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(A speech for the Clatsop Association of Realtors)
By: Charles Hillestad
Businesses are being sold all the time. Listings for them are highly sought after and rightly so. Because the value of the business itself (above and beyond the land and improvements) usually substantially increases the purchase price, such sales can mean a truly huge paycheck to the brokers involved.
It can also mean big risks to those same brokers if it is not done right. And, simply asking the parties for sufficient information to fill in the usual blanks found on standard form real estate contracts often is not the right way to do it when a sale of a business is involved.
Unfortunately, many issues which can be critically important to a smooth closing and a peaceful transfer of ownership are not even mentioned in standard printed forms intended solely to change title on real estate.
Defining Assets
For example, what happens to the phone number of the business? That can be vital for future sales particularly since phone books only appear once a year. Don't assume the seller will voluntarily transfer it if it wasn't discussed in the contract. And, don't assume catchall phrases such as "all the business assets" will automatically pick it up either.
Sometimes, the phone number also happens to be the personal phone number of the seller being used for the business and the seller might be reluctant to part with it. Sometimes, the seller simply opts for greed and demands to be paid extra for the phone number. Wouldn't it be better to have that issue resolved up front rather than in court later?
The same applies to existing fax numbers, web pages, post office boxes, e-mail addresses and all associated artwork and trademarks. If such items are important to the business, the brokers involved either should be sure to include them in the wording of the contract, should be sure the parties understand they are not being included or at least should strongly encourage the parties to seek legal counsel before signing. Otherwise, if something goes wrong, the adversely affected party will be looking at the broker as the only expert involved and asking why the issue was not discussed.
In a similar vein, is there going to be a formal assignment of the business name? Although obvious, it might be too obvious. For some reason, that issue is often forgotten in the drafting.
Since the name is often critical to the good will of the business continuing, perhaps it might even be worthwhile to also add a contingency to the contract to allow the buyer time to confirm that the seller not only owns the name, but that it is owned in all markets the buyer is interested in pursuing. You only need to look at the recent case decision where the national Starbucks coffee chain successfully sued and prevented a local company from calling itself Sambucks coffee despite the proprietor having been born with that name.
Don’t forget by the way, when it comes closing time, if a name is being transferred and it is filed with the state or federal government, then appropriate paper work, often on special forms, needs to be prepared.
Are there vehicles to transfer? That takes different paperwork. Is stock being transferred or is this a pure asset transaction? Stock is handled differently. In each case, make sure that the full set of assets being purchased are discussed in the initial contract. Later may be too late.
If it is not possible to itemize everything up front, then make it a contingency for the parties to agree to a more specified list prior to closing.
Including “Good Will”
Almost everyone will remember to list on the contract what among the business owned F, F & E (furniture, fixtures and equipment) such as desks and chairs is being included or excluded in the sale. Unfortunately, not everyone will remember to specify that all supplier and client file information is to be considered as part of the purchase. That is personal property too.
Can you imagine the post closing battle likely to erupt if seller deprives the new owner of such necessary data as, for example, where the inventory is usually purchased or the accumulated names and addresses of customers? By the way, does the buyer believe he or she has exclusive future use of client lists? The buyer might well make that assumption. How will buyer respond if it is discovered seller duplicated and plans to sell the mailing list to third parties?
Guess who gets dragged into such battles? That's right. The brokers. Will it really be undeserved if something as important as the customer list is forgotten when the contract documentation is drafted?
Valuation
All brokers of course remember to put a total price tag on the property. You would be amazed though how many leave out valuation of its components such as the F, F&E subcategory which is distinct from the land value which is distinct from the improvements. An even larger number of licensees leave out valuations of good will and valuations of non-competition agreements when applicable. Thanks to income tax laws, the interests of buyer and seller are diametrically opposed on all of those points. Encourage the parties to speak to their own accountants before finalizing the valuations.
If the parties cannot agree, this is a likely flash point when the IRS enters the picture wondering why one side reported on its income tax returns that the computer equipment was $10,000 out of the total while the other listed the same equipment worth only 10¢.
There may be very good reasons for the valuations not to be "codified" or otherwise expressly spelled out in the contract. The parties may knowingly agree to take their chances with privately reporting different valuations. On the other hand, if cooperation is needed, do not expect it after the contract is fully signed and the deal negotiations concluded. If brokers want to be left out of a subsequent possible fight, the brokers at least should make sure the parties have made a specific knowing determination to not value the sub-elements making up the total sales price.
Once again, if the parties cannot agree at the time the contract is initially signed, perhaps suggest they make it a pre-closing contingency to come to agreement.
Floating Inventories
Speaking of value, what about daily inventories (meaning resale items, not trade fixtures)? There is often a long lead time between the first showing of the property and the closing. Is the value of "stock in trade" items part of the total purchase price or separately valued? Is seller obligated to maintain a certain level of inventory? How is that to be determined?
Then there are possible bulk sale laws and insuring creditors are alerted as to the sale so they will not cause potential problems.
Assumption of Third Party Agreements
Is the seller obligated to continue operating up to the closing date in the "ordinary course of business?"
What about "pay now, get later" items and vice versa such as advertising, yellow pages, trade association memberships? Shouldn't those be prorated like taxes?
How about licenses if they are transferable?
Are there operating contracts to be assumed such as boiler inspection agreements? Are they formally assigned? What about labor contracts? Health plans? Equipment leases? Accounts receivable? Bad debts? The cash box on the day of closing? Those are just a few of the items that continue past closing which might need to be addressed between the parties.
Training
Does the new operator expect the old operator to be around after closing for a while to "show the ropes" or, at a minimum, answer questions? To what extent?
How about an agreement of the old owner to say nice things to old customers about the new owner? Again, to what extent?
Confidentiality
Should there be a restriction on the buyer about discussing the sale with employees prior to closing? Seller may not want employees to know a sale is being considered. They might start looking for new jobs if they hear a sale is contemplated.
If buyer elects not to buy, seller might want to insure that the sensitive internal information discovered is not used against seller when the buyer suddenly opens a competing business across the street. Does the buyer have to surrender all such data copies?
Non-competition
Non-competition agreements were mentioned earlier. Those need to be discussed. If there is to be one, it better be in writing. Can you imagine the irritation of the buyer when seller after the sale opens up a new business across the street and in direct competition? Buyer made a big mistake and is going to be looking around for someone to blame. You may represent only the seller, but not every buyer fully understands the nuances of that. Even if a broker can win a case brought on the point, he or she still tends to "lose " in the long run. If nothing else, there is all the time that must be spent in trial prep and in court that could have been more productively spent selling real estate.
Warranties
Are there any warranties or representations that should be made by either party? Remember, the rules are not the same for commercial property as they are for residential property on such issues as disclosure.
Is a certain physical condition of the property required? How about a license, zoning, master lease, utility or other critical matter relating to whether or not the business can legally operate or continue in the event of sale? Should they be a warranty of seller or a contingency for buyer to find out on his or her own?
Inspections? Keep in mind that books and records often have to be analyzed. Should there be a representation that they are being kept pursuant to normally accepted accounting standards? Unfortunately, sometimes there are two sets of books.
Third party contracts might have to be reviewed. Is there sufficient time provided for such review? Is there a contingency for third party approval?
What about risk of loss from the time the contract is signed through closing? Accidents happen. What happens if one occurs?
Insurance? Does that continue? Can it be assigned? Should the buyer have a contingency to see if he or she can get all insurance desired and at an affordable price?
How about indemnification? Should the seller expressly indemnify buyer for all things up to closing? Should buyer indemnify seller for all things after closing?
Are all these issues mentioned in the contract? Whose responsibilities are they? Who pays?
Financing
Often in residential closings, the financing contingency is merely left to buyer's satisfaction. That might be acceptable when it is such a short time between contract signing and loan approval on a residential matter. On commercial loans however, it often takes significantly longer especially when it is a government backed loan or when something like an MAI appraisal of a business might be needed. As a result, seller might want the buyer to specify in advance exactly how much loan is needed and on what terms and provisions. While buyer might want to have a one percent loan with one hundred percent financing, that simply will not happen. To avoid taking the property off the market for a long period, seller might like to know in the initial offer whether or not buyer is seeking an unlikely loan.
Whether or not seller is going to carry a portion of the financing, it might be a good idea to allow the seller to check the buyer’s credit. If seller wants that, then the document should not only state the general principle, but also indicate that buyer will provide up to date financial statements, copies of recent tax returns, perhaps copies of title docs and certainly sign appropriate release forms to allow the information to be verified by buyer’s bankers, employers, etc.
Forgotten Necessities
If everything cannot be done by the parties at or prior to closing, is there a power of attorney and/or a corporate resolution form, as appropriate, allowing any loose ends to be wrapped up after closing? If one is needed, it should be executed. Better yet, it should be built into the initial contract.
Speaking of surviving closing, is there at least some express language of the parties in the initial contract (which will survive the closing) whereby they agree to reasonably cooperate regarding forgotten details like the name assignments?
Conclusion
Are those the only potential problems in a contract to sell a business? Not by a long shot. They are mentioned only as representative details easily overlooked in the rush to get parties to sign.
The bottom line is beware. Sale of a business is complicated and fraught with opportunities for conflict on unresolved issues. If you are uncomfortable and fear that you might miss something when drafting, get some assistance (some refer to it as spreading the liability). Or, if nothing else, make sure that you have made some pretty thorough disclaimers on your part and that such disclaimers are physically part of the contract.
Good luck and good hunting.
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