Updated: Jan 27, 2022
By Tsu-Li Liew
Selling a small business is tough work. First, an owner must prepare the business for sale, then find a buyer to commit to the sale. Once the owner manages to get through those steps, they will have to close the deal in order to complete the sale. However, closing a sale is not just signing an agreement and shaking the buyer’s hand. There are many documents a small business owner will need to prepare and negotiate in order to hand off their business properly. The letter of intent and the purchase agreement are two such documents that a small business owner should be familiar with before going through the closing process.
Letter of Intent
The letter of intent is a non-binding agreement between the business owner and the buyer. It is the first step to closing a deal, showing the buyer’s intention of buying the business. It will include the terms about the parties and the business involved, the nature of the deal, and the steps that either party will take during this process and can also include a non-disclosure provision. If the letter does not include such a provision, the owner should suggest including it to protect the business’ confidential information. According to Investopedia, a letter of intent will allow both the buyer and the business owner to perform their due diligence, when investigating the owner’s business or the buyer’s capabilities. The letter might also include a right of first refusal for the buyer. This right will give the buyer the first opportunity to buy the business, even if other prospective buyers appear at a later time.
The letter of intent is beneficial for both parties. For the business owner, it is an assurance that the buyer is serious about closing the deal. According to The Balance, the owner will also have the authority to check whether the buyer can afford to pay and whether they are a good fit for taking over the business. For the buyer, they will be able to invest in investigating the business and its finances without worrying about other buyers. Since investigating a business costs a lot of money, the letter of intent will ensure the buyer that they will not lose that money from investigating because they are the first in line to buy the business and will not lose the opportunity to another buyer.
Not all business sales will have a letter of intent. Larger and more complicated businesses will usually use them. However, it is one tool a business owner can use to stop wasting time on non-serious buyers and prevent them from accessing the business’ information. While the letter of intent is not all legally binding, many of its terms can be reused later in the purchase agreement if both parties agree to move on with the sale.
The purchase agreement is one of the documents needed to close a sale. This legally binding agreement makes the sale official and includes the most important terms and conditions, such as the purchase price, asset list, and any representations and warranties the parties make. At this point of the sale, the buyer has committed to buying the business and confirmed their purchase decision after a thorough investigation of the business. The owner has also done their own due diligence to ensure that the buyer has the financial means to pay the price and the business capabilities to run the operations.
Depending on the size and type of the business being sold, the agreement can either vary in length. For a simple and small business that are selling for less than $100,000, a business owner might be able to use a pre-written, fill-in-the-blanks form. However, if the owner and buyer choose to use such a form, they should each check with their attorneys if the agreement will comply with local and state laws. The attorneys will also be able to tell them if such an agreement is sufficient to cover specific details about the business and may suggest adding more provisions where necessary.
For larger and more complicated businesses, the purchase agreement will be longer and include exhibits and attachments to cover all the details about the business. Either parties’ attorney can write the first draft of the agreement, which will then be sent to the other party for review and suggestions. However, usually the buyer’s attorney will write the first draft, since the buyer will be the one running the operation after the deal.
During this process, both parties can negotiate each of the terms that are included in the deal. According to Inc, the agreement will include basic information such as names and locations of the seller, buyer and business, assets, liabilities, closing date, and price of the sale. It will also include terms such as adjustments, seller agreements, payment terms, security agreements, list of all inventory, accounts receivables, representations and warranties, seller’s covenants, obligations and rights, business transfer agreements, as well as boilerplate provisions, which are terms that appear in any agreement. Trembly Law has a list of common boilerplate provisions. Some of these provisions could also be detailed in their own separate agreement as well.
Most of the agreement will cover details that will not concern the owner once the deal is closed. However, the owner should be aware that some provisions of the agreement will still bind them for years after the deal has been closed and the purchase price has been paid, specifically the representations and warranties clause and indemnity clause. Representations and warranties are statements made by the business owner that a buyer can rely on, for example, that the business owner owns the title to the property. The indemnity clause allows the buyer to seek compensation from the owner for any harm or loss coming from the agreement. However, if someone sues the buyer for something that the business owner covered in the representations and warranties clause, then the business owner might have to cover the losses from the lawsuit through the indemnity clause.
A business owner should try to limit their liability from these clauses. BizFilings suggest that the owner should negotiate which liabilities the buyer will assume and which the owner will include in their representations and warranties clause. While an owner might not be able to remove the indemnity clause as it is standard in most contracts, they should try to limit the time frame of when it is active, which is usually a few years, or limit the dollar amount that the owner will cover. This will hopefully prevent the buyer from trying to claim money from every small problem they encounter with the business afterwards.
Since the purchase agreement should cover all aspects of the business, it will be one of the most important documents that a business owner will sign during this process. Once both parties have signed the agreement, the business will officially be passed over to the buyer. After that, the owner will just have to collect the money, which will be dependent on the payment terms.
While the purchase agreement does include all the necessary information to transfer the business to the buyer, the parties can also create additional agreements for further documentation. These can include and are not limited to the bill of sale, assumed name certificates, promissory notes, lease assignments, affidavits, and Secretary of State filings. According to Tremmel Law, there are other matters that could be their own agreement or be included as provisions in the purchase agreement, such as the proration agreement, work in progress, non-compete agreement, consulting agreement or employee training and transition agreements.
Many of these agreements ensure that the aspects of the business will have a smoother transition. For example, a bill of sale is usually a document that details a transfer of property from one party to another. In the sale of a business, a bill of sale is used to document the transfer of personal property from the owner to the buyer. The Chron has a guide on what to include in the bill of sale. While there is no required format for a bill of sale, it should include information detailing what is being transferred, the price, the location and date of the sale, and both the owner’s and the buyer’s contact information. While representations and warranties might be included in the purchase agreement or in its own agreement, it should also appear in the bill of sale. Depending on the state, there may be other requirements for the bill of sale. A business owner could also provide an affidavit to affirm that the representations and warranties in the purchase agreement are true. While it is not necessary to provide since the representations and warranties are legally binding, an affidavit might help put a buyer more at ease since it is an additional legal document.
Some of these documents may include another party, aside from the owner and the buyer. For example, if the owner was renting a space for their business, they will need to obtain consent from their landlord to pass the lease on to the buyer, if the buyer intends to continue using the same space. Depending on the situation, the owner may have to end their lease and the buyer will instead have to negotiate with the landlord themselves. If the business being sold is part of a franchise, the franchisor might have to approve the buyer beforehand. The parties might have to complete additional documents to send to the franchisor prior to closing. This will depend on the franchise and its requirements.
Other documents need to be filed with the Secretary of State’s office and the county clerk, such as an assumed name certificate. An assumed name certificate allows the business owner to operate a business without creating a formal legal entity, according to The Balance. If the business has been operating under an assumed name, the owner will need to abandon the name so that the buyer can then file for the assumed name. This ensures that the buyer can operate under the assumed name without a problem, while the owner will avoid any future liabilities. Although assumed name certificates only apply to sole proprietorships, if a business is a partnership, LLC or corporations, the parties will be required to file an update on the change in ownership with the Secretary of State’s office.
While the requirements needed to close a sale might feel overwhelming, a small business owner can reduce it by preparing early. Gathering all the necessary documents and information of the business at an early stage can make the process much smoother when the time comes to put together the letter of intent, the purchase agreement, and supplementary agreements. While the letter of intent might not be used, a business owner should take their time when drafting and reviewing the purchase agreement and other agreements, preferably with an attorney. If done thoroughly, these agreements will make the business transition much easier, and the owner can relax once the deal is closed.
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