Negotiating the Structure of Your Deal: The Key Legal Points to Know When Selling a Business
Selling a business in New Jersey? Let’s Make a Deal!
It’s easier said than done. Typically, to have a quick sale that successfully closes, you’ll need to convince a prospective buyer of several important points, such as:
- The structure of the sale: Will you be selling the business through an entity (i.e., the partnership, corporation, or LLC), or just its assets and/or business equipment?
- What are the assets being transferred? Will you keep some assets, equipment, (accounts receivable, for example, or a laptop computer) that are currently part of the business? You will have to identify exactly what you are selling and for that matter, what you may not be selling.
- Payment terms: Will the buyer pay cash up front? If not, how big a down payment will you insist on? What payment terms and interest rate will you offer and the buyer commit to?
- Seller protection: If the buyer is not paying all cash and fails to make a required payment(s), what will your legal options be to recover your business and/or collect your money from other sources? For example, will you receive a security interest in the buyer’s house as well as an interest in the business’s assets?
- Seller warranties: What, if any warranties (warranties are simply “promises”) will you make about the profitability, gross sales, and condition of the business or its assets and equipment? For example, are you willing to guarantee that the business will operate trouble-free for 6 months after closing, and if there is a breakdown, are you prepared to pay the cost of the repair(s)?
- Buyer warranties: In addition to providing security in case of nonpayment, what, if any other warranties will you ask the buyer to make? For example, until you’ve been paid off, will the buyer agree to keep the business equipment in good shape, maintain the inventory at presale levels, and continue operations from the current location?
- Liabilities: How will you and the buyer handle current business debts and IOU’s? Who will be responsible for existing debts and possible lawsuits against the business originating from the past?
- Ongoing associations with the business. Will you as the seller agree to perform future services for the business as part of the sale? If so, for how long, and how will you be compensated?
- Ability to compete: Will you be able to immediately invest in, own, or work for a similar business? If not, how will these restrictions be imposed?
Understand the Differences Between Selling Your Business as a Stock Sale or an Asset Sale
While it may seem like a minor detail, how you sell your business is A BIG DEAL, mostly because of legal liability issues and income tax consequences. Your business may now be organized and operated as a sole proprietorship, a partnership, a corporation, or a limited liability company (LLC). Sole proprietors and partners don’t need to focus much on whether it’s better to structure the deal as an asset sale or an entity sale because as a sole proprietor, the tax consequences will be the same. A sale of a partnership is also almost always structured the same as an asset sale.
But if your business is legally organized as a corporation or LLC, there are, as a rule, two frequent ways to structure the sale. The first method is to sell the corporate stock or LLC membership units. The second method is to sell all or most of the assets owned by the corporation but not the corporate stock or LLC units.
Here’s How a Stock Sale Works
Let’s use an example. If your business is either a corporation or an LLC, an entity sale would work as follows:
- If selling your corporation. You (and your fellow shareholders, if any) can sell all your stock to the buyer. The buyer of the corporate stock then becomes the owner of all the assets the corporation owns: furniture, fixtures, equipment, inventory, intellectual property, and so on. The corporation, under its new ownership, will remain responsible for the debts and other liabilities of the business.
- Selling the LLC. You can sell your LLC membership interests to the buyer, making the buyer the owner of the LLC itself. Just like with the sale of corporation stock, the buyer takes control of all the assets, etc. of the LLC. The LLC, under its new ownership, will remain responsible for the debts and other liabilities of the business.
How an Asset Sale Works
If your business is either a corporation or an LLC and a decision is made not to sell the stock or LLC membership units, then the following example explains how an assets sale would work:
- Selling the assets of the corporation or an LLC. You (and your fellow shareholders, if any) can arrange to sell all or most of the business assets to the buyer, in which case you’ll continue to own (nothing more) than the corporate shell. After the sale, the company will still exist but will have no (or few) assets other than a promissory note from the buyer for the balance of the purchase price. The assets that you sell aren’t limited to just the real estate and other physical property. The buyer can also buy the company’s goodwill and its trademark(s). When the assets of the corporation are sold, the buyer does not become responsible for the debts and other liabilities of the business but may agree to assume liability for at least some of them. To avoid future disagreements, you and your attorney need to be very specific in the sales agreement about what’s being sold and what is not. Otherwise, you may get into a fight later over whether something as seemingly minor as the business’s phone number or trade name belongs to you or the buyer.
Signing a Sales Agreement
The principle legal document used in the sale of your business is called a sales agreement. This document is a legal contract that must specify in detail the terms of the sale and the obligations of both the buyer and the seller. When possible, the sales agreement should be plainly written with easy to understand language. If it’s drawn up thoughtfully and carefully, the sales agreement should allow you to transfer your business and/or its assets to the buyer with minimal disagreement on a specific date (called the closing date). Should a disagreement arise before or after the closing, the clear terms of your sales agreement will be the first place both parties look to resolve it. Before you sign a sales agreement and related documents, it’s essential that you contact an experienced NJ business sale attorney. You can reach Fredrick P. Niemann toll free at (855) 376-5291 or email him at firstname.lastname@example.org. Want to learn more about business sales contracts? Then visit our dedicated website devoted exclusively to contract law in New Jersey. Please visit our page on NJ contract law (click here).
Understanding the Transfer of Intellectual Property
In today’s global and electronic world, a substantial number of small businesses own intellectual property- a legal term that covers copyrights, trademarks, patents, and trade secrets. They have real value and you want to be sure that you don’t overlook the worth of your intellectual property when negotiating the sale price.
When drafting the initial sales agreement, your attorney needs to be clear about which intellectual property is being sold and which is being retained. In some cases, it may be appropriate to retain legal ownership of intellectual property but license it to the buyer to use. In other situations, the reverse may be the way to go. You transfer the intellectual property to the buyer but receive back a license to use it
Closing Your Sale
After signing the sales agreement and before the business is legally transferred to the new owner, a closing takes place at which the buyer pays the sales price, or the agreed-upon down payment, and typically signs documents such as a promissory note, security agreement, escrow and pledge agreement, etc. In exchange, the seller will sign over stock certificates or LLC documents (if an entity sale), or a bill of sale for the business assets, plus all the necessary paperwork to turn ownership over to the buyer.
Protecting Yourself Against the Buyer Failing to Make Payments
Your initial negotiations with the buyer centered around what is being sold, their price and the terms of the sale. These issues are primarily business and financial, not legal. By contrast, legal considerations come into play when you begin to put your deal in writing.
Most often when a small business is sold, the seller doesn’t receive the entire purchase price in one lump sum, although cash deals occur when the buyer is a larger corporation or can get third-party financing. More often the buyer makes a down payment and gives the seller a promissory note for the balance. The promissory note usually sets up a schedule of payments to be made over a period of time with the buyer paying interest on the unpaid balance.
Whenever you receive a promissory note for a part of the sales price, there’s some risk the buyer won’t make all the required payments.
It’s essential that you adopt several practical and legal means to protect yourself should the buyer default.
- Carefully investigate the buyer.
- Sell only to a buyer who has proven record of entrepreneurial competence.
- Get a substantial down payment.
- Have the promissory note cosigned by the buyer’s spouse and, if possible, guaranteed by someone who’s clearly financially strong.
- Get the buyer to give you a first or a second mortgage on real estate with enough equity to cover the amount outstanding on the promissory note.
- Have the buyer sign a security agreement allowing you take back the business assets if payments aren’t made.
- If the business operates from rented space, seek the right to take back the lease as well so you can get back into business if necessary, at the same location.
An Overview of Key Tax Issues
- The type of legal entity you’ve chosen for your business. You’ve most likely set up your business as a C corporation, S corporation, a single-member limited liability company (LLC), a multi-member LLC, a partnership, or a sole proprietorship. There are differences in how the tax laws apply to each of the business entities.
- How your sale is structured. The big issue here is whether you sell your business as an entity or you sell its assets. Depending on which route you and the buyer agree to, there can be widely different tax consequences.
- Whether the sale price is paid in one lump sum or is spread over several years. If you receive full payment when you sell your business, your gain will be taxed all at once on your next tax return. By contrast, if you sell your business on an installment payment basis, your immediate tax liability will be limited, because you’ll only receive a portion of the sale price during the current tax year and will be taxed now only on that portion. You’ll pay tax on future installments in later years as payments are received.
- Capital gains vs. ordinary income. When you sell your business through an asset sale (as opposed to an entity sale), you’ll need to allocate the sale price among the different categories of assets established by the IRS. How you allocate the sale price can have a major effect on your tax liability.
Tax Issues When Selling the Business Entity
For tax purposes, the distinction between an asset sale and an entity sale is significant for some businesses but not for others. The key is what type of business organization you’ve chosen to use.
- Sole proprietorships and singe-member LLCs. If you’re a sole proprietor, your business is never treated as a legal or taxable entity separate from yourself for federal tax purposes. This means when you sell the business, the sale is always treated as if you sold individual items of property (that is, it’s treated as an asset sale). The same is true if you’re the sole member of an LLC and pay taxes as an individual, which is the case if you haven’t filed the form electing to be taxed as a corporation. Because your LLC isn’t treated as a separate taxable entity by the IRS, the sale will always be treated as an asset sale for federal tax purposes.
- Corporations, multimember LLCs, and partnerships. If your business is a corporation, a multimember LLC, or a partnership, selling your entity can lead to significantly different tax consequences than if your entity sells its assets.
How an Experienced Business Lawyer Can Help You
An experienced small business lawyer like Fredrick P. Niemann and Hanlon Niemann & Wright will be invaluable to the success of selling your NJ business. Our lawyers will work with you to:
- Make sure your partnership, corporation, or LLC documents are complete and up to date.
- Evaluate what kinds of consents and approvals are needed from any owners of the business, third parties and others.
- Determine whether a business/real estate lease and other contracts can be readily transferred/assigned to a buyer.
- Identify relevant NJ state and local laws that apply to your sale, such as bulk sales laws.
- Analyze the pros and cons of selling your assets versus selling the entity.
- Review the listing agreement with a broker if you’re thinking of working with one.
- Negotiating the terms of the sale.
- Preparing a nonbinding letter of intent summarizing the deal terms.
- Developing a strategy for making sure you can get paid the full sale price
- Determine the scope and wording of your disclosures.
- Draft or review the sales agreement, including important clauses on the allocation of responsibility for liabilities.
- Draft or review other important documents such as assignment of your intellectual property rights or an employment contract you sign with the new buyer.
- Make sure that your consulting agreement or noncompete agreement protects you adequately
- Prepare or review the necessary transfer documents if you’re selling a building or land.
- Create a closing checklist and prepare the paperwork for the closing and
- Conduct a smooth and thorough closing and post-closing process.
Sounds like Hanlon Niemann & Wright is the right law firm to handle your sale, doesn’t it? So call Fredrick P. Niemann today toll-free at (855) 376-5291 or email him at email@example.com to schedule a convenient consultation about the sale of your NJ business. He welcomes your call today.
Written by Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a New Jersey Selling a Business Attorney