|6. Buy-Sell Agreements
Planning Your Exit
When it comes to planning, how you exit your business is just as important as how you start it. The goal is to maximize the value of your company before converting it to cash, and to minimize the amount of time consumed.
Getting out of business is a process. The length of time required to complete the process is directly related to the complexity of the business, and the circumstances underlying this decision to get out of business. It can range from one week for a home-based sole proprietorship to several years for a corporation forced into involuntary bankruptcy. Disputes and litigation add another dimension to the timeframe.
The getting out of business process typically includes the following steps. You may want to incorporate them in your post-venture plan:
- Reach Agreement and Obtain Authorization from Owners to Dissolve Your Business Entity. Agreement and authorization to dissolve a business must be established under some acceptable, governing set of rules, such as the bylaws or partnership agreement. It is best to settle disputes quickly, and document any terms and conditions that apply.
- Designate a Leader & Organize a Team. Authority and roles should be clarified. The owner may be the only team member for a home-based business. For a large entity, however, the team may consist of the executive management team and important functional managers whose expertise is not represented: finance, human resources, legal. This group should be as small as possible for efficiency, and large enough to include the expertise required to cover the basic planning issues.
- Engage Professionals & Consultants as Team Members. For most small businesses, this group consists of the firm’s legal counsel, CPA, and a business broker or valuation expert. Professional expertise and advice in these areas will contribute to a smooth process and improve the outcome.
- Perform a Thorough Review of Business and Identify Problem Areas. Establish and maintain a problem list to focus on. Determine the condition of the firm’s records. Review transactions. Problems extend the timeframe and cost money.
- Prepare a List of Assets and Perform a Physical Inventory. The inventory is very important input to several activities. It is used to establish the value of the business, make decisions and manage disposition of assets, and it becomes the basis for tax calculations and tax returns.
- Perform a Valuation of the Business. It is difficult to make prudent decisions without knowing the market value of the business and its assets.
- Prepare a Detailed Plan and Assign Responsibilities.
- Develop a Schedule for Implementation. A schedule provides the ability to measure progress, estimate completion of critical steps, and project the end of the process. The schedule is also extremely useful for managing cash flow during this uncertain time.
- Release Announcements & Notices. This step is about timing and legal notice. At some point, interested parties must know what is happening: market, competitors, customers, vendors and suppliers, professional service providers, consultants, trade groups, employees, media, creditors, contractors. The notice should designate an official point of contact for questions or inquiries.
- Implement the Plan. This is where momentum and activity builds. Things happen very quickly. Without the planning steps, an important degree of control is lost. When that happens, net value is usually decreased in some substantial way.
- Conclude or Transfer Contract Obligations. This process may require approval from contracting parties, and involve negotiation of final terms. Office, car, and equipment leases need to be reviewed, addressed, and terminated. The timing of termination dates for insurance contracts and benefit plans are very important to all involved.
- Close Operations. The timing of this step is important. There is a time when manufacturing or production must cease, retail sales must end, and human resources are pared down. Each affect cash flow and net value dramatically. Security and maintenance services may be an important consideration from this point on.
- Dispose of and Transfer Assets. This is an important tax event. Insurance coverage can be reduced or eliminated.
- Settle Accounts Payable & Debt Obligations.
- Prepare Final Financial Statements & Tax Returns. Final financial statements for the business are important to establish the tax implications for assets, gains, and losses conveyed to the owners, or other involved parties.
- File Articles of Dissolution. State licensing departments require a formal filing to terminate the legal and tax status of the business. Examples are articles of dissolution, certificates of withdrawal, and cancellation certificates. This process also results in a review of tax liabilities, and issuance of a tax clearance notice or certificate.
- Prepare and Issue Special Filings, Notices, Informational Returns, and Taxes. To develop a checklist, retrace your steps taken during startup. Generally, some action is required with all federal and stage registration, taxing, and licensing agencies contacted to start the business. Final submittals of payroll, unemployment, industrial insurance, and other business tax returns must indicate that the business status is closed, or changed.
- Receive Tax Clearance Notice. File in financial records.
- Close Bank Account.
- Store Business Records. These records should be kept for at least seven years.
Planning and awareness are crucial. The process, timing of events, and tasks must be tailored to the type and complexity of the business. Each case is unique because reasons for dissolution differ, and problems that exist or develop are unique to the circumstance. The following is a checklist of items to consider as early in the process as possible. Most of these issues have some impact on the process of getting out of business:
- Disputes and employee grievances
- Employee benefit plans: incentive plans, benefits, pensions, deferred salary plans, stock options
- Medical insurance
- Business equipment in employee possession; home offices, business cars, cell telephones
- Termination notices
- Employment contracts and severance arrangements
Finance and Accounting
- Condition and completeness of records
- Deposits outstanding
- Prepaid accounts: insurance, advertising, utilities
- Valuation of assets: intellectual property, work in progress, software, project files, R&D
- Financial planning: capital gains on asset disposition or sale of business
- Bank and investment account(s)
- Loans from financial institutions or individual investors
- List of creditors
- Liens and security interests
- Accounts payable and commissions owed
- Account receivables
- Outstanding tax claims, audit processes, or IRS action
- Cash flow and expenses related to getting out of business
- Business tax planning
- Tax liabilities: local and state business taxes, payroll, industrial insurance, property, corporate income tax
- Audit status
- Stock option conversions
- Warranties/Guarantees: product, service, contract
- Contacts and agreements: assignment, completion, non-compete, confidentiality, nondisclosure, franchise
- Contingent legal problems: litigation, disputes, judgements
- Strategic alliance agreements and obligations
- Labor union agreements
- Inventory: material, products, work in progress
- Physical inventory records
- Asset records and list
- Purchase orders outstanding
- Shipments in transit
- Financial obligations
- Modifications to secure plant and buildings
- Lender lease
- Storage of assets and equipment
- OSHA or EPA filings
- Field offices
- Condition and completeness of company records: charter documents, minutes, stock records
- Documents of title, mortgages, deeds, and security agreements
- Business insurance
- Pensions, deferred compensation plans, benefits
- Professional support. CPA, attorney, PR & advertising, marketing, internet host & publisher
- Registrations, permits, & licenses
- Storage location of corporate records
- Continuation of board of directors
- Termination of business licenses and tax account
- Dissolution of business entity
- Ownership of intellectual property: trademarks, patents, trade secrets
- Applications in progress: intellectual property, licenses
- Stockholders or equity investors
- Estate issues
- Key person insurance
Marketing & Public Relations
- Sales representatives agreements
- Proposals in process of preparation
- Proposals submitted
- Professional, trade, and telephone directory listings,
- Public notice of change
- Tradeshow and convention commitments
- Samples, price lists, and marketing materials in the field
- Web site
Look for guidance and information from the following resources:
- Small Business Development Centers – Business Counselors (www.asbdc-us.org)
- Small Business Administration Business Information Centers (www.sba.gov)
- SCORE Counselors (www.score.org)
- Business Brokers & Professional Business Consultants
- Public Library, Business Section. Books and publications on the topic of buying and selling businesses
- State Departments of Licensing or Commerce
- Business Owners and managers who have experienced the dissolution process
In conclusion, the process for getting out of business successfully requires the same amount of planning as going into business. While the process should be easier, it is likely to be less enjoyable and more stressful. The best advice for business owners is to think about the future during the early stages of getting into business. Exert managerial influence to ensure that complications and problems which could affect dissolution, and net value, do not develop into roadblocks. When the time for getting out of business comes, engage the invaluable expertise you will need, and prepare a plan.
The sales agreement is the key document in buying the business assets or the stock of a corporation. It is important to make sure the agreement is accurate and contains all of the terms of the purchase. It would be a good idea to have an attorney review this document. It is in this agreement that you should define everything that you intent to purchase of the business, assets, customer lists, intellectual property and goodwill.
The following is a checklist of items that should be addressed in the agreement:
- Names of Seller, Buyer & Business
- Background information
- Assets being sold
- Purchase price and Allocation of Assets
- Covenant Not to Compete
- Any adjustments to be made
- The Terms of the Agreement and payment terms
- List of inventory included in the sale
- Compliance with the Bulk Sales laws of the state
- Any representation and warranties of the seller
- Any representation and warranties of the buyer
- Determination as to the access to any business information
- Determination as to the running of the business prior to closing
- Possibilities of having the seller continue as a consultant
- Fees — including brokers fees
- Date of closing
Confidentiality agreements and non-compete covenants are most often entered into between employers and employees or business partners. Enforceability of these contracts varies among the states so if you are considering utilizing either, it is recommended that you contact an attorney in your local jurisdiction.
Confidentiality agreements ensure that proprietary information disclosed by one party will be kept secret by another party. Such agreements are often the only method to ensure that employees keep trade secrets, allowing both parties to acknowledge that a duty of confidentiality exists, defining the scope of the duty and spelling out the possible remedies or sanctions associated with the breach of the duty.
The purpose of a non-compete covenant is to ensure that an employee will not compete against an employer or former employer. Since competitors often recruit each other's employees hoping to gain an advantage, these covenants are especially important. Without such a covenant, a top salesperson leaving to work for a competitor may be able to take a list of important clients, thus harming the business of the original employer.
Examples of confidentiality contracts can be found on the Lawsmart site. A sample non-compete covenant can be found at Visitorinfo.com .
What is a contract?
A contract is an agreement between two or more parties that creates an obligation to do or not do particular things. Contracts almost always contain the following essential elements:
- Parties who are competent to enter into a contract. For example, a mentally disabled person could not enter into a contract. Minors can enter into contracts, but can void them in most cases before they reach majority age.
- Mutual assent by all the parties; i.e., all parties have a meeting of the minds on a specific subject. Each party either promises to perform an act that the party is not legally required to perform, or promises to forebear from performing an act that it is legally entitled to perform.
Depending on the circumstances, a contract may or may not have to be put in writing and may or may not have to be signed.
Why should I use a written contract?
To be enforceable, some agreements must be in writing. The situations in which an agreement must be in writing can differ from state to state, but usually include transfers of real estate, sales of goods valued at over $500, and contracts that require more than a year to perform.
Your written agreement becomes your proof of what was agreed upon and prevents someone from forgetting or changing the story later.Writing makes the parties focus on the essential points and come to a definite agreement.
Can and should I write my own contracts?
Yes, you can write your own contracts. If there is much at stake or if the matter is complex, definitely use a lawyer. Your best money may be spent up front in preventing any problems. If the amount is moderate or the terms simple, you may use a legal form that both sides understand.
How do I enforce a contract?
The parties can agree to have a mediator review a contract dispute. The parties are not bound by a mediator's decision, but may be convinced to avoid a costly court battle by how the mediator rules.
The parties can agree to binding arbitration of a contract dispute. A neutral party listens to the arguments from both sides and issues a decision that is binding on the parties. This is cheaper and less time-consuming than a court battle. The parties can take their contract dispute to court to obtain a decision from a judge or a jury.
When attempting to enforce a contract, a party should consider the effect it will have on any long-term relationship such party has with the opposing party.
A contract may be unenforceable because it fails to contain an essential element outlined above, there was fraud or mistake in the making of the contract, or the contract contains an illegal subject matter or is against public policy.
Credit Agreements and Policy
Keys to collecting debt legally and successfully include preparing a policy and procedure manual and a credit application form.
Attempting to Collect a Debt
A measured approach to debt collection is better in the long run than immediately going to a collection agency or court. Consumer credit laws affect preliminary debt collection methods, while the Truth-in-Lending Act regulates the amount of interest that can be charged on overdue payments. In addition, it may help to look at sample debt collection letters before composing your own.
Your Customer's Bankruptcy
The debtor has the benefit of an "automatic stay" immediately upon filing a bankruptcy petition. That stops you from taking any further action to try to collect the debt unless or until the bankruptcy court decides to the contrary.
Interest on Overdue Payments
Interest charged on late payments may be subject to state usury laws limiting the amount of interest that can be charged. If the maximum amount of interest is exceeded, the debt may be forfeited and a penalty assessed. In addition, interest on overdue payments must be written clearly and conspicuously in order to avoid violation of the Truth-in-Lending Act.
Before hiring a collection agency to pursue your debtors, make sure that the agency is licensed and bonded. Your state's collection agency administrator can provide information on licensing requirements. In addition, make sure the agency operates under the Fair Debt Collection Practices Act, and check with your state's consumer protection agency or regional FTC office to see if there have been any grievances filed against the agency.
Collecting Money Judgements
If a money judgement is awarded to you in court, further action may still be needed to receive payment. Such action may include contacting the defendant, or in worse cases, providing information about the defendant to a law enforcement officer so that they can assist you in collecting the debt.
Contractors who are hired to improve real estate, but then are not paid for work completed, may file for a lien against the property. Should the debt remain unpaid, the contractor has the right to collect it by a foreclosure sale of the property.
It is important during the closing to make sure that you have legal counsel available to review all of the documentation necessary for the transfer of the business.
The following items should be addressed in a closing:
- Adjust purchase price — This would take care of prorated items such as rent, utilities and inventory up to the time of closing.
- Review documents required to be provided by the seller — This would a corporate resolution approving the sale, evidence that a corporation is in good standing, any tax releases that may be been promised by the seller. Check with your local department of corporations or secretary of state.
- Signing promissory Note — In some cases the seller will carry back financing, so have an attorney review any Note documentation.
- Security Agreements — These documents may be necessary if you are going to finance your purchase. A Security Agreement lists the assets that will be used for security as a promise for payment of the loan.
- UCC Financing Statements — These documents are recorded with the Secretary of State in the State you have purchased your business. Again, these documents are necessary if you are going to finance your business.
- Lease — If you have agreed to assume an existing lease, you will be required to execute the assumption. Make sure that you have the landlords concurrence to assumption of the lease. You may instead have negotiated a new lease with the landlord instead of assuming the existing lease.
- Vehicles — If the purchase includes vehicles you may have to execute the transfer documents for the vehicles. You can check with your local department of motor vehicles to determine the correct procedure and necessary forms.
- Bill of Sale — The bill of sale will be proof of the sale of the business and will transfer the ownership of the other tangible business assets not specifically transferred on their own.
- Patents, trademarks and copyrights — May need to execute the necessary forms if part of the transaction.
- Franchise — May have to execute franchise documents if the purchase of the business was a franchise
- Closing or settlement sheet — The closing or settlement sheet will list all financial aspects of the transaction. Everything listed on the settlement should have been negotiated prior to the closing so there should be no surprises.
- Covenant Not to Compete — It is a good idea to have the seller execute this agreement. This will help add to the success of your operation of the business without any interference from the previous owner
- Consultation/Employment Agreement — If seller has agreed to remain on for a prior of time this documentation would be necessary.
- Complete IRS Form 8594, Asset Acquisition Statement — This document will indicate how the purchase was allocated amount the various assets. Important for your tax return.
- Bulk Sale Laws — Make sure that all bulk sale laws have been complied with in the transfer of the business assets.