Buying/Selling a Business: Important Terms
Author: Barrett Schaefer
October, 2012 Issue
When a business is bought or sold, the buyer and seller use an agreement that reflects the terms of the deal. When assisting a buyer or seller of a business, I find my clients often don’t appreciate the true value or significance of certain terms in the agreement. Woe to the buyer or seller who doesn’t have counsel! Below is a list (admittedly, not a complete one) of provisions in a purchase agreement that can literally cost someone thousands of dollars if they're not careful.
Payment terms. The buyer and seller should consider the following when negotiating payment terms:
• If there will be a note (loan) by the seller, the interest cannot be too high. Usurious loans are illegal.
• How the purchase price will be allocated between assets such as goodwill. This affects the tax consequences for both buyer and seller.
• Whether someone will guarantee the payments, and if so, who will be guaranteeing them.
Make sure to speak with an attorney or accountant about other important payment terms.
Seller’s warranties. Generally speaking, the seller’s warranties are disclosures based on what the seller knows about the business. These provide reassurance about what the buyer is actually buying, including various important financial information. The buyer relies upon them and generally can bring a claim against the seller if a warranty is incorrect. The seller may provide warranties such as: the seller owns the business, the business’s books and financial situation are accurate, particular amounts owed to others, any current or possible litigation, the seller is not violating any laws and so forth. Again, generally speaking, these warranties are based upon what the seller knows.
The “indemnify, defend and hold harmless” provision. Imagine you’ve just bought a business and then one of the following surprises happens:
• Someone makes a claim that they slipped and fell at the business before you owned it, and then you get sued as the owner of the business;
• Someone demands that the business should buy him a new car because, six months ago, one of the business’ employees got in an accident with him while running an errand for the business (and the employee failed to tell anyone); or
• The seller didn’t pay some advertising bills before selling the business, and now the advertisers want to be paid.
With an “indemnify, defend and hold harmless” provision, the buyer can help protect him- or herself from claims or lawsuits based upon something that happened before the buyer became the owner. If the provision is properly drafted, the seller agrees to pay for all aspects of the problem including the buyer’s defense in court, any ultimate payout, settlement or court judgment. The seller agrees to make sure the buyer is left “harmless” at the end of the matter.
Good purchase/sales agreements will have a well-written provision that similarly protects the seller, in which the buyer agrees to indemnify, defend and hold harmless the seller from any claims, lawsuits and such that arise after the seller no longer is the owner and for which the seller shouldn’t bear responsibility. This way the buyer is giving the same assurance to the seller, but for claims, lawsuits and so on, for which the buyer rightfully should be responsible.
Security for purchase price. If the buyer is going to pay the seller over time for the business, the seller should consider what will happen if the buyer stops making payments. The seller should consider some kind of collateral, or security, to help ensure the seller will get paid at the end of the day, even if the buyer stops making payments. For example, this can take the form of a deed of trust in some circumstances.
Allocation of purchase price (tax issues that could save you thousands). A purchase agreement should have a provision that allocates the purchase price among the assets being sold. This is an important provision, because it affects the tax consequences for both the buyer and seller. This can be complicated and requires a qualified professional.
Noncompete clause. People often think noncompete clauses simply say that the seller won’t compete with the buyer after the sale. The general rule in California is that such bright-line noncompete clauses are invalid. Noncompete clauses are much more likely enforceable if they’re bargained for and include details about what the seller can and cannot do. For instance, they can include issues such as how, where and for how long the seller won’t compete with the business being sold, and whether and to what extent the seller may use all or a portion of the business’ client list.
Dispute resolution provisions. These provisions typically provide that the parties will try to resolve any disputes before resorting to the courthouse and formal legal proceedings. A popular and often effective pre-lawsuit dispute resolution tool is mediation, a nonbinding process that involves a neutral mediator who works with both sides to resolve the dispute. If the parties use a mediator they both respect and trust, mediation can be a successful and inexpensive way to resolve the matter and avoid the courthouse.
Another dispute resolution alternative is arbitration, a more court-like process that is usually binding on the parties. A lot of attorneys believe arbitration isn’t as preferable for a number of reasons, such as the fact that in California arbitrators aren’t duty-bound to follow the law like judges. As a result, some have found that arbitration may result in less predictable outcomes. Nevertheless, some people still prefer arbitration for a number of reasons, such as the potential for quick resolution of a dispute.
There are many other provisions in a purchase agreement to which the buyer and seller need to pay attention. Hire counsel as protection to prevent disputes or problems that could have been avoided with a little planning and discussion beforehand.
Barrett Schaefer, Esq., is a small business and real estate attorney at DeMartini & Walker LLP, a law firm in Marin County. You can reach him at (415) 472-7880.
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