Part 1 of 2 articles on buying and selling businesses; Adam Jacobs, Esq., details the process and preparation that goes into purchase and acquisition.
Decision to acquire a business and Goals. There are many reasons you may decide to buy a business. Regardless of the reason, a key question is what is the desired goal? The goal or goals will impact the advice provided by the professionals engaged to assist the buyer.
Representatives: Attorney, CPA and others. The process of acquiring a business has many parts and steps. Having a team of competent and experienced advisors is crucial. The advisors generally recommended and utilized are attorneys and accountants, and preferably those with experience representing clients buying and selling businesses (often referred to as mergers and acquisitions or M&A). From review of the proposed deal and due diligence to the closing and post-closing and everything in between, the advisors are there to assist. The buyer’s attorney and accountant will address various legal, tax and accounting issues along with transaction specific issues and matters. The magnitude of the engagement and the scope of services needed from the advisors depends on the actual transaction, what is discovered during due diligence and other factors. Having the team in place early in the process is always preferable to waiting until a letter of intent or other agreements are entered into in order to avoid potential initial missteps.
After the buyer has made the decision to pursue the acquisition of a business and has an attorney and an accountant on board, the initial steps of the acquisition proceeds. The advisors will discuss the initial background of the proposed transaction with the buyer along with an understanding of the buyer’s goals and objectives. Deal terms from the buyer’s perspective along with how the buyer will fund the acquisition will be discussed. Understanding the buyer’s operational and business plans after acquiring the business will be discussed. The advisors will explain in detail the process, steps and timing. The advisors will outline the transaction details to be discussed and agreed upon, along with customary transaction documents to be entered into. It is important to discuss and have an understanding of the purpose and content of confidentiality agreements, due diligence lists and requests, the letter of intent, the purchase agreement and ancillary agreements. These documents are addressed below in this article.
Planning: Entity selection and capital/financing; estate planning. An important early decision for the buyer is the type of entity the buyer will use to acquire the business. The specific type of entity will depend on the facts and circumstances, the buyer’s ultimate goals, and other planning factors such as financing requirements and estate planning. The buyer’s advisors will provide guidance regarding entity selection and options to consider. Related to and a very important factor that will impact the overall transaction is the capital source for a transaction and financing. How is the buyer funding and financing the transaction and the business going forward? Will the buyer be paying cash for the business? Will the buyer be borrowing to finance the acquisition? Will the buyer have investors providing capital? Will the sellers accept a promissory note from the buyer for a portion of the purchase price? The answers to these questions will drive entity selection and structure of the transaction and should be discussed with the buyer’s advisors early on in the process. The buyer should review and consider estate planning and tax planning during the pre-acquisition phase because there may be opportunities and strategies which may be taken advantage of. The buyer should consult with estate and tax advisors.
Active involvement of the parties; Understanding the sellers’ perspective and the sellers’ representatives. In some transactions the sellers and the buyers are actively involved in the process and steps of the acquisition engaging directly with their counterpart on conference calls or otherwise. Sometimes the sellers may be too actively involved and counterproductive. In other transactions, the sellers and the buyers have minimal or no engagement with one another until perhaps the closing. In many transactions the advisors of the parties handle all interactions. It all depends on the facts and circumstances. Regardless of the level of interaction between the buyers and the sellers, understanding the sellers’ perspective and sellers’ team is always helpful. For example, knowing a seller wants to sell because they are retiring or due to another life cycle event is good information. Knowing a seller is difficult, unyielding, detached or uncooperative in the process is all good intel. Knowing a seller is inexperienced with the sale process or has sold many businesses in the past is all good information to be aware. If the sellers’ advisors are inexperienced is also good intel to set expectations and challenges.
Due Diligence List and Confidentiality Agreement. An initial part of the acquisition process is production by the buyer of a list of documents and information which the buyer wants the sellers to provide – this is usually referred to as a due diligence list. The due diligence list is usually a combination of legal, financial and operational information and documents requested by the buyer (based on the advices of his legal and accounting team). The information and documents to be provided will enable the buyer’s representatives to review the documents and information regarding the sellers and the business in order to learn more about the business and to uncover issues and possible concerns. The production and delivery of the documents and information requested in the due diligence list can be a time consuming and challenging process for the sellers. The sellers usually will not provide due diligence information or documents to the buyer until the buyer has entered into a confidentiality agreement or non-disclosure agreement. The confidentiality agreement will require the buyer to safeguard the information provided to keep the same confidential without disclosure to any third parties (other than buyer’s advisors); the buyer will be liable for unauthorized disclosure. Many of the terms of confidentiality agreements are customary and commonplace, but the same should still be carefully reviewed by legal counsel and modified as needed.
Letter of Intent. The letter of intent is a key step in the process for the buyer. The letter of intent, which is sometimes referred to as term sheet, is prepared by the buyer and is usually a non-binding offer to engage in an acquisition transaction with the sellers. The buyer’s counsel will work closely with the buyer in the preparation and submission of a letter of intent. The sellers may accept or reject the letter of intent and the sellers may counter or question the offer and/or certain terms and conditions.
Although most of the provisions of a letter of intent are non-binding, there are several provisions which are customarily binding – including confidentiality that the parties are discussing a possible transaction and exclusivity rights granted to the buyer (granting the buyer a period in time during which the sellers will only engage with the buyer regarding a possible transaction). It is important to note that although a letter of intent may not be binding to require the buyer to go through with a transaction, the letter of intent should be presented and offered in good faith. It may be difficult to change the purchase price and terms with the sellers unless the buyer presents solid reasons why the price and terms are being modified (and even so the sellers can reject such modifications and the deal at that point). Deals often do not survive beyond the letter of intent stage because there may not be a meeting of the minds between the buyer and the sellers.
Some letters of intent are very general and set forth a few key and high-level business terms; while others are detailed and serve as almost a blue print or summary of all of the terms and conditions. Usually a letter of intent will set forth:
- the specific type of transaction (an asset purchase where the buyer is offering to acquire substantially all of the assets of the business as a going concern from the sellers, OR a securities purchase agreement where the buyer is offering to purchase all of the shares of stock owned by the sellers in order to acquire the business);
- the purchase price;
- payment terms;
- assets to be conveyed free and clear of liens (in the case of an asset purchase) or shares of stock/equity to be acquired free and clear of liens (in the case of a securities purchase);
- liabilities to be assumed or required to be paid off by the sellers;
- non-competition and non-solicit terms;
- general closing condition precedents such as receipt of third-party consents from landlords, types of contracts to be assumed, and consent needed from governmental bodies for the transaction or the buyer’s receipt of permits and licenses;
- reference to a definitive agreement which will set forth in a comprehensive manner all of the terms and conditions of the transaction along with some level of reference to customary representations and warranties and indemnification provisions;
- continuation of due diligence; and
- an exclusive period during which the sellers commit to only engage with the buyer regarding a sale during such period.
Due Diligence. Due diligence is the process of reviewing information and documents provided in connection with a possible transaction. The purpose is to investigate, review and essentially do your homework regarding the sellers and the business. Due diligence includes the discovery of issues and possible problems to be addressed during the transaction. As noted in this article, a buyer will submit a due diligence list and the sellers respond. The buyer and the buyer’s advisors will review the due diligence provided by the sellers. The buyer’s advisor will go through the due diligence material provided (and note what is missing) and discuss with the buyer. The results of due diligence can lead to the need for more information and explanations, discussions with the sellers and their advisors, a delay in the transaction, new terms, or even termination of the deal. The sellers’ role in due diligence is critical. The buyer expects the sellers to be fully responsive and to timely provide the information. Nonetheless, sellers may be reluctant to provide certain information and trade secrets, even though a confidentiality agreement is in place. The sellers may also refuse to provide certain information until the eve of the closing, a definitive agreement is entered into, or alternative arrangements are made for review of specific diligence items. In addition to due diligence provided by the sellers, the buyer’s advisors will order or conduct lien and judgement searches, conduct a tax review and obtain or request tax clearances if available and perhaps a formal environmental assessment may be conducted. Certain transactions and businesses may require the need for specialists. The buyer may, of course, want to pursue information and understanding of the industry, customs and norms of the business and industry.
Purchase Agreement. Preparation, negotiation and finalization of the purchase agreement (and exhibits and schedules) and ancillary documents noted below are probably the most critical steps of the acquisition process. It is essential that the buyer work closely with buyer’s advisors throughout these steps. Usually the buyer’s counsel prepares the initial draft of the purchase agreement and submits the same to sellers’ counsel for review. Sellers’ counsel may then mark-up the draft purchase agreement with counterpoints and proposed changes; and this back and forth may continue until the agreement is finalized. This is a key part of the acquisition process and where the right legal and accounting team members are important and can make all the difference.
The purchase agreement or definitive agreement (as it is often referenced in the letter of intent) (whether structured as an asset purchase agreement or equity/securities purchase agreement), will set forth the following in detail:
- the parties;
- recitals setting forth some limited background information;
- the type of agreement (asset purchase or equity purchase);
- the purchase price and adjustments to the purchase price;
- payment terms;
- purchase price holdback or escrow provisions may be included as part of the deal;
- assets included (and some that may be excluded (especially in an asset purchase agreement);
- closing details and mechanics;
- the sellers’ representations and warranties regarding the sellers and the business made to the buyer;
- the buyer’s representations and warranties regarding the buyer and other customary areas;
- closing conditions and deliverables; and termination provisions;
- closing and post-closing covenants and agreements between the parties;
- indemnification terms;
- survival terms related to representations and warranties, and covenants;
- post-closing agreements;
- governing law and venue (or arbitration provisions);
- notice provisions; and
- other customary provisions.
The above bullet points regarding the purchase agreement provisions are meant to provide a very general and high level summary and overview. The terms and provisions of a purchase agreement require detailed explanation and an in-depth discussion; however, this article is intended to be introductory and not a deep dive into each of the provisions and related terms. The actual provisions in a purchase agreement will be detailed, comprehensive and complete. Other terms and provisions specific to the transaction or local practice may be agreed to between the parties. Also, there certain other terms and provisions which are customary and needed in an asset purchase agreement but are not needed in an equity/securities agreement, and vice versa. The purchase agreement will also cross-reference and set forth the delivery of certain ancillary closing documents which may be customary and others may be specific to the transaction – see ancillary documents discussed below. The forms of the various ancillary documents are usually attached as exhibits to the purchase agreement and referenced therein. Schedules which are related to representation and warranties in the purchase agreement set forth factual information, exceptions or disclaimers with respect to referenced representations and warranties, and are attached and incorporated by reference to the purchase agreement (the sellers usually prepare the schedules for review and agreement by the buyer).
Ancillary Documents. Ancillary documents and agreements are critical parts of the acquisition process. Ancillary documents and ancillary agreements are agreements and documents agreed to by the parties to be delivered and/or executed in connection with the transaction. Ancillary documents and agreements may include:
- non-competition and restrictive covenants agreements;
- employment or consulting agreement with a seller;
- promissory notes being delivered as part of the purchase price;
- an escrow agreement regarding a portion of the purchase price;
- the written consent of and estoppel certificates from landlords;
- assignment of trademarks, patents and other assets;
- assignment of and delivery of motor vehicle titles;
- lease assignments;
- secretary/officer certificates;
- good standing certificates from governmental bodies related to tax payment and annual reports; and
- sellers’ written consents authorizing the transaction.
The above bullet points regarding ancillary documents and agreements are meant to provide a very general overview. The actual ancillary documents and agreements in a purchase agreement depends on the transaction terms, business, assets and industry.
Closing. This is it! The closing is the point in the transaction when everything comes together and the actual purchase and sale is consummated. The buyer has purchased the business and the sellers have sold the business. Transactions and definitive agreements are often either a sign and close later structure or a sign and close deal. In the former the parties finalize the purchase agreement, with the ancillary documents and schedules, and the purchase agreement provides that the transaction will close once the closing conditions have been met or waived by the buyer; there are also termination provisions and schedule updating provisions. In a sign and close transaction, the parties sign the purchase agreement which has the ancillary documents and schedules attached and provisions for any post-closing deliverables. In either case the terms of the purchase agreement are followed with the deliverable made and the purchase price paid in accordance with the terms of the purchase agreement.
Many transactions are now closed remotely and the parties are not present at the same location but remain available as needed – signature pages and counterparts are often exchanged by overnight courier or electronically and held by counsel until closing conditions are deemed met and the parties agree the documents may be released to close the transaction and funding commences. In the past most transaction closed in person.
Post-Closing. Some closing deliverables are agreed to be provided post-closing. Many of the ancillary agreements address post-closing matters and post-closing periods of time – such as non-competition agreements, promissory notes, earnouts, sellers’ consulting agreement, transition services, and so on. Other post-closing matters involve claims for indemnification based on alleged breaches or representations and warranties set forth in the purchase agreement. Certain matters and mechanics in the purchase agreement are to be addressed post-closing – such as true-ups and adjustments related to inventory or assets count and inspection, working capital adjustments and finalization or earnout calculations. Other documents and agreements which are immaterial in relation to the overall transaction may be agreed to be provided post-closing in order not to delay the closing. All of these post-closing deliverables and issues should be explained and addressed by counsel so the process is fully understood.
This article is intended to provide a high-level overview from the buyer’s perspective of the legal process, steps and some of the terms and conditions of buying a business, but this article does not go into all of the details and terms to be addressed. While this article is meant to be informative it is not legal advice. There is much more detail and material to be discussed and explained regarding each section of this article, but the intent was to introduce the various steps in the legal process in the acquisition of a business between a buyer and third party sellers of a business which is not publicly traded.
While there is a lot for a prospective buyer to consider in the acquisition of a business, being well informed regarding the steps and process will help not only the buyer, but will also greatly assist and foster better communications and efficiency with the buyer’s advisors and even the sellers and sellers’ representatives.
Working with experienced and competent counsel can be invaluable to a buyer of a business. Counsel will not only legally represent them throughout the process, but counsel will advise and guide the buyer of (a) the actual process from start to finish along with pre-closing and post-closing matters to consider, (b) explain the sellers’ and the buyer’s roles throughout the process and (c) detail what to expect along the way.
A second article will address the seller’s perspective with respect to the sale 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 firstname.lastname@example.org.