Legal Clean Up: What Legal Areas Should You Look At Before You Market Your Business?

At one time or another, most business owners consider the prospect of selling their business. This could be initiated by a prospective buyer making a specific offer, someone merely asking if your business might be for sale, an owner might be approaching retirement, or an owner wanting to move on to another challenge.

 

In any of those situations, it is best to be sure there aren’t any major legal problems before a deal is struck in principle with a buyer. When the buyer makes an offer, even if non-binding, the buyer generally is assuming that the business has no legal problems. In addition, usually the seller would like to move fast, striking while the iron is hot. Many deals get untracked because of legal issues or problems that arise in the middle of negotiations or due diligence, and if they arise after closing the problems can be even greater (the sales contract probably will have representations, warranties and indemnities that survive closing, perhaps lasting for years).

 

1. Who Owns the Business and Whose Consents are Required? One of the first and most basic issues from a legal perspective is to be certain who owns whatever is being sold, and whose approval is required. A buyer often will want to be sure that the person to whom the buyer is sending the purchase price has the authority to sell the business that is being bought. A first place to check is the corporate minute books (or similar documentation for a limited liability company or other similar business entity). If the records have been poorly maintained, stock certificates have not been correctly authorized, stock transfers documented incorrectly or incompletely, officers and directors elections not documented, or annual meetings missed, there will be a lot of last minute, frantic work to try to clean these matters up. If a consent or agreement to a transfer document is required of a prior business owner who has left the state, there will be a significant problem.

 

2. Are the Assets Being Sold Owned by the Seller and Are They Free and Clear of Liens? Other primary concerns of a buyer are that the seller owns the stock or assets being sold, and that they are free of any liens or encumbrances that weren’t disclosed by the seller. First, check the public records. For example, review the county title records, for land, to understand exactly who is the record owner, and what mortgages or easements might be encumbering the real estate. Normally a title company and a surveyor will undertake these actions, but if a problem is discovered late in the negotiations, the closing might be delayed and even jeopardized. A UCC check is very inexpensive and will reveal outstanding financing statements that still might be in effect, even if the underlying loan was paid off years ago. Waiting until the day before closing to be sure that there are no UCC-1 financing statements covering some or all of the property being sold is not advisable.

 

3. Compliance With Laws and Regulations. Depending on the size of the business being sold, legal due diligence to ensure that there are no major legal non-compliance issues may be relatively easy, or it might be time consuming task. Perhaps a buyer will pay the purchase price without checking in this area, and perhaps the sale will be on an “as is” basis. However, in most situations the buyer will review the major legal areas before closing, including employment law compliance. For example, the buyer probably will want to ensure that the people who are working for a company but are classified as “independent contractors” are not actually employees. If a business has been treating “employees” as independent contractors, each “employee”, and many government agencies, including the IRS, could have sizable claims against the business. And the new owner probably will not want to take a similar legal risk. As a result, the compensation costs to the new owner will be greater, and the price for the business that had been tentatively agreed upon will have to be substantially reduced. This may very well kill the deal, after many hours of time and costs in preparation for the transaction, have been wasted. Similarly, are I-9 forms on file? These forms are required of every employee, as a check on an employee’s right to work in the US. Even if each employee does have this right, the forms will have to be completed, so a business owner might as well complete them in advance, and not wait for the buyer’s lawyer to bring it up the day before closing. There are many federal and state laws that apply to a business that hires employees. A short listing is in an article on my website, http://www.whitakerbusinesslaw.com/blog

 

4. Other Legal Areas of Concern. Compliance with other laws also may be very important, depending upon the nature of the business being sold. For example, a manufacturing company that uses or disposes of hazardous wastes will have environmental concerns: How were the wastes disposed of? Were the waste disposal contractors properly licensed, and didn’t merely leave the wastes in barrels in a deserted tract of land (this happened to one of my clients)? If a significant portion of a company’s value is its brand names, then its trademark situation should be major area of focus.

 

5. Are the Contracts and Permits Assignable? Some businesses have a significant portion of their value in long terms contracts or leases, or government permits. In many cases, these contracts or leases will not be assignable without the other party’s consent, which might result in the other party renegotiating them. For example, a business might be reliant upon a long term fixed price supply contract or a patent, trademark or copyright license necessary for major product manufacturing or sale of a major product of the business. In any such case, the buyer will want to be sure that the contract or license is still in effect and will be in effect after the business is bought. If a permit is to be assigned, the government agency might require a new permit application, perhaps applying regulations that weren’t in effect when the permit was originally issued. One way to avoid many of these concerns is to sell the stock or ownership interests in the business, rather than its assets. However, this is not necessarily an easy fix. First, the contract or lease might be written so that the other party’s consent is required even for a transfer by operation of law, through a stock sale. Second, the purchaser of the stock in a business will acquire the business subject to all of its liabilities, such as yet unknown claims, while an asset sale might (but this is not necessarily true) be able to transfer the business without an assumption of unknown liabilities. Third, a business broker might find itself unable to participate in the transaction because of recent SEC positions on compliance with broker dealer requirements that arise from the sale of stock, as opposed to the sale of assets, of a business. In order to avoid any of these concerns derailing the deal at the last minute, it is highly advisable to review all significant permits and long term contracts and leases for assignability issues before any price negotiations take place, and make the offer subject to any you have identified.

 

6. Other Areas of Concern. In addition to the legal areas mentioned above, there are many financial and operational concerns that should be addressed before closing, including accounting and tax issues, business plans and strategies, post closing integration issues, the competitive landscape, and the condition and warranty coverage of major equipment and vehicles.

 

In sum, understanding the strengths and weaknesses of your business should be undertaken before you strike a deal. If the buyer discovers a problem after the price has been agreed upon in principle, at a minimum negotiations will be required, which usually result in a lower price and possibly also an escrow and extended indemnities. For an undisclosed problem that can’t be fixed before closing, the buyer might insist on a price reduction or an escrow to the extent of the maximum amount of the potential liability. In other situations, a transaction that with proper planning might have been feasible might be killed. My advice is to conduct your own due diligence and plan accordingly before you start the negotiations to sell your business.

©2011 Whitaker Business Law

 

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For more information contact Gary Whitaker, Whitaker Business Law, This e-mail address is being protected from spambots. You need JavaScript enabled to view it .  Gary Whitaker is at Trusted Advisor of the BUSINESS HOUSE, inc.^SM