How To Buy A Business: The Legal Side
Buying or selling a business is a big event in your life. The legal process of how to buy a business includes a lot of documentation, and mistakes can cost you upwards of $25,000 in escrow alone if the deal goes south. It can be extremely stressful to tackle alone. In this article I will give you an overview of the process and an idea of what to look out for so you feel more comfortable.
I. The purchase contract
This is the most important document in the entire transaction. The purchase contract sets the most important terms of the transaction including price, escrow agent, escrow payment, termination, and breach of contract. Some terms, like price, are obvious and easy to understand. Some terms are surprisingly negotiable, like who the escrow agent is or how much you will have to put into escrow. Some terms are absolutely critical and you may not even know about them. For example, did you know that you cannot receive attorney’s fees for a breach of contract claim unless expressly stated in the contract? I’ve even seen some contracts try to give the right of attorney’s fees only to one side (obviously the drafter of the contract). If you choose not to hire a mergers and acquisitions or transactional attorney, you need to make sure to read these terms carefully and do a lot of research.
Another area of serious concern is the escrow terms. The buyer of the business will almost certainly be required to make a down payment into an escrow account. Both the buyer and seller typically recommend their own escrow agent so they won’t get screwed if the other party breaches the contract and disappears. Whether one party compromises or they both agree to use a neutral third party, an escrow agreement needs to be executed. This requires the escrow agent to disperse the funds according to the contract, including special provisions for when a party breaches the purchase contract.
The escrow payment itself is where the concern comes into play. Who gets the escrow funds if a party breaches the contract? What constitutes a breach of contract that entitles a party to the escrow funds? If you are a buyer, you want to make sure that variables outside of your control do not make you liable to lose the escrow payment. These include failure to acquire lending, unsatisfactory lending terms, and finding new information during due diligence that makes you want to exit the contract. If you are a seller, you want to receive the escrow payment for as many variables as possible because you are losing out on the chance to sell to someone else by committing to the buyer.
Much like buying a house, lending is the longest and most frustrating portion of buying and selling a business. The lending requirements are vast and often unnecessary. God bless you if you can avoid this and pay in cash. This is a coordinated effort from the buyer and the seller, as the lender will require many documents from both sides. Since you have already signed the purchase contract, you are typically acting as one team at this point, openly working together with the lender and sharing documentation. Much of the requests are for tax history, financial history, legal statements about the business, and purchaser assets / collateral.
IV. Transfer documents
After signing the purchase contract and during the period of meeting lending requirements you will have to draft several documents to actually transfer the business assets. Business accounts are held by financial institutions. Physical assets, such as equipment and property, have both titles and creditors / mortgage holders. The title needs to be transferred and the lending account needs to be assigned to the buyer. This must occur for every business asset and can quickly become a full-time job. If you are financing the acquisition the lender will also require you to amend the title of every piece of collateral being used to note the lien. This includes both the business assets mentioned above and your personal collateral.
Leases and franchises add further transfer documentation to your acquisition. Since you will likely be entering commercial property you don’t own, you will need to either assign the existing lease from the seller to the buyer or you will need to coordinate the landlord to release the seller and enter a new lease with the buyer. When the business being purchased is a franchise, the process is the same: you must either assign the franchise agreement and its term to the buyer or have the franchisor release the seller from the franchise and enter a new franchise agreement with the buyer.
When considering how to buy a business, this is the day everyone thinks about. Again, similar to buying real estate, closing is the day of signing all transfer documents, lending documents, liens, and transferring payment. The legal aspects of this stage consist of filing the transfer documents and liens. All of these documents will be filed with a government office to effect the transfer and also perfect the security interests in the liens. Once signatures are executed the physical possession of business assets is given to the buyer and the transaction is complete.
How to buy a business the most efficient way:
Be competitive before signing the purchase agreement, then be a team player
Even if you already know how to buy a business, there is no valid reason why you would do this entire transaction without an attorney, so hire one up front. You can have your attorney do the initial introductions and negotiations to present yourself more seriously, or you can keep your attorney out of it and come across more collaborative, whatever suits your negotiation strategy. However, once a draft purchase agreement is circulated you need to have your attorney review it with a fine-tooth comb and have a meeting to discuss potential revisions. There will likely be several back-and-forth revisions done until an agreeable document is finally signed. Before signing, you will implement negotiation tactics including arguing about price, requiring documentation to show finances, and keeping as much information close to the vest as possible.
Once the purchase agreement is signed, you need to switch gears and be much more open with information. Your terms with the seller will be locked in and working together makes the next steps easier and more efficient.
Use online file sharing
Each party needs to share an immense amount of documentation when buying a business. Many documents will need to be submitted multiple times, especially with the lender. Exchanging files by email or messaging is miserable because emails can only hold a handful of documents at a time and organizing a shotgun of documents is tedious. Instead, share a Dropbox or Google Drive folder and upload each party’s documents in well-organized folders. This is by far the fastest and most convenient method of sharing documents.
Organize document requirements by source of information
Information that will complete many of the documents above will come from different sources. For example, the lease assignments will be done in coordination with the landlord, an existing contact of the seller. Personal collateral will be noted with current lien holders, which are existing contacts of the buyer. The attorneys should be drafting documents, sending them to the parties to fill in information, and then reviewing the documents as they come back. The parties should be communicating with their contacts to finalize the required documentation. It is possible but inefficient for the buyer to get in touch with the landlord and work on the leasing requirements. Furthermore, lenders require some business financial forecasting. This is done through analysis of the business’ financial records and, while possible for the buyer to do, is much easier for the seller to complete.
How To Buy A Business: Conclusion
Buying a business is an exciting time and a cumbersome process. Having a transactions attorney during this process is absolutely essential for a smooth and secure purchase. Hopefully this guide on how to buy a business has improved your comfort level with the process. If you are looking for a transactions attorney to work with on your business purchase, please contact me today. Let me worry about the documents and you enjoy the excitement.
I went to law school at Capital University in downtown Columbus. There, I became the first person in school history to graduate the program (a 3-year program) in just 2 years while on the Dean’s list. I started my firm straight out of law school after marrying my beautiful wife and passing the bar exam. Now, I represent businesses in litigation, draft transactional documents, provide legal advise to business owners, and represent them in transactional negotiations.