Sales of small businesses are still quite active even during a recession. Despite the recent slow-down in M&A activity by public companies looking to use equity as currency due to the current “bear market” in equity prices, strategic and financial buyers looking to acquire small businesses (sub $10 million) for cash in an effort to fill in gaps in a product roadmap or consolidate businesses in a given market may see this period as an opportunity to pick up some desired assets and customers at better values.
If you have a small business that may be for sale, consult with legal counsel before you sign anything and before you give the potential buyer access to any of your company information. Unfortunately, when approached by a buyer, the first reaction of a prospective seller in this market is often to refrain from hiring M&A counsel given the size of the deal and rather to try and save money by relying on the advice of friends or by going it alone. Or, worse, a prospective seller often relies on buyers’ counsel for guidance on getting the deal done. To coin an old phrase, this may be penny wise but pound foolish. Buyer’s counsel represents the buyer. Buyer’s counsel’s job is to get the buyer the best and least risky deal they can negotiate. Your lawyer’s job is to eliminate post-closing risk for you, the seller, and to help you negotiate the terms to support the best business and tax deal for you. This starts with the term sheet and continues through every schedule attached to the definitive agreement.
Even a two or three page term sheet or letter of intent can be critical to the long term ‘success’ of a deal from a seller’s standpoint. What small company sellers often times do not understand at the term sheet stage is that strategic and financial buyers will most often use for a small company transaction the same counsel, whether outside or inside (in the case of large buyers), that they would use to document much larger transactions. If you don’t have an attorney working to eliminate issues at the term sheet stage, it will be harder when the buyer’s counsel hands you an actual agreement. Sellers should expect to receive very lengthy and detailed stock or asset purchase agreements and related documents with all the bells and whistles that would benefit greatly from the experience and expertise of seller counsel. It is not unusual to see a 60-page agreement for a company selling for a few million dollars. Usually the longer the agreement, the more it protects the buyer – not the seller.
A good M&A attorney representing the seller will help, in an asset purchase, identifying and agreeing upon the assets being transferred and the pre-closing liabilities being assumed by the buyer. Further, as asset purchase agreements typically provide for all of sellers’ employees to be terminated at close and for all or some of those employees to be rehired by the buyer, the seller needs to understand the costs associated with terminating all of its employees and take that into account in negotiating the purchase price. Ideally, the buyer would cover all such termination costs or, at least, the costs of terminating the employees that the buyer expects to re-hire at the close.
Whether the acquisition transaction is structured as an asset or stock purchase, a seller should expect the buyer to propose that a portion of the purchase consideration be in the form of an “earn-out” or other contingent payments. Here the advice of outside counsel is invaluable. Counsel for the seller can help structure an earn-out or other contingent payment structure that uses metrics that make sense given the business being sold, that are clearly measurable, that are not entirely in the control of the buyer and that can be readily documented and demonstrated after the fact. And, since earn-outs many times are the subject of disputes between buyers and seller, counsel for the seller can help structure an efficient dispute resolution mechanism short of litigation that does not unduly burden a party desiring to exercise its rights under the contract while being onerous enough that each party is encouraged to work together in good faith and compromise in resolving disputes.
Reps and Warranties:
Small company sellers should also expect an acquisition document replete with representations and warranties addressing all issues and matters imaginable. Given the negotiating dynamics between a strategic or financial buyer and a small company, the ability of the seller to have changes made to the representations and warranties is limited. Here the value of counsel is in reviewing and advising the seller as to the meanings and impacts of the representations and warranties and, more importantly, to engage with the seller in a due diligence process with the goal of preparing a fulsome disclosure schedule apprising the buyer of as many of seller’s exceptions to the representations and warranties as possible.
Counsel can also be helpful in seeing that the terms of the acquisition document do not make the seller an insurance policy for all losses that the buyer may incur after the close. Here, ensuring that the seller’s disclosure schedule is as complete as reasonably possible goes a long way in limiting the seller’s potential liability for any such losses. Further, seller’s counsel can ensure that the acquisition document contains customary and appropriate language waiving each party’s liability for lost profits and consequential damages and limiting each party’s aggregate potential liability to the other for losses arising from a breach of the acquisition agreement. Absent these protections, a seller may face potential liability far in excess of the consideration received in the acquisition.
A small company seller can also expect the acquisition agreement to provide for a non-compete. Non-competes are generally enforceable under California law when entered into in connection with the sale of a business. Counsel to seller can help structure a non-compete of a customary and reasonable scope and duration. A seller continuing on with a buyer as an employee needs to be wary of entering into an employment agreement governed by the laws of a State not California. The governing law of the employment agreement may contain enforceable post-employment non-competes (in some instances, without the payment of any additional consideration) that may have the effect of broadening the scope and duration of the non-compete in the acquisition document.
And finally, the advice of counsel is helpful to a seller in advising on a choice of law and jurisdiction provisions that do not make taking a matter to court completely untenable. For an out of state buyer, the desire is invariably to have the document(s) governed by the laws of the jurisdiction of the buyer’s organization or residence, if not the same, and to have disputes adjudged by the federal and state courts in that jurisdiction. The value of counsel is in helping the seller understand whether the buyer’s choice makes sense for the seller or whether a neutral jurisdiction would be more advisable.
The foregoing is not legal advice but a high-level overview of just some of the material issues faced by small company sellers in selling their businesses, that should be considered carefully before making the decision to go it alone without counsel. You worked hard to build your business. You want to make sure that when you sell it the earnings are yours to keep and not subject to surprise liabilities, taxes or lawsuits later.
All blogs on this site are for educational purposes only, do not constitute legal advice or opinion, and should not be applied to your situation, or any specific situation, without consultation with counsel. Strategy Law, LLP does not provide any legal advice concerning any matter discussed in a blog except upon formal engagement including, without limitation, execution of Strategy Law, LLP’s formal legal services agreement, and with respect to specific factual situations. No blog constitutes a guaranty, warranty, or prediction regarding the result of any legal matter discussed in the blog or any representation.