Navigating Business Sales

Why it matters. Business sales require careful attention to three critical areas beyond standard due diligence: consulting/employment continuation clauses to transfer knowledge, noncompete agreements to protect the buyer's investment, and dispute resolution terms that limit conflicts before they escalate into costly litigation. 

The sale of any business is a time where risk and legal issues can combine to overwhelm the expected excitement. This is not unusual because while both sides to a sale want a positive outcome, the balancing of interests and protections that both parties need can conflict. So, whether you are the seller or buyer, what are some deal terms to watch for. 

Understanding the foundation 

To weigh sale terms we must start with a fundamental understanding of why businesses exist. Whatever legal form they take, business entities allow individual people to make and market skills and services. Most business formalities operate to protect those individuals from personal liability and responsibility. So when a business is sold, not only must those protections be preserved, but the very nature of trying to move the skills and services to another person must be managed. 

Getting the basics right 

Managing that transition often begins by ensuring the business itself is properly formed and operating, and securing those representations in the sale agreement. Obvious categories like insurance and tax compliance are self-evident. Yet, while it can seem a mundane start to an exciting transaction, many small businesses have gaps in their formation and operational documentation that can cause real headaches at the time of a sale. 

A frequent example is found in required yearly meetings, minutes and reporting, which some small businesses may forego. Observing and recording corporate formalities is important to show that the business is being treated as a separate entity that protects the owners. Where company formalities are not observed it can legally complicate separating the owner from the business in a way that protects the purchaser and allows the seller to obtain proper value. 

Balancing owner interests and value 

Because the goal of separation and transfer of ownership interests is a critical part of any sale, so too is balancing the different types of owners in any company. This is because the definition of proper value can vary greatly between different types of owners, and each owner’s respective interests and entitlement to sale proceeds must be properly documented in a transaction. 

For example, owners can be active or passive in their role with the company, with each feeling their role is worth more or less than the other. Or where ownership interests are split between founders and legacy, questions of value can be intertwined with years of effort and difficulty that are not shared across all owners. Sellers should be prepared to address these items before the market forces in a sale transaction impose extra stress. 

Purchasers also have an interest in balancing prior owner interests. With a goal of any business sale being to secure knowledge, where that crucial asset is split amongst owners, or where the controlling owner lacks the critical skills that have the most real world value for a company, a purchaser can find the overall target devalued. 

Securing protected value is the crucial motivator for both sides in any business sale, and also where conflict tends to exist. That is a reason purchase and sale agreements can be long and legally complex. Apart from quality due diligence to ensure proper formation and operation, and standard protections for representations and indemnity clauses, there are at least three areas to consider as terms that help manage the operational and ownership protections for purchasers and sellers. 

Three critical deal terms to consider 

Consulting and employment continuation. To maximize the transfer of knowledge and relationship-capital, many sale agreements include consulting or continued employment term clauses. Typically these require active owners and other critical employees to continue their service for the company post-close of the sale. This can be for a period of time or until set business metrics are met.  These roles are usually compensated and can create conflicts as they are sometimes viewed as simply an unwanted increase of the overall purchase price. Moreover, where active owners are unwilling or unable to continue their service, devaluation of the transaction can occur. Careful consideration and express negotiation of these terms can help ensure positive further service, while also setting necessary limits to ensure new ownership can drive the company as it intends. 

Noncompete agreements. Protection vs. restriction. Where a consultancy terminates, or former owners are no longer involved, new ownership will also often want a noncompete clause that prevents the prior ownership from starting or joining a rival business. In situations with multiple owners, the passive level may have no concerns with this idea, while active selling owners may not want to bind themselves to such terms. And while most buyers consider a noncompete agreement simply a part of the purchase price, attention to these terms and their scope must be made to avoid running afoul of policy justifications that prohibit market-manipulation, and risk voiding the clause in its entirety. 

Dispute resolution. Planning for the unexpected. Because conflicts can become disputes even with thoughtful preparation and documentation, agreement terms that govern how disputes are resolved can help limit both their duration and scope. Required mediation or arbitration, as opposed to trial, are commonly known terms that can avoid court proceedings. Lesser used, but sometime more impactful, controls can include agreements to limit recoveries to a portion of the sale proceeds held in escrow for defined periods of time. Or, clauses that require attorney’s fees to be paid commonly for competing owners can help parties start with demands that may be more reasonable and thus limit the potential for lengthy and expensive litigation. Setting rules for how sale contests are handled and limiting potential recovery often have the effect of stopping conflicts from blossoming into disputes in the first place. 

Special considerations for small and family-owned businesses 

The above issues gain more impact in sales of small businesses, which include most glass and glazing companies whether you measure by employees or total receipts. And with many also closely held family-run companies that are to be sold or transferred to family members, the business risk is complicated by family dynamics. Proactive due diligence and constructive sale terms can help maximize value for buyer and seller, whether family or friend.