December 1, 2009
Short of starting one’s own business, the method to own and operate a business is through the acquisition of an existing enterprise. Particular issues should be considered in this acquisition process such as due diligence, letters of intent, confidentiality agreements, non competition arrangements, availability of seller financing, and stock versus asset acquisition. The purchase and sale agreement culminates resolution of these issues in a thorough manner, but contemplates a closing at which time title and the purchase price are exchanged, often not without last minute glitches.
Any business acquisition should necessarily include a detailed review of the business= history, its legal structure, assets and liabilities, collections, leases, retirement plans, labor contracts and other financial commitments. The principal purpose of the investigation is to determine whether or not the acquisition should be finalized. An estimation of all aspects of future business operations should be made, such as review of the seller=s reliance upon particular customers or suppliers, seller=s vulnerability to cost increases of materials, the likelihood of new competition, and whether new products may make the existing products technologically obsolete.
Letters of Intent
A letter of intent provides a format for the proposed acquisition from which the definitive agreement can be drafted, usually after the price, financing contingencies, timing and other important terms have been agreed upon. However, the letter of intent should provide flexibility since the exact structure of the transaction – asset or stock purchase and whether the purchasing entity will be a new corporation or existing company – may need to be finalized. Often these letters of intent are expressly non-binding or are constructively non-binding since they contain so many contingencies. Nevertheless, such documents should be used to establish a firm commitment upon which due diligence and the final details can be developed.
Confidentiality and Non-Competition Agreements
Proprietary information such as customer accounts, financial information, and trade secrets must necessarily be reviewed by the prospective purchaser in order to finalize the sale. Such proprietary information should and can be protected by having a prospective purchaser sign a confidentiality agreement which acknowledges the existence and disclosure of such information
and excludes such party, and its agents and officers, and directors, from using or disclosing same to any person. The confidentiality agreement usually provides a remedy for a violation in the nature of obtaining a court order barring such illegal use and provides for monetary damages, inclusive of attorney fees, in enforcing this provision. Finally, such confidentiality agreement contains a provision that the prospective purchaser, his agents, officers, and directors shall not compete against the seller based upon the disclosed confidential information.
ost sales of closely held companies today contain some element of seller financing, whereby the seller agrees to accept a deposit at closing and the balance of the purchase price over time. The purchaser encourages such financing arrangement since no other financing may be available, the terms will be favorable, and if the business does not succeed, the purchaser may attempt to void the outstanding balance due to alleged seller misrepresentations. The seller, of course, would prefer to receive all the purchase price at closing. Seller financing may at least provide a decent return on the seller=s money and a steady cash flow for a number of years.
However, seller financing is definitely risky for the seller since a default by the purchaser might leave the seller without his company, little extra funds, and a large legal battle. These risks can be minimized by proper legal documentation of the promissory note, which should be secured by all assets of the business, and guaranteed by the purchaser, individually. Such documents should also provide that all costs of collection, including legal expenses, should be paid by the purchaser in the event legal action is commenced. Buyer=s and the guarantor=s credit history should be closely checked to predict repayment prospects.
Stock v. Asset Acquisition
A buyer may either purchase the assets of a seller or the stock of the seller=s corporation to effectuate an acquisition. An asset purchase provides greater security to the buyer that no undisclosed or contingent liabilities will be transferred. In a stock sale, all undisclosed or contingent liabilities remain with the corporation. Examples of such exposure are unfunded pension plans, delayed hazardous waste leakage, undisclosed guaranties, or personal injury claims occurring prior to the acquisition.
But some circumstances dictate a stock sale for either business or tax reasons. For example, one business reason for a stock sale is when a seller has been licensed to sell a certain product or to sell franchises. Such seller probably would not be able to transfer the governmental approval in an asset transfer, but would be able to transfer the same in a stock sale. A tax reason for a stock sale would be if the selling company has net operating losses which the buyer can use to offset future taxable income.
The buyer should seek protection in the stock acquisition context by insisting upon seller indemnification of undisclosed or contingent liabilities well after the closing, or by escrowing funds to offset any unexpected liability.
The purchase agreement should establish a firm commitment from the parties, evidenced by a sizable deposit, and should limit the contingencies upon which the transaction may be terminated. The buyer should seek to maximize the representations the seller makes concerning profitability, sales volume, outstanding liabilities, threatened or pending litigation, and sales backlog. These seller representatives should be renewed as of the closing and should, if possible, survive the closing date. Covenants not to compete by the seller and principals should be obtained to prevent immediate and direct competition. Finally, notice to creditors should be made or a substitute provided for in the event of an asset sale to prevent future claims by creditors of fraudulent conveyances.
Business acquisitions present exciting opportunities to grow and reinvigorate existing businesses. But prudence in the form of due diligence, confidentiality and non-competition agreements, along with carefully drafted and structured legal documents, should be used to ensure that the business acquisition will be long lived and profitable.
The Greater Boston attorneys at Goldman & Pease, located in Needham, concentrate in business law, real estate law, condo law, civil litigation, and estate planning and serve the greater Boston metro region including Alston, Arlington, Belmont, Brighton, Brookline, Cambridge, Canton, Dedham, Dover, Milton, Natick, Needham, Newton, Norwood, Waltham, Watertown, Wayland, Wellesley, Weston, West Roxbury, Westwood, and all of Massachusetts.