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Feb 18, 2022 | Business Law

Part 2: Preparing Your Business for Sale or Transfer – Legal Review and Planning


Content: Part 2 of 2 articles on buying and selling businesses; Adam Jacobs, Esq., details the issues and process of preparing for a business sale or transfer.

Understanding and identifying legal issues and problems in advance and, where possible, taking corrective action prior to proceeding with the sale process or transfer will significantly help the sale and transfer process. Such review and identification along with corrective action eliminates last minute problems, surprises and blockers to closing a transaction efficiently and timely. Unaddressed or unknown legal issues and problems will usually not remain undetected or unknown once third party buyers, their counsel and others commence their legal due diligence and then discover unaddressed legal issues and concerns with the business. One inquiry we often hear from business owners is – when should we commence the legal review and planning for sale or transfer? The short answer is that the business and its owners should have been preparing the business for sale or transfer the day the business commenced and throughout its continued operations; but it is never too late for legal review and taking steps to prepare the business for a future sale or transfer.

This article focuses on and discusses in general the legal steps and legal review to consider taking in connection with a plan to sell or transfer a business. This article is not specific to any particular business or industry, but rather is general in nature to provide a broad sense of the legal review to consider.

Set forth below are a list and summary of legal issues related to businesses which should be reviewed and discussed between business owners and their counsel along with actions to be taken or considered to address discovered legal issues and concerns. Many of the issues and matters noted below can be thought of as preventative legal maintenance. A buyer of a business will generally produce a comprehensive legal due diligence list and document request list, which will address many of the items and issues noted below. It is also best practice for the business to set the right impression to a buyer that the business is well run and operated, the transaction should have minimal or no delays due to legal issues, and for the business to be in a position to quickly address and provide requested information – all of which goes very far in the successful negotiation and transaction process in connection with the sale of a business or implementation of a succession plan.

Summary of legal matters, which should be reviewed, considered and discussed between business owners and their counsel (and other professionals as needed):

  1. Entity and Government Filing Requirements.
    • Legal Books and Records. Does the business maintain files or books and records, which contain the formation and organizational documents, written consents and resolutions, stock ledgers and equity ownership records and so on? Are such records up to date?
    • Governmental Filings – Secretary of State Filings. If the business is operated via an entity such as a corporation, limited liability company or partnership, are the formation, organizational and governance documents up to date and have they been reviewed recently? For example, is the entity in good standing with the Secretary of State’s Office? Are all Annual Reports and required filings up to date? Sometimes during review it is determined that an entity has neglected some of these items and may have been administratively dissolved which then needs to be attended to. Does the business operate in multiple states and other countries?  
    • Governmental Filings – Tax Filings; Escheatment. Have all required tax returns been filed? Have audits been attended to? Sales tax and exemptions – are the same attended to properly? Have accountants and CPA reviewed tax practices related to the business – sales tax, income tax, payroll tax and benefits, and other tax matters. Have tax elections and depreciation methodology been periodically reviewed? Transfer tax issues? Any escheatment issues or concerns?
    • Agreements among Equity Holders; Governance Documents and Bylaws. Are there written agreements such as a Shareholders Agreement, Operating Agreement or Partnership Agreement addressing various governance matters and equity transfer restrictions, capitalization and related matters? Are such agreements up to date? Are there special provisions, such as transfer restrictions in the Articles of Organization or Certificate of Organization which need review or updating? Who needs to authorize the sale of the business or a transfer in connection with estate planning or a succession plan to employees or others – which documents and agreements address the same?
  2. Financial Books and Records. Budgets.
    • Financial Records. These should be reviewed to make sure they are in good order and any known issues are addressed. Is there anything not recorded in the financial books and records? Why? Are there any changes in accounting practices? Any concerns from the business’ accountants?
    • Financial Statements. Does the business have “management prepared” financials? Accountant prepared financial statements? Audits? Only tax returns prepared annually and no financial statements? What has been provided to third parties such as lenders?
    • Tax Returns. See above notes.
    • Specific Expenses. Any concerns about items being expensed which are marginally related to the operations of the business? Other expense concerns?
    • Budgets. Does the business have a budget and business plan? If so, is it tracked and reviewed for performance to the same?
  3. Loans, Leases, Liens and Judgements. Bankruptcy.
    • Loans and Lease Documents. All documents and records should be maintained and in an orderly fashion, including any and all financial information provided to lenders and lessors. Are any of the owners personal guarantors? Prior loans – have the cancelled promissory notes been returned? Have loan provisions regarding the sale of the business or succession planning and equity transfers been reviewed? How are relations with the business’ lenders?
    • Previous Loans and Leases. With respect to loans which have been paid off and leases which have terminated, does the business have cancelled promissory notes and evidence of termination? Have Uniform Commercial Code Financing Statements been terminated so they are no longer outstanding? Motor Vehicle titles – have paid off liens been removed and titles returned? It may be advisable to do a lien search.
    • Defaults; Work-outs and Restructuring History; Bankruptcy. Any issues? If so, be prepared to explain the issues and resolution or prior defaults of loan related issues. Is there any history of loan workouts, modifications, restructuring and so on? These will need to be detailed and explained.
  4. Litigation.
    • Litigation and Claims Made Against the Business. Be prepared to explain and provide detail regarding the same, including resolution and status and estimated magnitude of the same, and whether covered by insurance. All litigation documents and files should be organized and maintained by the business. A list of counsel and the litigation matters they have attended to on behalf of the business should be maintained.
    • Litigation and Claims Made by the Business. Be prepared to explain and provide detail regarding the same, including resolution and status and estimated magnitude of the same.
    • Class Actions or Unusual Claims. Any? Be prepared to explain and provide detail regarding the same.
    • Governmental Claims and Petitions. Any? Any non-tax audits or claims by any governmental agencies?
    • Other Litigation or Claims? Any? Be prepared to explain and provide detail regarding the same.
  5. Contracts.
    • General. How are contracts of the business maintained and organized? Who is in charge of and authorized to execute contracts? Issues? Summaries and overview to be provided. Are sales/revenue generating contracts on standard or custom forms of agreements and have the same been reviewed and updated? Any systemic issues?
    • Key Contracts. What are the key contracts of the business? Any government contracts – federal, state, local or other? Any issues? Any contract transfer or assignment issues?
    • Industry Specific Concerns. Any?
  6. Customers and Vendors.
    • Key and Sole Customers and Vendors. Any? Summary needed. Any unusual terms or provisions – such as sole source providers, concentration of customers, exclusive dealing and so on?
    • Issues. Any general issues or concerns? On-going issues?
  7. Employees and Employment Agreements.
    • General. Need overview.
    • Written Contracts and Offers; Personnel Files. Any? Up to date and managed in an orderly manner? Does the business comply with personnel file laws? Paycheck laws complied with? Background checks? Drug testing? E-verify?
    • Handbooks. Any? When was the same reviewed and updated? Does the business maintain and provide legally required notices to employees, including workplace posters?
    • Union and Collective Bargaining History. Any? Details will be needed, include CBA review, strikes, bargaining disputes and so on. Any general issues? Infighting? Labor shortages? Overstaffed? Management structure and management issues? Out of state employees? Overseas? Leased employees? Any history of or on-going governmental investigations, audits or inquiries?
    • Training and Certification. Any unique employee and labor requirements or training? Any issues?
    • Independent Contractors. Does the business use contractors? Has the same been reviewed for any issues? Employee versus independent contractor issues and review?
    • Wage and Hour Practices and Claims. Have any claims been made? Are overtime and general payroll practices in compliance? Have the same been reviewed? Any pending claims or investigations?
    • Termination and Claims. History and any issues?
  8. Employee Benefits and Healthcare.
    • Benefits and Benefit Plans. Summary needed and discussion. Any issues with providers and administrators? Law being followed?
    • Issues. Any audits, investigations or claims? DOL audits? EEOC audits?
    • COBRA. Any issues? Any former employees on COBRA?
  9. Insurance Policies and Risk Management. Insurance policies and risk management should be reviewed, including discussion with insurance brokers. Claims history should be reviewed and analyzed – any systemic issues?
  10. Leases and Real Property; Environmental and Permits/Zoning.
    • Leased Real Property. Does the business lease its real property and are there written leases? Are the leases up to date and any issues with the landlords, such as defaults or chronic issues? How are relations with the landlords? Have provisions regarding assignment and equity transfers been reviewed – any issues? Are Certificates of Occupancy and zoning requirements in order?
    • Owned Real Property. Does the business own its real property directly? Does a related party own the real property used by the business? If so, details will be needed to determine whether the lease, if any, sets forth market terms or otherwise.
    • Environmental and Permitting. Any issues – governmental claims, third party claims? To the extent there are prior issues, are all documents organized and readily available and summarized? Any environmental review or consultant reports such as Phase I reports? Any zoning or permitting issues? Would matters need to be addressed upon a transfer?
  11. Tangible Equipment.
    • Lists and Records. Are they kept in an orderly manner? Is equipment owned by the business? Is equipment leased by the business?
    • Maintenance Plans and Records. Kept and in good order? Warranties? Issues in general?
    • Permits and Licenses. All in order?
    • Capital Expenditure. History, plans and sufficiency of assets to operate or deficiencies – will need to be able to provide and discuss.
    • Issues. Any? Anything unique about the tangible assets? Concerns?
  12. Intellectual Property and Contracts.
    • Scope and Use of Intellectual Property. Depends on the business but details regarding all intellectual property are important. Are there third party licenses granted to the business? Any in-house developed and owned intellectually property? Any acquired and owned (rather than licensed) intellectual property? Anything unique to the business?
    • Employee Assignments. Have employees provided assignments of intellectual property to the business?
    • Infringement. Any claims against the business? Any claims by the business?
    • Privacy Laws and Issues. Any issues or breaches of customer or employee personal identifiable data? How addressed? Safeguards?
  13. Permits; Licenses. Barriers to Entry. Restrictions Related to Business.
    • Schedule and Details. All permits and licenses should be carefully maintained, monitored and scheduled. Any missing permits or licenses needed to operate the business or other issues? Renewal dates, conditions and issues?
    • Barriers to Entry. Any unique or difficult to obtain franchises, permits, licenses, approvals or contractual right that would prohibit or make it difficult for others to enter the business?
    • Claims. Any claims against the business related to licenses, permits, contracts or otherwise?
    • Prohibitions and Restrictions. Is the business subject to specific restrictions related to operations? Any governmental citations or agreements, or third party contractual restrictions entered into or subject to?
  14. Safety; OSHA; Environmental. Any safety issues or concerns? Any OSHA or state and local governmental safety issues and claims? Any insurer safety concerns raised? Other than real property environmental matters noted above, any operational environmental claims or issues?
  15. Acquisitions and Dispositions. Has the business acquired other businesses or the assets of other businesses? Documents and history will be needed and should be orderly, kept and maintained. Detail will need to be reviewed and summarized. Any confidentiality or nondisclosure agreements outstanding related to transactions that did not proceed?
  16. Competition and Risks. Known and upcoming, if any, should be understood and discussed.
  17. General Records and Record Retention. Overall, does the business maintain records and documents in an orderly and clear manner across the board? Any issues? Any issues with missing records or documents? Other problems?

A business owner may want to consider engaging in a mock due diligence exercise with counsel by reviewing a sample buyer legal due diligence request and preparing responses and gathering requested documents or at least reviewing and discussing key portions of the same, and identifying potential issues and concerns. Although it can be time intensive and disruptive, going through the exercise can prove to be a very valuable process and tool in identifying and addressing legal issues and concerns early on that may otherwise lay dormant until faced with a real sale or transfer.

The above is meant to be a general overview of some of the legal areas to be reviewed and considered by most businesses; but there are other legal areas to review and consider, and depending on the business and industry there may be other specific in-depth legal matters to review and consider. In addition to legal matters, various other aspects of the business should be carefully reviewed such as accounting and accounting practices, how to increase and maximize revenue and profits and lower costs, detailed employee benefits review (retirement and healthcare) and summaries, and industry specific matters and trends.

This article was written by Adam W. Jacobs, Esquire.

A previous article addressed the buyer’s perspective with respect to the purchase and acquisition of a business.

This Article is not legal advice and should not be taken as such or relied upon as legal advice. The business attorneys at Wilchins Cosentino & Novins LLP are ready, willing and able to assist with business transactions, sales, and transfers and planning for the same.  Please contact Adam W. Jacobs, Esquire to discuss at 781-235-5500 or 781-247-8055 and at ajacobs@wcnllp.com.

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