We are pleased to share Robert Konstand's seminar presentation regarding business negotiation strategies for buyers and sellers.
Making and Evaluating Offers: Business Decisions v. Legal Decisions.
It is prudent for the client to get his attorney involved in the discussions for the sale or purchase of a business very early in the process. Buyers and sellers tend to hear only what they want to hear in negotiations and are usually afraid to approach the difficult deal points that they perceive as a weakness. Effective legal counsel can take the lead role in negotiations to ensure that the client is protected. However, the attorney must be fully apprised of the legal and business issues in the negotiation. In the initial phase of negotiations, the discussions will be centered on business matters.
The attorney should meet with the client prior to any meeting with any potential seller or seller, and understand exactly what the client is looking for in the transaction. Attorneys sometimes shy away from discussing business matters. With adequate preparation, the attorney can effectively present what the client is seeking. It is beneficial at times for the client to step back and listen to his or her attorney state what the proposed deal is during the negotiations.
Rendering business advice to a client can be problematic. The attorney can offer advice on business matters if the attorney is well-versed and understands the situation and the client understands that it is merely a business opinion and not a legal conclusion. Business opinions may be helpful for the attorney to get the client 'down to earth' in matters where the client's goal may be extreme or unrealistic or could end up damaging the client.
Caution is necessary in offering business advice to the client. Often, we see as attorneys, clients making obvious mistakes in the operation of their business. It is the role of the attorney to point out issues that may have beneficial or detrimental effects on the business side of things, where the attorney has that knowledge. If the attorney does not understand or has no knowledge of the business issues at hand, then the attorney should not be making any opinions or statements regarding the business. A good example of sound business opinion would be where a party seeks to buy a business that would require a large sum of cash to operate the business initially and the client does not have the cash or the access to the cash to operate the business. It is obvious that the business will fail without the cash in place, and therefore the attorney if comfortable, should advise the client of that. It is incumbent upon counsel to assist clients in making the right decisions.
It is more important to make sure that the initial negotiations include all of the major business points of the proposed transaction. The finer points can be left up to the written agreement; however, issues can arise with regard to lesser points that become major deal-breakers that perhaps would have been better to have been dealt with in the initial discussions.
Evaluating Your Client's Strengths and Weaknesses in the Transaction.
Every client is different. If you know your client well, you can find out about its strengths and weaknesses prior to the negotiations. A common weakness would be insufficient cash to purchase the business. An example of a strength would be that the client is a good business person and could make money but lacks the financial resources. It is important for the attorney to know this so that any agreement can be negotiated to avoid or minimize any client weaknesses and take advantage of any client strengths.
Another important issue is how much time your client can devote to the business. Will the business require full time involvement or not and will the client devote the necessary time and attention to the business.
If the client has insufficient cash for conventional bank financing and cannot meet the requirements for an SBA type loan, then obviously owner financing or outside partners would be in order. Depending on the various weaknesses or strengths, it may be beneficial for the client to be present and discuss the strength or weakness at the initial meetings of the buyer and seller and counsel. It helps to set limitations and demands on the negotiations and shows the other side that your client is truthful. Every client has weaknesses and strengths in their particular transactions and it is up to their counsel to utilize these strengths and weaknesses to the client's best advantage. Also, it is wise to have the client present at all negotiations to see where the issues are and the intensity of the issues. It is easy for a client to make unreasonable demands if they are not in the heat of the negotiations.
Another example of weaknesses would be the client's lack of knowledge with regard to financial statements and accounting. It is surprising today that this is prevalent. If either the seller or a potential bank sees this as a weakness, the deal may not go forward. The client then needs to enlist the help of a professional who can be there to answer questions and to give the other side assurance that the appropriate professional advice will be available to the client and be part of the team. I find it helpful at times to get the client's accountant involved in negotiations at a very early stage. This is particularly beneficial where the accountant knows the client well and understands the financial matters of the client.
The same goes for a client that has strong financial capabilities but lacks specific knowledge of running the particular business. Once again, the client should obtain help and present this to the other side, particularly where there will be owner financing and/or bank financing in the matter. Maybe a representative of the seller can stay on for a period of time after closing, to assist in the transition.
Discussions should be memorialized during the initial negotiations to make sure that every party is on the same page. Initial negotiations can be discussed through a term sheet prepared by the buyer. The term sheet is an outline of the deal points which can serve as a basis for discussion. Once there is an initial meeting of the minds and verbal agreement on the major points, then a letter of intent should be prepared. Clients question letters of intent because they are usually nonbinding. Recently however, I have seen binding provisions with regard to confidentiality and similar terms while the business points are not binding. It cannot be overemphasized that once business points and terms have been agreed upon in the letter of intent, it is usually difficult to negotiate away from those understandings. Some clients like to agree to certain points in the letter of intent knowing that they will not be able to agree to the same points in the final agreement. I strongly advise against this practice. If a client is unsure as to a specific deal point, he or she is better off to omit the deal point from the letter of intent and then deal with it as a new subject in the agreement.
Meeting Conditions of Sale.
Once the deal has been made and the agreement is signed, then each party must perform according to the terms and provisions of the agreement. Both the buyer and seller will make certain representations and will have certain obligations with regard to closing the transaction and thereafter.
It may be helpful to keep a punch list of your client's obligations as well as the obligations of the other side to ensure that all items are met in the closing. One cannot depend on an Escrow Agent in a real estate closing to make sure that all conditions are met and performed. It is up to us, as counsel for our clients, to make sure that everyone performs as agreed. Once again, it must be stressed that if your client is unable to perform according to the agreement, then this should be brought to the attention of the other party as soon as possible, in most cases. It may be possible to work around any issues. In the drafting of the agreement, the attorney for each party must carefully consider what the default provisions are, if the agreement does not close. As attorneys, we need to make sure that we protect our client's potential weaknesses in the agreement in case there is a default. In today's difficult economic times, it may be difficult for sellers to provide proper title to the assets sold, watch out for the undisclosed 'short sale' of assets.
Discussing the Finer Points of the Acquisition Agreement.
The question always comes up as to whether the seller or buyer should draft the agreement. This should not be a major issue unless the party drafting the agreement is not competent to draft it. I personally have no issue with making changes and doing red lines on agreements to make sure that all of the points I need are included to protect my client. As the transaction is negotiated on the term sheet and letter of intent, I keep notes of deal points and legal matters that I want to make sure are included in the agreement. Check lists are helpful, as well. However there will be times when the first version of the agreement is not even close in reflecting the transaction. Then is it is wise to start over with your own agreement.
Drafts of the agreement should be reviewed and discussed with your client before meeting with the other side. Some clients may understand most of the agreement, some clients may not. However, it is up to us as counsel to fully disclose and explain the agreement to the satisfaction of our clients. Clients, at times, tend to want to close things quickly and not pay attention to detail; it is incumbent upon us as counsel to ensure that our client understands the fine points and the nuances that are beneficial or potentially detrimental to the transaction. The last thing we want is for the client to say that they did not understand what they were signing or that it was not fully explained to them.
Discussions with the client help to vest them in the process. It assists the client in making sure that he or she can fully perform as expected of them not only in the closing of the agreement but in running the business thereafter.
Dealing with Liabilities.
Liabilities are always an important factor in the sale of a business. The buyer may have to assume certain liabilities. Liabilities must be detailed; representations by the seller must be made to detail the extent of those liabilities. If any liabilities are to be assumed or if the seller makes a representation that there are no liabilities, then the seller should back up the statement by a personal guarantee or other agreement.
If your client assumes liabilities, then the client needs to make sure that the liabilities can be paid and will not detrimentally affect the operation of the business. Liabilities need to be closely documented with the creditor to ensure that everything is as represented. Assuming liabilities can be helpful in financing a business, but care must be taken to ensure exactly what the liabilities are and the terms and conditions of the repayment of the liabilities.
Counsel should also look for any possible unknown potential liabilities in the transaction. Are there potential employee claims that have not been brought? Are retirement plans properly documented? Is there any litigation threatened or pending? Are there agreements that have disclosed but are in default? What if there are agreements that have not been disclosed? It is important for counsel to examine all of these matters.
In owner financed transactions, the agreement should contains a provision for a dollar for dollar set-off against any sums due the seller, where there is a breach of any representations, covenants, or other obligations of the Seller.
If you are unsure of any potential liability, it is wise to hold an agreed upon sum in escrow after the closing to investigate the liability and have the money available to resolve it. If the other side is unwilling to do so and it is a reasonable request, then this is a red flag, and if your client desires to proceed then it must be done with extreme caution. Sellers like to generally get out of their business quickly and in a clean manner. However, when there are issues of uncertainty, the buyer must insist on being protected. If there are potential issues, a reputable seller should be willing to provide for reasonable requests.
Environmental Issues.
Today, environmental issues are very important in any transaction. If the sale of a business includes real estate, then a Phase One environmental survey and perhaps a Phase Two will be necessary to ensure that the property is environmentally clean, even if there is a lease. Once again, representations by a seller may be worthless if the seller is not collectible and the buyer inherits the seller's environmental issues.
This can be more troublesome in a transaction where the sale of real estate is not involved. Environmental issues can be present in the real property that is leased and equipment can be contaminated.
A business operating out of leased premises has the potential for environmental liability and should be evaluated. Landlords are becoming aggressive in demanding clean-up of their real estate by tenants.
Successor Liability: Taxation, Tort and Contractual.
Successor liability is an issue in taxation with regard to Trust Fund taxes including Federal, state, and local as well as sales taxes. One common issue overlooked, is the status of the workers' compensation premiums paid, as well as the rate, as a result of the history of claims by the seller. Another issue is whether or not the new business entity of the buyer will be considered a successor employer or not.
If the business entity is purchased, then an examination of all filed tax returns must be made as well as the payments thereon. Investigate and confirm any potential IRS or state audit issues.
Tort liability can be an unknown. If potential tort liability is insured and the seller had insurance on an "occurrence" basis, then coverage should be available post-closing. If insurance was made on a "claims made" basis, then it may be incumbent upon the buyer to continue insurance. More important is the potential for uninsured future tort liability where the seller must represent that there is none and that the representation would be backed by sufficient assets for indemnification purposes.
Contractual liability is generally not insurable and thus representations have to be made by the seller and that sufficient assets will be in place for the benefit of the seller for indemnification purposes, post-closing.
Unpaid Taxes, Sales Tax, Payroll Tax and Income Taxes.
As previously discussed, these can be successor liability issues for the buyer. Provisions in the purchase agreement must be made for indemnification. As part of the buyer's due diligence, sales tax returns for the selling entity as well as payroll tax and income tax returns must be reviewed, as well as verification of the payments for the tax due. Obviously, if the internal statements of the seller reflect different numbers than contained in the tax returns then there are potential issues not only for liability purposes but for the real value of the seller and whether or not the tax returns may be erroneous.
Accounts Payable.
Once again, accounts payable must be verified and if assumed, then indemnification should be provided by the seller for any accounts payable other than as represented. During the due diligence process, the buyer should examine the accounts payable not only as to the amount but the timing of the payment. Arrangements should be made to ensure that the accounts payable can be paid on a timely basis. Most accounts payable today provide for interest to be charged on delinquent balances at fairly high rates and this should be avoided for cash flow purposes for the buyer. Make sure that vendors will continue to do business with the new entity at the same pricing and terms as before the sale.
Insurance for Environmental Issues.
Insurance is available, but it is very expensive and often contains exclusions and requires personal indemnification. Insurance is usually required for large real estate sales and where non-recourse financing is provided. The mortgagee will want as much environmental protection as possible and may seek redress from the seller for environmental liability issues. Environmental insurance is worth investigating but may be cost-prohibitive.
Non-Competition Agreements and Seller Participation, Post-Closing.
Non-competition agreements are crucial in the sale of a business where the principal of the seller could continue to compete or interfere with the buyer's enterprise. The courts look at non-compete agreements on a case-by-case basis. Most artfully drafted agreements provide that the seller and its principal cannot compete with the buyer for any set duration of time and within a certain distance or geographical area. The Courts look more favorably upon stricter provisions where the non-compete agreement is with the principal of the seller, rather than just as an employee of a company without a sale pending. Make sure that the agreement provides for appropriate injunctive relief that may be sought in enforcing a non-compete agreement.
Breach of Contractual Representations and Survival of the Agreement.
If a party defaults before the agreement is closed, the agreement usually provides for a default process which may or may not include litigation. Post-closing defaults are more troublesome. Indemnification provisions should be used extensively by counsel for the buyer to protect the buyer against defaults or breaches of representations made by the seller. Care must be given in the drafting of the purchase agreement to ensure that important representations and covenants survive the closing of the agreement.
Once again, there needs to be recourse upon a collectable entity.
Using ADR Effectively.
Most agreements for the sale of business provide for some type of alternative dispute resolution. Some agreements call for binding arbitration or a similar arbitration process; other agreements may have a mediation requirement and then litigation. It may be effective to provide at least an informal hearing of some type, either by mediation or arbitration, before litigation ensues. It allows both sides a forum to air the grievances and get a taste of litigation. Litigation is the least preferable way to resolve conflicts in the sale of a business because of both cost and time factors.
Closing the Deal.
Once again, checklists are crucial for the closing of a transaction. The buyer's attorney will need to assist not only with the obligations, including due diligence, contained in the sale agreement, but also provide services and assist with any third party financing. The funds must be obtained and financing qualifications must be met. Counsel should be vigilant to make sure that all terms and conditions of the agreement are met and that the client is prepared to operate the newly purchased business. This may necessitate forming a new entity, obtaining insurance, obtaining tax and accounting (including payroll) advice, as well as operational advice.
There will be times when the seller will insist on an opinion of counsel. These should not be given lightly as there is tremendous exposure to the lawyer. It is best to negotiate what will be contained in the opinion, while negotiating the agreement. Obviously, the goal is to limit what matters are opined. Also make sure that all necessary qualifications are contained in the opinion, like choice of law, bankruptcy and insolvency, and default.
Post-Sale Duties and Obligations.
Again, it is incumbent upon the attorneys to make sure that all post-sale obligations are met. The use of checklists again is useful in this process. The goal of the attorney representing the buyer would be to continue to represent the buyer because he or she is knowledgeable of the transaction and is in the best position to continue the representation. Careful consideration of post-sale duties and obligations will ensure that counsel continues to be retained in the future.
