What to consider when buying or selling your business

Buying or selling a business can be complicated, costly and time-consuming, especially when deals fall through 

By Ryan Howe, Associate, Alexander Holburn Beaudin + Lang

Buying or selling a business can be complicated, costly and time-consuming, especially when deals fall through. However, it doesn’t have to be this way. Understanding the value of due diligence and the role of your business lawyer can help.

Due diligence

  • Seller due diligence. Most sellers ignore this step due to perceived cost and time; however, many sales benefit (and would benefit) from this process. Seller due diligence involves retaining professionals (tax, legal or otherwise) to identify and address barriers to sale. Common barriers to sale include issues affecting title to the assets being sold, outstanding liabilities and corporate deficiencies. Seller due diligence allows the seller to put out fires before the buyer smells smoke, facilitating smoother negotiations.
  • Buyer due diligence. Unless a buyer is familiar with the details of the business, due diligence is always recommended and should be commenced as soon as possible due to the time associated with receiving certain results, such as tax search results. Buyer due diligence involves retaining professionals to assess the characteristics of the business, including, but not limited to, value, liabilities, operations and any barriers to sale. Due diligence is an integral step in the transaction, especially where the nature of the target business is inherently risky or where the buyer is unfamiliar with the business.

With the information gained from the due diligence process, a seller is able to accurately gauge the risk associated with acquiring the business, negotiate a purchase price, and include representations and warranties and other deal terms that reflect the due diligence results and account for such risk.

Negotiations


  • Letter of intent (LOI). The buyer and seller will agree to loose deal terms, which are then formalized (usually) in an LOI. An LOI is a framework of essential deal terms that is used as the basis for the purchase agreement.

At this stage in the transaction, lawyers should become involved in order to ensure that their clients’ interests are adequately protected in the LOI, that the LOI is not binding (unless the parties wish it to be) and that the LOI has sufficient detail to allow the parties to prepare the purchase agreement. Non-competition and non-solicitation clauses are critical terms to consider at this stage.

Tax advisers should also be involved to help determine whether the sale should proceed by way of asset purchase or share purchase, or some combination thereof. Generally, sellers prefer to sell shares because of capital gains treatment, and because they can avoid capital cost allowance recapture on the business’ capital assets. Conversely, buyers generally prefer to acquire assets because of the limited liabilities associated with them, and because of the ability to depreciate certain types of capital property.

  • Purchase agreement. Once the LOI has been signed, the buyer’s lawyer prepares the purchase agreement. As the buyer’s lawyer prepares the agreement, due diligence results are usually coming back, and, depending upon what they reveal, certain mechanics of the deal may change. This is often a turning point in the transaction that can sometimes lead to the deal falling apart. However, where the seller has conducted due diligence, these unforeseen and unaccounted-for results are already known and have presumably been addressed in the LOI.

Once the due diligence results have been addressed and the first draft prepared by the buyer’s lawyer, the lawyers assist their clients in a back-and-forth game of risk allocation, which is accomplished, in general, through various representations and warranties, adjustments to price, and holdback mechanics to allow the parties (ideally) to allocate risk to their mutual satisfaction.

Closing

  • Pre-closing. Assuming the parties have been able to reach agreement on risk allocation and no new issues have surfaced from ongoing due diligence, the lawyers’ role at this stage is to ensure on both sides that the various conditions precedent to closing (including any covenants of either party) have been satisfied. From there, the various closing documents necessary to legally transfer the assets and liabilities, or shares, as the case may be, are executed by the parties with their counsel on or before the closing date, and, unless there are post-closing obligations, the deal closes. 
  • Post-closing. Common post-closing items include discharging encumbrances, holding back a portion of the purchase price and working capital adjustments. In each case, the lawyers on each side will be monitoring the agreement to ensure that their clients are fulfilling their side of the bargain. If a party fails to meet a post-closing obligation, litigation, mediation or arbitration generally ensues, in accordance with the terms of the agreement. It is the business lawyers’ role to help their clients avoid such a result wherever possible, as these forums of dispute resolution are incredibly costly and time-consuming.

Video: Judy Rost and Ryan Howe discuss what to consider when buying or selling your business:

To learn more about what to consider when buying or selling a business, register today for BIV’s Business Excellence Series: Buying & Selling a Business event.