Ceasing operations

Business owners need to do their legal homework before selling

The sale of a private business — particularly one with a long family ownership history — can stir emotions.

Joe Goodman, an attorney and partner with the local office of Callahan Witherington PLLC, specializes in the legal concerns of such transactions, noting, “Asale is not all about the sales price.

“There are feelings that attach to the private business for employees, the business, the customers, the vendors, and the inevitable complex relationships between the family(s) and the business,” Goodman says. “ You are selling your legacy — maybe with your father’s name on the door — abandoning long-time employees who got you here and eliminating your kids from consideration as next-generation owners. Do it well. Call a family business psychologist/consultant first.”

Emotional concerns notwithstanding, Goodman notes it is important to understand the myriad of legal considerations involved in selling a business.

“Sellers typically wish for short, simple documents but they usually end up with long documents filled with unexpected issues, details and factors that can greatly reduce the final price,” he says. “Sellers should get with a knowledgeable attorney early in the process.”

Godman says sellers should be informed about basic legal matters before responding to, or making, any offer. Uncle Sam is your significant business partner so don’t ignore taxes. And understand your company’s realistic value in the marketplace.”

Goodman says there are various missteps and oversights business owners fall prey to when selling. For example, he says many sellers fail to enlist a skilled and experienced advisor early in the process. He notes that some sellers have an inflated sense of the value of their businesses and fail to prepare for the complexity of the transactions. Such fumbles can be further hampered by poor records and by not spending sufficient time to optimize the value of the businesses being sold, Goodman adds.

And then there are the often-confusing legal documents required for a transaction.

“Those 50- to 100-page legal documents can be a nightmare for small business deals,” Goodman says. “And small deals have many of the same issues as big deals — just smaller numbers. There are details about warranties and guarantees about the assets you are selling. And the liabilities you transfer to the buyer can be far-fetched sometimes, but buyers’ lawyers love them — and buyers are reluctant to leave any out once they see them in print.”

Goodman says sellers “rarely appreciate” the tax ramifications involved in a sale. In contrast, he adds, buyers do.

“A sale is rarely all long-term capital gain,” he explains. “There is a lot of ordinary income that usually jumps up from strange places. Lower income taxes today (for example, from depreciation) are often designed to be ‘recaptured’ at the time of the sale. Everyone dreams of a simple stock-for-stock tax-free exchange, or a stock sale for cash, but it never happens except in the Wall Street Journal.”

Seller-financed loans are gradually gaining some favor within the realm of business sales. By offering to accept deferred payments through a seller-financed loan, the seller can, in theory, attract more prospective buyers than would otherwise be the case, better facilitate the purchase transaction and convey faith in the future of the business. As a result, the seller in a seller-financed deal — through which a promissory note explains the repayment promise and loan terms — tends to obtain a higher purchase price. On another positive note, the seller can spread sale proceeds over multiple years, which may spare her or him from taxation at higher rates.

However, Goodman cautions that there can be risks with a seller-financed deal.

“Of course you can get a better after-tax price if you finance the deal, but what happens if the buyer can’t make all the payments, or gets out a magnifying glass to see if he/she can change the deal or offset the note payments in the 30 pages of warranties and guarantees, or there are post–sale developments?” he asks rhetorically. “Do you want to sell for cash, or promises?

Goodman says a combination of cash and promissory notes may be a reasonable option in some cases, provided the seller has competent lawyers involved. Some buyers readily use Chapter 11 bankruptcies or threatened default as a routine financing tool to lower or eliminate the installment payments, he says. Shared risk “earn outs” and deferred payment formulas have many issues, he adds.

Interestingly, finalizing the legal documents typically requires only “modest” cost and time, with computers having expedited the process, Goodman says. He notes that law firms start with 100-page documents and trim them down from that point.However, what comes before the finalization can be tricky.

“The time and expense come in the strategic planning, negotiations over numerous exotic points, back-and-forth changes among lawyers, meetings, emails, which, candidly, are needed,” he says. “The difference in time and costs may come where you have lawyers told to make the deal work, as opposed to client instructions to get top price for the seller, on one hand, and no business risk for the buyer on the other.”

Goodman says that a seller of a business should expect to pay $8,000-plus (on the low side) in legal fees and $100,000-plus on the high side (for a privately owned business worth under $20 million). The typical fee is between $30,000 and $50,000. A seller should increase all estimates by 50 percent if she or he has sloppy records and  unreasonable expectations. The fees are for this is much more than documents, negotiations, and closing. They cover  strategic planning, tax planning, financing work, inevitable changes in the deal, and cleaning up poor records, among other legal matters. 

“And it always costs more if you have to negotiate with lawyers from New York City or California.”

Goodman says there are various reasons folks sell their businesses.

“Sellers sell when they have no successorship plan in place,” he says. “They ignore this and wait too long to start, run off the kids or other potentially attractive successors who get tired of waiting (along with their spouses). On a positive side, sellers sell or merge to reduce duplicated overhead expenses, expand into other markets and to grow the business and business value. A friendly sale to younger family members or key employees needs long-term planning (at least five years, usually) for an optimum sale result for all sides.”

Goodman says sellers of businesses are “rarely happy” with the price they get. Perhaps in an ironic twist, some business owners work with such fervor and for so many hours per week that no one else wants their jobs — or to buy their businesses.

“They just sell for a modest price or liquidate,” Goodman says. “A business without goodwill and good earnings in excess of the owner’s labor value might as well be liquidated on an orderly basis to just convert business assets to cash. A sale to key employees almost always involves substantial seller financing and risk, but that may be the best option.”