In recording this episode's topic of buying a business, Matt's metaphor, in comparing the process to getting married probably went too far, but it does help guide even the most savvy of business acquirers.
Matchmakers (Brokers) and Finding Your Spouse (Targets)
Business brokers can be excellent tools in finding the right deals and an aid in getting a deal done. Their function can at times be inverse to attorneys, the gatekeepers to a transaction, who tend to be much more conservative and sometimes even obstructionist in their approach. Of course, the answer is a balanced team.
Buyer-brokers are actually not as common in small business acquisitions due to the fact that often these businesses are not publicized openly (like on an MLS) and so the market generally gravitates towards seller representation. It's not to say that buyer-brokers do not exist, in fact there are some really great ones–especially in niche areas. If you intend to use a buyer-broker, be prepared to pay non-commission based fees in addition to commission-based fees. Another tip is that good buyer-brokers are often either exclusively or predominantly representing buyers.
If you go into a transaction without representation, do not fall into a common mistake in forgetting that without a written agreement stating otherwise, it is not the responsibility of the seller's broker to look out for the buyer's interest. This warning seems obvious, but many transactions only include one broker and dual representation just does not give much value to the parties.
Proposal (Letters of Intent)
Letters of intent are non-binding (and sometimes including binding provisions) agreements as to what the parties intend to agree. The purpose behind these simplified documents is to outline in a expedited, efficient manner the business terms for which the parties will agree to the purchase and sale of a business. They are great tools and though some small or quick transactions skip this step, a letter of intent will help make the transaction smooth by addressing the broad strokes early in the negotiation process.
Many letters of intent are non-binding and though there is such thing as a "binding letter of intent" or more often called a "memorandum of understanding" (not to be confused with a "non-binding memorandum of understanding"), most letters of intent will have some binding provisions such as an agreement to negotiate exclusively within a certain period of time or to keep the negotiations and information exchanged confidential. The non-binding provisions often include the actual terms the parties intend to place in the binding, definitive documents such as the purchase price, periods of due diligence, closing conditions, etc.
Because of the casual and expedited nature of letters of intent, many buyers fail to give enough attention to the minutia of what is included (and sometimes what is not included) in the document. Even if non-binding, a term in a letter of intent will be much more difficult to change when the definitive agreements get drafted. If you are reluctant to address a perhaps sensitive business term, you may opt to not address the term altogether until you get the main agreements drafted and hope for deal fatigue to be in your favor when you insert it into the definitive agreements later in the transaction.
Local vs. Destination Wedding (Equity vs. Asset Purchase)
The marriage metaphor is a stretch here, but any business acquisition discussion must address the differences between an equity and asset purchase. To understand the difference, the status of corporations, LLCs, and partnership as separate legal entities must be clear.
In an equity purchase, you are buying the ownership interest in the entity that operates that business. The tax id is staying the same and the legal entity is staying the same. You, as the buyer, are standing in the same shoes as the stockholders (for corporations), members (for LLCs), and partners (for a partnership) are standing. Compare this to an asset purchase where you are only buying the assets that the entity owns (no debts).
In most cases, you are going to opt for an asset purchase. Unlike an equity purchase, you are able to navigate and choose, a la carte, the assets and liabilities you wish to acquire, whereas in an equity purchase, the entity remains the owner of all assets and remains liable for all liabilities. Though even in an equity purchase the seller will typically agree to compensate (indemnify) you in the event that the entity becomes liable for liabilities that accrued prior to closing, but this may not be desirable as the third party creditors are going to go after the business, not the seller, and the seller just sold a revenue source affecting their ability to indemnify.
Another advantage of an asset purchase is that you can amortize the goodwill being purchased and there is no need to deal with (probably) minority owners, whereas an equity purchase requires you to buy the ownership of all owners in order to achieve 100% ownership rights.
Even though most purchases are asset-based, there are plenty of reasons why an equity purchase, despite its apparent drawbacks, is more attractive. Equity purchases are favored where a desirable asset, contract, or even relationship is not freely transferable, i.e. a government issued license or a non-assignable contract (without a change of control provision). Sometimes it may just be because the buyer and/or seller want to make the sale private. It is not guaranteed, but an equity purchase can usually be kept hidden, or at least discreet, from public disclosure.
The Engagement Period (Due Diligence)
There is typically a period between signing a letter of intent and a period between signing definitive agreements and closing where the buyer is given time to asses and back out with little to no consequences. During this period the buyer determines whether the target business is a good fit, the financials are sound, and there are no hidden skeletons.
The due diligence periods are more intense for equity purchases due to the fact that the business needs to understand what kind of hidden liabilities there may be, but understand that even if you do not obtain the liabilities in an asset sale, third party creditors may not see it that way and attempt enforcement against a successor (even if such purchaser has a legal defense). In any case, due diligence is not just what could happen but what has happened in order to understand the potential success and failure of a business.
Accordingly, buyers can be expected to request or be offered a trove of documents to review. A sophisticated buyer will understand the documents and reports to request. Do not expect the seller to volunteer information as sellers typically do not agree an affirmative obligation to disclose anything and everything to the extent, but no one can lie (commit fraud) in their disclosures. This means you have to ask the question if you want the answer. Absent fraud, this ensures an informed decision. There are plenty of due diligence checklists our there when buying, but also remember these processes are specific to the type of business.
Often forgotten in the due diligence process and missing from many lists out online is to conduct a UCC lien search to determine whether a business' assets are encumbered by some third party creditor. These can be a pain to remove last minute so doing a search early and late in the sale is essential.
Marriage Officiant (Escrow)
Many transactions require some sort of earnest money that the buyer may not trust in the hands of the other party to return or there may be some post-closing hold-back of funds that will require a third-party escrow. Though there are plenty of escrow companies that exist to handle real estate transactions, many of those same companies will not or are not experienced to handle a business acquisition.
Accordingly, find an escrow company that is experienced with these sorts of transactions especially if you have some kind of unique post-closing transactions that require longer holds of funds. Some escrow agents do not wish to hold funds for too long.
The Wedding (Closing)
Business closings are definitely not as glamorous then any wedding, but they do range from complexity from the Vegas shotgun wedding to the elaborate hours long ceremonies. These days, closing is a non-event and often done virtually.
Ancillary documents needed post-closing should not be neglected. These include documents such as certified resolutions that provide approval by the parties that the entities are authorizing the sale, consents of third parties of any assignment and assumptions of contracts or liabilities, bills of sale for the assets (if applicable), and other documents that may be needed to provide proof to third parties of the transfer.
Honeymoon (Post-closing transactions)
Buyers and sellers often go their separate ways after closing, but there are many ways to stay in touch if you so desire. A good way for a buyer to cover loss or a business that did not turn out what it was expected to be is some kind of clawback provisions which allows the buyer some immediate recourse upon certain events. For example, if the purchase price is based upon a certain multiple of EBITDA, the buyer could set a certain amount of the purchase price aside to pay after closing based upon the EBITDA of the months leading up to closing or perhaps the parties expect some sort of liabilitiy payment of an uncertain amount they wish to ensure money is left to pay.
Seller-financing is a common post close transaction that keeps you in touch with the buyer. Like any loan, these can vary to the simple monthly payment for X months to lump some payments on a quarterly or annual basis.
Seller-financing is a common post close transaction that keeps you in touch with the buyer. Like any loan, these can vary to the simple monthly payment for X months to lump some payments on a quarterly or annual basis.
NASIR: Welcome to our podcast!
My name is Nasir Pasha.
MATT: And I’m Matt Staub.
We’re two attorneys with Pasha Law – a firm practicing in California, Texas, New York, and Illinois.
NASIR: This is where we cover business in the news and give you our legal twist to that news.
Today, I think we’re going to do a nice walk-through through a process of what I like to call buying a business. I just made that up.
MATT: This is going to offer more than just the business in the box thing that you can purchase which I’ve never actually looked into, but I’ve heard people tell me about it. I don’t know what’s in there, but hopefully we can hope for something more insightful.
NASIR: Yeah, we’re going to expand on that a little bit more and take you on a nice cruise or flight from coast to coast, starting to figuring which business you want to buy to even post-closing transactions. I think, even though it’s going to be pretty technical, it’ll be fun. I don’t know what kind of pop news…
I’ve lost my train of thought, anyway.
MATT: I mean, we can just kind of jump into this.
Like you said, you know, finding a business to buy, I guess it’d probably be helpful if the prospective buyer knew what they wanted to buy. Let’s just assume they are going to.
I think a question that gets asked a lot of times – at least to myself, and I’m sure to you as well – when a potential buyer approaches is us whether they should find a business broker for the transaction because, sometimes, that’s just the starting point or what they think they should do. Honestly, it’s probably something they typed into Google and “business broker” popped up. I think that’s something that, a lot of times, is in the back of their mind that they need. But, as we’ll discuss, it isn’t always the case and doesn’t always make sense.
Frankly, it’s just not as common. There’s a reason for that.
What I think a lot of people are more familiar with is selling a home. Buyer and seller brokers are common. I mean, you have to have both. But, when you’re selling a business – for, I think, obvious reasons – oftentimes, these businesses are not just posted somewhere where, all of a sudden, you have a “for sale” sign outside your door. Obviously, people want to keep those kinds of things confidential. Even if it is semi-public, it’s more kind of shopping around. Only certain people know about it.
Accordingly, all the information is usually held by the seller. In order to tap into certain markets, the seller often uses or utilizes a broker. Just because of that concept – that confidentiality aspect of it – there’s this natural progression of more brokers tend to be representing sellers.
There’s plenty of buyers’ brokers. It’s just kind of a different world for when you’re approaching this. When you’re thinking about a buyers’ broker, you need to consider some other factors.
Let’s say you’re the buyer. I guess, let’s say you’re the seller and buyer, and those parties already know. As the buyer, you find out that the seller has a broker. It doesn’t always mean that you’re at a disadvantage at this point because, a lot of times, a seller might have a broker because it’s a very niche area or maybe their job – sometimes, or a lot of time – is to find the right buyer for this transaction.
It doesn’t need to be the case that you feel like you’re already off – you know, you don’t have the leverage in this situation. On the flip side of that, if it is a broker in a niche area or industry, then they’re probably going to know things that are probably going to be advantageous to the seller.
Whether you get a broker or not, from the buyer’s perspective, it’s just kind of a due diligence thing and knowing as much as about the potential transaction as you can going into it, and the industry as well.
Again, depending on the industry, like you said, it could be a very small group of potential targets. And so, similarly, there’s going to be only a small group of potential brokers in that area. I found this in different areas – that you’ll have brokers that all know each other and it’s kind of a small space. Again, it depends upon the industry.
One thing, most people know this, but just in case, I’ll just put it out there. If you are acquiring a business and that business happens to be represented by a broker, it can sometimes be confusing – sometimes, at the part of the broker’s own doing – as to which party that broker represents.
Now, that broker obviously – just like any other broker – they get paid typically on the transaction itself. Just be weary or just be cognizant that this broker likely represents the seller unless otherwise disclosed to you. Even if there’s dual representation, there are some biases there.
That’s where a buyer’s broker may help, especially if you need representation and it’s something that you don’t have a lot of experience in. Remember, brokers come in all ranges and sizes. Some are literally just connectors – they’ll introduce you and then that’s it and they’ll just expect a commission at the end. Others will negotiate, help you structure the deal and be really involved. Obviously, depending upon the level of service comes the price and the quality of service as well.
MATT: Exactly. I think that the more you know about the business that you’re going to be buying, the less likely you might be to have a broker or to use a broker. The more complex the transaction might be, the more inclined you’re going to be.
There’s a lot of sliding scales on this, but just know that they are out there. Like you said, there’s good and bad. They can provide a wide range of services that they’ll actually offer for you. Obviously, you have to pay them as well. Sometimes, that can be well worth it if they do negotiate on your behalf or have some recommendations that end up being very beneficial for you.
NASIR: You also find that a lot of the buyer brokers are not necessarily contingency-based or commission-based. It may be a combination of that as well as either an hourly fee or retainer.
Just like any broker’s agreement, the brokers are going to push for long-term representation agreements. You’ll probably want to keep that short, depending on the window that you’re looking for target businesses.
Let’s say you found the business, you know what you want, what’s the next step?
MATT: Well, I think you buy it and that’s it, right? Is that how it works?
NASIR: Either you take out your wallet – hopefully you have enough cash; otherwise, you may have to go to the bank which is an extra trip, so it may delay you a little bit.
MATT: Well, it’s probably funnier to us for a different reason because it doesn’t just happen like that. The reason being, a lot of times, there’s a lot of due diligence that has to be gone through or documents provided and all that.
What happens a lot of times is the parties will enter into a letter of intent where they basically jot down, you known, it could be a lot of terms, it could be less and just some material terms, but the understanding between the potential buyer and seller as to what the terms of this transaction are going to be. You get that in place and then you can go through the due diligence and negotiation process from there.
NASIR: Yes, letters of intent are a great tool. It’s not for every transaction, especially very small micro transactions, but if it’s anything significant – and when I say significant, that’s relative to the buyer and the seller for that matter; if this is a big transaction for you and want to make sure you get this right – a letter of intent is a great tool. Typically, if it’s drafted properly, it’s going to be non-binding or there’s going to be non-binding provisions.
The idea is to basically say, “I want to buy your business. Here are the basic terms. Let’s hash out the main details now because I don’t want to spend all this time – whether it’s attorney’s fees or even my broker’s time or my time – if we can’t agree on these basic terms.” You’ll find the obvious stuff in there – the purchase price, the timing of everything.
Most of the provisions will be non-binding but there are sometimes going to be binding provisions in there – some of them that you may actually want. For example, a typical binding provision will be that both parties will engage in exclusive dealing – like, “I’m going to be talking to you, I’m going to be negotiating with you, but I don’t want you to be playing me off some other potential buyer. I want you and I to be discussing to draft these definitive purchase agreements exclusively for the next X number of days – 30 days, 60 days, or what-have-you.” Those can be binding.
There could be other binding provisions like confidentiality and things of that nature as well.
MATT: Again, it all comes down to what the sides are willing to agree to.
But, yes, from the buyer’s perspective, as much of it non-binding as you can – other than the pieces that you want to. That way, you can still walk away from the deal if it’s not what you first thought or not what you were sold on initially.
I think the thing with letters of intent – like you said – they can be a useful tool, for sure. The more you can put on that piece of paper, the better, but just make sure that what’s on that piece of paper is accurately reflecting your understanding or what you want from the transaction because, if it’s something on there – especially if it’s binding, obviously – later on, it’s not what you had agreed to or at least what you thought you agreed to, it can be a problem down the road.
NASIR: Yes, that’s a good point.
I think a lot of people, because it’s non-binding, they take it loosely. The problem with that is that you are kind of ignoring the tool of the LOI itself. I mean, this is a negotiation tool. If you’re able to get your terms in there now, even if it’s non-binding, you’ve created a situation where it’s going to be difficult to take that term back – assuming that it’s favorable to you.
The opposite could be true, too. If you take it too lightly and you have a certain term in there that you’d prefer and then you want to go back, the other party is going to be reluctant and say, “Hey, we already agreed to this. Why are we going backwards here?”
MATT: The nice thing with a letter of intent is that, obviously, you want to try memorialize as much as possible, but if there’s something that the parties can agree to and you just don’t want to be hung up on it and you want to kind of keep the ball rolling here, you can always leave it out altogether or even make some sort of footnote or something – basically even a clause in the actual LOI stating that’s something that the parties will discuss later or agree to later in the actual transaction.
I’ve seen LOIs that are terrible. At the end of the day, it is a contract. I have seen some that basically ended up being the underlying contract.
Again, it’s kind of similar to the broker. You can have a very limited one or you can have a very inclusive one.
NASIR: Yes, and it’s a really good point because I’ve seen where it may say “letter of intent” but, because of how it’s actually drafted, it ends up being binding. Get an attorney that knows what they’re doing. It’s a pretty simple process.
Also, it doesn’t take that long for an attorney to do. From a cost-benefit analysis, I think it’s worth it to get done.
MATT: Sure, I definitely agree with that.
Again, if it’s drafted in the right way, you can walk away from the transaction with pretty minimal expense on that. Or at least that should be the case.
Let’s get into the actual underlying transaction. There’s a couple of options here.
You say you’re going to buy a business. What it comes down to is whether it’s an equity purchase or an asset purchase. There’s obviously a lot of pros and cons to each, and it’s very fact-specific.
But, generally speaking, equity purchase means you’re going to buy everything; asset purchase means you’re buying the assets and the liabilities are not part of this underlying transaction. This is where the due diligence and the full understanding of the financials definitely comes into play, but this is a huge piece because, obviously, if you’re going to do an equity purchase, you want to be 100 percent sure you know what you’re getting into because there’s a lot more risk involved as opposed to just strictly buying the assets of a company.
NASIR: Yes, precisely right.
If you guys understand the different kinds of entities – there’s LLC, corporation, limited partnership – when in an equity purchase, you are buying the ownership interest in that particular entity. In other words, the tax ID, for example, some people will look at it as a tax ID, the tax ID does not change. You are still going to be using that particular tax ID. What does that mean? All the liabilities, all the contracts, the positive and negatives are going to stay within the business – unless you contract otherwise, and you can have indemnification provisions. Again, that’s getting too detailed here.
And so, many would say, “Why would you ever do an equity purchase?” because, in asset, first of all, you can pick and choose which assets you want to buy. You can pick and choose which liabilities or contracts you want to assume. And so, why would you ever do an equity purchase?
I’ll tell you, there’s lots of reasons. It happens all the time. It’s hard to go through every reason, but this is how I kind of explain it and how it covers pretty much everything.
Equity purchases are favored where there’s a desirable asset, contract, or some kind of relationship that’s not fully transferrable. What do I mean by that? As an example, let’s say that the business has a particular governmental-issued license. That license might not be easily transferrable from one entity to another. Or it may not be transferrable at all. In those cases, because that license has value, the only way to get into it is through an equity purchase.
Another example is, for example, let’s say you have a lease or a contract that is very valuable – whether it’s a service contract that’s revenue-making or a contract that’s a particular lease like a space lease in a building that you really want to get into because there’s value in that – and the only way, because that particular other party is not going to sign the lease to you, the only way is for you to actually buy the equity – assuming that there’s no change of control provision restricting the assignment.
MATT: Yes, that’s the thing for a location-based business, especially if it’s a long-term lease and the rent is favorable to the tenant. I mean, the landlord is going to want to try to get out of that. But, yes, again, you do have to look at the actual lease itself to make sure that you’re not triggering any sort of change in control provision and the landlord can get out of it that way. They can be pretty tricky.
Like you said, there are times where it definitely makes sense to do an equity purchase. But, for all the times that it doesn’t, an asset purchase is nice because, as you said, you can buy everything. Or you can pick and choose what you want.
I don’t know how much more we can really say about it because, again, it’s really fact-specific in terms of which option you should choose. Just know that both those options are out there.
One way or another, the debt probably gets discussed.
NASIR: That’s true.
MATT: That’s definitely something to consider.
Obviously, if you do an equity purchase, you’re going to have to deal with it yourself, but it’s still, even if you do an asset purchase, the debt of the seller is still going to be in consideration of everything as a whole.
NASIR: Yes, just because you buy the assets doesn’t mean that whoever are the creditors for that debt for the selling business isn’t going to try to go after you, right? Because they’re going to look at you as a successor in interest and, most of the time, when it’s an asset sale, you’re going to be legally protected and also probably indemnified by the seller, but that doesn’t mean that you’re not going to have to deal with that.
Before we go, one other thing that I forgot to mention on the equity side is another good reason to do it that I’ve seen. If, for some reason, both the buyer and the seller don’t want to disclose to any third parties, they want some privacy that there’s been a change of ownership because, typically, in pretty much every state, if you sell the stock or ownership interest in an entity, you don’t have to publicly file anything to that effect. Now, if you change the officers or directors or managers of the entity, that’s a different issue.
But my point is that it could be a very private transaction whereas, if you buy the assets and you’re operating under a new entity, even if you are using the same name, there’s going to be a paper trail that’s going to be much easier found on the public record for that.
MATT: Sure, that’s another good point.
Well, let’s get to the next phase here. Whether you do equity or asset purchase, you’re going to want to do your due diligence, it’s going to be more important maybe for some sides than others, but this is probably the time where – let me step back a second.
If and when an LOI is signed, this due diligence phase is typically going to be the time where the deal is going to blow up or not end up happening or the buyer is going to walk away because this is when you’re going to be able to really request documents, get a real good look into the detail of how this business is run and what the operations are and every little thing in there that you are requesting and given, I suppose. It could be the case where you don’t always get everything.
But assuming that you ask for everything and you receive it, this is a time where you really have to look into it and get a good idea of whether you still want to go through the deal or not – assuming you can walk away if you wanted to.
NASIR: There’s difference phases of due diligence.
Right after the LOI is signed, there’s kind of this preliminary phase. Again, it depends how the deal is structured. But, even after the purchase agreement is signed, there’s usually a period – again, typically – that is another due diligence period which allows, even if there is some kind of earnest money deposit for the buyer to drop out. As a buyer, that’s a very key point because you want to be able to get into a definitive agreement where you, as a buyer, can unilaterally walk out at any time, but the seller is obligated to sell at the agreed terms no matter what. Whether or not you’re able to negotiate that, whether you need to put up more earnest money, whether some money needs to go hard, et cetera, those are all kind of deal points you can deal with.
MATT: If we’re looking at this from the personal standpoint, I think the LOI is securing the first date. Now, we’re in the phase of due diligence. This is the period of time where you decide whether this relationship is going to work or not. No one’s signed on the dotted line yet, but this is the opportunity to fully vet either side. And so, we’re moving right along in this in the business standpoint.
I don’t know if you like my analogy or not, but I was hoping.
NASIR: I was trying to wait for you to get to when you were going to propose.
MATT: Well, we’re going to get to it.
NASIR: So long as you go down on one knee. That’s all I want.
MATT: We should also mention UCC searches – whether there’s a lead that’s been filed on any of the assets of the company. I guess, if it’s run through an escrow, oftentimes, escrow companies will do this, but this is something that, from the buyer’s perspective, you’re definitely going to want to do just to get an idea.
Honestly, this could be something where the seller might not even know that there is a lien out there.
NASIR: That’s true.
MATT: I guess it’s possible.
NASIR: No, it’s very common because you’ll either lease some equipment and the lessor will put up something. Or you have a loan or what-have-you. Sometimes, if it’s an old business, you will just have UCC liens just out there that should have been removed a long time ago.
The thing is this applies whether or not it’s an asset or equity sale because, if the assets are encumbered and that UCC lien is on there – just to be clear, a UCC lien is just something you file, I just want to simplify it really quick.
If you have a security interest as a creditor on some kind of real property, tangibles, intangibles, et cetera, then you can file – usually on a state level – a UCC lien basically telling the world, “Hey, I have an interest in this particular property – this personal property.” And so, basically, that puts you on notice.
If you don’t do your search, it’s on you. That’s part of it.
I mention this because it’s just often forgotten for some reason. I don’t know how many times this is just like last-minute transaction and they’re like, “Have you done a UCC lien search?” and then, of course, something pops up.
MATT: It’s just something to keep in mind. Even if an escrow company is going to do it for you, still, it doesn’t hurt to double check.
Well, let’s assume that everything goes fine in the due diligence process. At this point, you’re moving in together.
NASIR: Well, I was going to say, I think the proposal point is basically when you sign the definitive agreement. It’s like, “Let’s agree to get married. We’re not getting married yet, but—"
MATT: You know what? I think I’m going to have to agree with that. That’s a good point.
Maybe the UCC search is like, if you find a lien, “You never told me about this hidden secret that you should have told me about.”
MATT: It’s the compatibility test that sometimes couples take. It can be between the proposal and the marriage or the wedding date. I think you’re right.
NASIR: It depends. Everyone’s relationships are different, but this seems to be more traditional.
NASIR: I don’t know where the escrow comes in. Maybe you can think of one.
Escrows are – believe it or not – not as common for business transactions or acquisitions. The main reason is because, sometimes, if there’s earnest money, it’s usually just a small amount, and that can be held in an attorney-client trust. I’ve seen it. Sometimes, you just give it to the seller. It’s just like you’re basically committing to it that, most likely, we’re going to go through this transaction, but escrow companies do exist.
The problem is – and this is just my personal experience, and maybe I just have a bad experience – it’s hard to find an escrow company that has a lot of experience with business transactions. They’re definitely out there, but you really have you search around to find some good ones, and it’s hard to keep using the same ones as well because some escrow companies are better for certain types of transactions as well. Some of them aren’t willing to hold money for a while without extra fees. And so, there’s a lot of options out there.
Maybe other people have different experience, but that’s my experience.
MATT: I think you’re right.
In the niche areas or things that aren’t common – you know, it’s just not a standard normal sale – I think that’s the time when you’ll definitely see it – like the transfer of a liquor license, for example, or any sort of license like that.
NASIR: Yes, they even have domain escrows, right?
MATT: Yes, true.
NASIR: If you’re buying a domain – which can be part of buying a business – you use an escrow company because, obviously, once it’s transferred, especially if it’s someone you haven’t met and it’s transferred, it’s hard to get back.
MATT: Well, I’m going to leave the analogy to you. You’ll figure this out because we’re at the closing stage of the transaction.
NASIR: Closing now? That’s the wedding day.
Maybe escrow is like the wedding planner? I like the wedding planner.
MATT: That could work.
NASIR: There’s one more thing on the escrow. We’ll kind of hit this on the post-closing transaction section as well.
If you have any kind of holdback, where this comes into play is that, okay, you buy a business and sometimes there are some known liabilities or unknown liabilities or there is some expectation that the value of the business is based upon certain performance post-closing – these kinds of things, right? Based upon what happens after closing may change how much money is owed to the other party or vice versa.
Sometimes, it’s useful to have a holdback where part of the purchase price is put into escrow. Depending upon what happens again after closing, the escrow company distributes the company accordingly. Again, this could be based upon certain IBDA or target. Or maybe in order to see certain liabilities. For example, in healthcare, a lot of times after closing, there might be some callbacks from healthcare pairs or the government, some kind of recoupment, for example, and you need to put money aside just for that because it’s an understanding and expectation of the business. After that’s known, you distribute the funds. And so, having a good escrow company for that is very essential. That’s the wedding planner. That’s their job.
MATT: Every due diligence has been done. Both parties still want to move forward with it. Now, we’re at the date where everything gets signed off on the dotted line and the transfers begin to occur. As a buyer, you’re now buying this business – whether it be all of it or a part of it.
This is my personal take. I view this kind of anticlimactic as, once you get to closing, well, everything’s already done.
NASIR: It can be.
MATT: Now, we’re just formalizing it. Everyone’s waiting for this day. Even when you buy a home, right? It’s kind of a similar thing. “Well, now, technically, I own it.” All the exciting stuff or the stuff that could have blown up has already happened. Now, I’m just getting what I wanted.
Hopefully, it’s not the case of driving the new car off the lot. You’re like, “Well, now I don’t even really want this anymore.”
NASIR: The one thing I want to mention about closing is that, a lot of times, I feel as though the parties – again, this is from our angle as attorneys – like you said, they just are over there. By this time, especially in a big transaction, everyone’s been in it for a while. They’re just ready to get it done at this point. They have deal fatigue. And so, they just want to sign and get out.
The only caveat to that is, if you want to have a Vegas wedding, you can do that. You can close. Have a nice wedding day and close it up really quick. But the right way to do it is to make sure you have all the closing documents prepared. These closing documents are extremely important – maybe not for that day, but for the day after in the sense that the closing documents are just not the purchase agreement. There are other documents in there.
For example, you’ll usually have a certified resolution that basically says that either party is authorized in the sale. This is very important when you have multiple owners of the company. Another one is a bill of sale, especially in an asset purchase. You need to be able to prove to a third party that you actually own the assets in some cases. You’re not going to show them the purchase agreement. You’re going to show them the bill of sale.
Another big one is any consents for assignment. I’m going to mention space leases because that’s one of the most common things when you buy a business that – again, whether it’s an asset purchase or an equity purchase – most often you need the consent of the landlord. That’s usually a contingency upon the sale.
At closing, you need to make sure that you actually have the consent signed by the landlord and that assignment of the contract so that, again, you can show a third party – whether it’s the landlord or a future landlord – that I am the rightful lessee of the space.
MATT: That’s a good point.
Usually, these agreements for the purchase agreement, there’s some sort of further assurances clause that the parties are going to execute, all documents or take all actions as required under the agreement, but it’s always good to have everything in place ready to go before closing so you don’t have to have to—
NASIR: Yes, and the reality is this happens all the time. You have to go back to the other party and, depending upon how smooth that transaction went, that may not be as easy as you think to get. The sellers may have already gone and retired to – what’s a good place to retire these days? Costa Rica, maybe? Anyway, yeah, they might be there by now.
MATT: All right. Closing.
You’re done, right? I mean, that’s everything. There’s nothing else to have to worry about at this point. Or is there?
NASIR: Are we still talking about marriage? I’m just joking. Very bad joke. I hope my wife does not hear that because I was just joking.
MATT: I’ve already texted her.
NASIR: Oh, darn it.
For the most part, for buying a business, closing is the end of it. But, as a buyer, this is definitely the case. If you’re dealing with seller financing, sometimes, whether it’s a promissory note where you’re paying over time or, like I said, those callbacks, and this is probably more sensitive for a seller, but you kind of are in wait to see and make sure that there’s nothing crazy that happens in the sense that everything that the seller told us was incorrect or fraudulent and somehow the business is not what it’s supposed to be.
The hope is that everything goes well but, generally, after closing it’s over.
MATT: That’s right.
Like you said, if there’s some sort of promissory note or anything to that degree and there’s personal guarantees attached, obviously, the relationship is not over at that point. You’re still going to have communication between the parties. But, if it’s a pretty clean deal and everything is squared away at closing, yeah, you should be pretty much done. There might be small things here or there, but for the most part that’s it and then you get on to actually running the business at that point.
NASIR: You’re going to your honeymoon, basically.
NASIR: I think we hit the analogy, right?
MATT: Yeah, with some help.
NASIR: I don’t know if we took it too far, but—
MATT: No, I think we’re okay.
Funny enough, I was just going to pause and ask to see if anyone has any questions. Of course, I very quickly realized that’s not a good idea to ask. But, if you do have any questions, feel free to send it over or comment on our blog post.
MATT: Yeah, we took a little bit of time off, so we’re a little bit rusty, but hopefully we can jump right back into this and it was beneficial for the listener.
Well, anyway, I do appreciate everyone joining us.
MATT: Yeah, keep it sound and keep it smart.