Tying it all together- Closing the deal

​At the end of the day, all your efforts to negotiate a good deal, to investigate the business, and put together the financing will be an academic exercise if the deal doesn't close.

While the broker usually represents the seller, a business broker can be a great resource when it comes to getting things to the finish line, in part because that's the only way they get paid. It is not uncommon for issues to arise at the last minute: inventory that the buyer thinks is stale, last minute financial information that may affect the price, or simply cold feet. The seller's broker and the buyer's team can help by staying on top of issues as they arise, communicating to the whole group, and clearly identifying in advance what the make-or-break issues are.

The buyer and seller will each have documents to sign, which may include a bill of sale, stock transfers, non-compete and consulting agreements, and for the buyer perhaps some loan documents. The parties do not all need to attend a signing together, in fact it is usually easiest not to do so. Often a spouse will need to sign something as well, and a notary may be needed. If an escrow has been established, the escrow officer may facilitate the signing, or the buyer's lender may want to control the signing.

The actual transfer of keys, access to premises, books and operations must be scheduled, and a final inventory count may be necessary. If no escrow has been used, the buyer and seller will need to have agreed on how and when funds will actually be transferred.

The seller's broker and the buyer's attorney can and should work out these logistics in advance, allowing the buyer to pivot their focus to commencement of operations and control of the business.

Due Diligence

While it is challenging to make a comprehensive list of items that a prospective buyer should investigate, what follows is a list of general categories and a few helpful hints. It bears repeating - this is why the buyer should engage their own team of experts.  No one person can have the expertise or the time to cover all the bases that should be covered.

It helps to start with a high level perspective, and then to focus in on areas that pose the greatest risk of future economic impact, whether in the form of lost sales or penalties and legal costs.

The Consumer Finance Protection Bureau (CFPB), established by Dodd-Frank,[1] has announced its 2016 Rulemaking Agenda. The CFPB is a multi-faceted entity, having been given rule-making, supervisory, reporting, and enforcement authority that has so far appeared to be broad in scope.

You can get the full text of the 2016 agenda here. In brief, here are the primary areas of interest:

• Arbitration clauses in consumer finance products (see proposed Rule)
• Payday, auto title, and similar lending products – see the article posted by CFPBMonitor.com for more detail on this
• Prepaid accounts- final rule expected this summer
• Mortgage servicing- final rule expected this summer
• Know Before You Owe mortgage disclosures- TILA and RESPA clarification for lenders and service providers

Other items on the list:

• Overdraft services on checking accounts
• Debt collection practices that would be considered unfair, deceptive, abusive, or otherwise unlawful
• Nonbank supervisory authority over larger participants in certain consumer financial products/services markets, with a particular focus on lenders offering auto title and similar consumer installment loans
• Reporting by financial institutions regarding applications for credit by women-owned, minority-owned, and small businesses
• Implementation of other mortgage rules

​The Bureau also referred to its longer term rule-making agenda, which was last updated in the fall of 2015, and includes an ongoing inquiry regarding credit reporting and its impact on the availability of credit, access to checking accounts, employment, and housing. Student loan servicers are also under the Bureau’s microscope, as it continues to monitor practices and evaluate potential rules.

[1] Dodd-Frank Wall Street Reform and Consumer Protection Act

Peeling the Onion

The process of disclosure by a seller is similar to peeling an onion. In order to pique buyer interest, some disclosure of a general nature is common, often in the form of a broker’s presentation or memorandum.  The buyer will have signed a nondisclosure agreement and in exchange be given some high level financial and business information. 

At this point an instrument known variously as a letter of interest, term sheet, expression of interest or something similar may be drafted by the buyer and presented for the seller’s consideration.  They are usually nonbinding in terms of any commitment to buy or to sell, but the benefit is that they lay out the terms broadly, and the buyer will often have also gotten a stand-still arrangement wherein the seller ceases to market the business or entertain other offers.  This is because the time involved, and the cost to the buyer of using their team of experts to assist them, is an investment that the buyer doesn’t want to see go up in smoke because the seller was still out looking for interested parties.  Think of it as a pre-engagement ring- the couple has agreed that they want to get engaged but they are not actually yet engaged.

The Purchase Agreement- Inking the Deal

Handshake deals are a wonderful concept. However, given the risks involved in today’s world, especially that the person with whom  you have an agreement may not be the one you end up dealing with later, they are simply not tenable in most circumstances. This is especially true for something as complex as buying someone’s business, even a very small one.  While acquiring a going concern is often a very good solution for someone, there are several ways this can go very wrong.  A comprehensive, well-written purchase agreement need not be a treatise, but it should encompass several things.

The Dealer Holds the Pot
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Other decisions that should be made fairly early in the negotiations include whether bulk sale laws are applicable, and whether an escrow agent will be used. Often these two considerations are commingled, and some confusion may result.

In general in California, bulk sale compliance is required for businesses whose principal business is the sale of inventory from stock, including manufacturers; restaurants; and certain auctions, or series of sales. One way to think about this is to consider whether it is possible that someone else is owed money that was used for the purchase of the goods, or inventory, being sold by the business. The bulk sale laws protect such creditors by requiring notice of the impending sale of either a majority of the assets or the entity itself.

Contrary to common understanding, there is no statutory requirement for an escrow with an asset sale, even if the transaction falls under the bulk sale transaction. 

Taking a sham guarantee doesn't invalidate the loan or the core collateral, it just means you won't be able to pursue the guarantor personally to collect a deficiency on a real estate secured loan following foreclosure.
 
As defined by the courts, a sham guarantee is one that is unenforceable because it was structured for the purpose of circumventing California's single action and anti-deficiency rules. 
 
These laws were developed years ago as a result of lenders who took advantage of unsophisticated buyer/borrowers.  A practice had developed in some arenas to inflate the value of the property in a sale, lend against that value and then when borrowers could not pay, and the property didn't satisfy the loan, the borrowers would be faced with a huge deficiency judgment.  Lenders were also filing multiple legal actions against these borrowers, who lacked legal resources and knowledge to combat them. The single action rule applied to real property loans means that the lender gets one bite at the legal apple in pursuing collection. The anti-deficiency component, when applicable, prevents the lender from pursuing the borrower for collection of any loan losses not covered when the lender forecloses and sells the collateral.

Structure of the transaction

[For the next several posts, we are going to focus on the steps involved in purchasing a business, rather than starting one. Later we'll return to the topic of startups.]

One of the first considerations in negotiating for the purchase of a business is how the transaction will be structured, whether as an asset sale or a stock sale.  Typically a seller will prefer a stock sale, and a buyer will desire an asset sale. For the seller, a stock sale allows for potential capital gains tax savings. Conversely, in a stock sale a buyer will not be able to capture a step-up in basis for the depreciable assets that are part of the transaction, and will therefore lose out on the benefit of depreciation expense write-offs thereafter. (see http://www.smallbiztaxadvisor.com/federal/top10.lasso)

Buyers also usually prefer asset sales because it is more feasible to limit their liability for the seller’s prior acts or omissions.  Not that an asset sale is bulletproof in this regard- failure to comply with applicable laws, conduct due diligence and incorporate strong indemnification and other clauses in the sale contract may leave a buyer exposed to seller-created liability in spite of its structure as an asset sale. However, in a stock sale, the buyer typically gets the whole frog, warts and all. In an asset purchase, the buyer can carefully exclude any or all liabilities and build in protections in the event of a future claim- in the case of the frog, the buyer can select only the legs, and not the rest.