Business
Acquisitions
By Howard S.
Goldman, Esq.
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.
Due Diligence
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.
Seller Financing
Most 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.
Purchase Agreements
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.
Summary
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.
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