectives, and get the representation you need when buying or selling a business, please contact Zana Tomich.