Keeping Secrets Secret

Thinking about selling your business? Perhaps you have entered into informal discussions with a possible buyer. The buyer is looking for some more detailed information about your business in order to decide whether he wants to make you an Offer. Maybe he wants some past financial records or other confidential information in order to determine price. How do you give him this information, before the deal is even made? Using a Nondisclosure & Confidentiality Agreement can be helpful. It will outline the terms upon which you agree to provide certain confidential information, and it will set out how it can be used, to whom it can be disclosed and when it has to be returned. This can be a separate stand-alone agreement, or similar wording can be incorporated into a letter of intent, where the parties at least agree that it is their intention to buy and sell and they will be entering into negotiations in this regard. The agreement, no matter the form, will help to clarify the rights and obligations of the parties, and may assist with narrowing down some of the issues to be resolved before a definitive Agreement of Purchase and Sale can be drawn up. Being careful with your business secrets just makes good business sense.

What's Your Exit Strategy?

I had a meeting recently with a long-time business owner and franchisee. I was reviewing a new franchise agreement that he was being asked to sign for several franchised locations. The agreement was for five years, no right of renewal. This gentleman was not concerned with the lack of renewal rights at first, since he figured he would be retired by then. But when we started to talk a bit more about the value of the business that he had built over 25 years, it was evident that he had not considered a sale of the business as part of his exit strategy. In fact, he just thought that in five years, he would walk away. The business had been good to him, allowing him to earn a living for many years. After discussing a possible sale, he realized that there could indeed be someone out there who might be willing to pay for an assignment of his franchise rights. Once this realization hit him, he understood the value of a right to renew in his franchise agreement (and his leases). It's interesting to me that some business people don't think of their businesses in terms of saleable. They are a way to earn a living, but can also be a substantial asset that someone else will pay good money for. Even though a business is franchised, and sometimes there are restrictions on sale, it's worth having a look at and determining what the exit strategy may be. Once you know approximately when and how you wish to exit the business, it allows you to have a look at opportunities you may not have thought of before. And the strategies for getting there - like ensuring you negotiate for a right to renew an agreement. What's your exit strategy? Knowing the answer to that question makes good business sense.

Selling Your Business - reps and warranties

If you are selling your business, you may be selling the assets or all of the shares of your corporation, but either way, the purchaser will likely want you to provide some representations and warranties with respect to your ownership of the assets, tax issues, employees, perhaps environmental warranties, etc. Depending upon the level of complexity of the transaction and the type of business being transferred, the reps could be as few as 5 or 6 and as many as 50 or 60. Either way, it is very important for a vendor to carefully read these representations and warranties to ensure that they are accurate and truthful. Often much of the negotiations around a transaction can centre around what reps and warranties will be given and whether they are limited to the knowledge and belief of the vendor or not. Make sure you understand what you are representing and warranting to a purchaser. If these statements are dishonest or inaccurate, a purchaser may have recourse against you after closing. Be sure to get legal advice about these items, prior to signing any agreement.

Allocating the Purchase Price

If you are selling all or substantially all of the assets of your business, or if you are buying the assets of a business, you will certainly have to come up with a purchase price that both sides can agree upon. However, the negotiating with respect to the purchase price should not stop there. The parties should be making an agreed-upon determination of how that price is allocated amongst the various types of assets. For instance, what is being paid for the goodwill or client list of the business verses the depreciated assets verses the leasehold improvements? It can make quite a difference to both sides, in terms of the tax consequences, and often the buyer and seller have opposite preferences. So the actual price can be influenced by how that price is allocated. Buyers will be more likely to pay more up front, for instance, if they can write the assets off quickly afterwards. It is important for both the buyer and the seller to consult with their lawyers and accountants with repsect to the allocation and to ensure that it is agreed upon either up front, or at the very least, prior to closing. Understanding the tax and legal implications of your decision to buy or sell at a certain price makes good business sense.

Two Ways To Sell a Business

I was on the phone with a client tonight, trying to explain the difference between an asset sale and a share sale, and, now that I am a blawger, it occurred to me that this might make a good blawg article. It's been a long day, so I am not going to get into all of the pros and cons of these two very different transactions - we'll leave that for another article. I am just going to try to explain why they are different.

First, let's presume Mr. Green owns a lawncare company. Let's call it Green Lawncare Inc. (totally unimaginative, I know). Mr. Brown wants to purchase the business. The business likely has value to Mr. Brown because it has assets - maybe some equipment, a vehicle, some inventory and, usually an established name and customer list. Mr. Brown could start his own lawncare company, but there is value in purchasing an existing lawncare business, since he can get used equipment, presumably at a lower cost, and can assume all of the existing lawncare contracts that Mr. Green's business has. This means instant income as opposed to pounding the pavement for lawncare contracts.

Mr. Green can sell his business in one of two ways:

1. Asset Sale: Green Lawncare Inc. (a separate legally incorporated entity) can sell all or substantially all of its assets to Mr. Brown. Mr. Brown would pay the corporation for these assets. The agreement could stipulate which assets Mr. Brown would buy and which would stay in the company. For example, Mr. Brown may not wish to purchase the accounts receivable of the business. He could list the assets he did wish to purchase, such as the "goodwill" (customer lists, existing contracts, phone number) and the equipment necessary to carry on the business. Mr. Brown would not likely assume the liabilities of the business. On closing, Mr. Brown would pay the company for its assets. Mr. Brown would either buy those assets personally, or set up his own company (Brown Lawncare Inc?) to purchase the assets and operate the business through. Mr. Green could be paid by the Company (now flush with cash from the sale) through salary, management bonuses or dividends.

2. Share Sale: Mr. Green could sell all of his shares in Green Lawncare Inc. to Mr. Brown. Mr. Brown would then become the sole shareholder, director and officer of the company. Mr. Green would get the cash on closing, personally. Mr. Brown would continue to operate Green Lawncare Inc.

There are many issues involved with determining whether a transaction will be an asset sale or share sale and, often, the purchaser and vendor are at odds over which form the transaction should take. Considerations such as liability issues and taxation (as usual in the business law context!) should be addressed with both your lawyer and your accountant, before a final decision is made. Knowing the difference between the two types of transactions is the first step in making the right business decision.