While Sellers may have varying motives – retirement, desire to exit at the top, partner with a large strategic Buyer, or a distressed sale to exit a weakened business – all of them have similar needs, and face similar risks, in executing a sale transaction. Here are KLC’s Top 5 Questions to Ask Before Selling a Business.

1. Who is buying the business, and why ?

Sellers need to focus on the Buyer for several reasons. First and foremost, in many sale transactions, the Seller is not paid in full at closing. Often the purchase price will be paid partly in cash at closing, and partly with a loan or promissory note (that may be financed by a lender or

the Seller). In addition, the final purchase price is usually determined only after various post-closing adjustments. Thus, the Seller’s prospects for full payment relies in large part on having recourse to a reputable Buyer with a track record of fulfilling their business promises.

Second, many times the Seller will be asked to assist with the transition for some period of time post-closing (and in some cases, to continue long-term as an employee or consultant). If the Seller knows that he or she will be cutting ties completely with the business and the Buyer at the closing, then the Seller’s only real concern is ensuring full payment of the purchase price. That is not always the case, however. Assuming there will be some continuing relationship – and assuming that the Seller’s receipt of the full purchase will depend in part on the Buyer’s trustworthiness and success in running the business – the Seller has an important interest in evaluating the Buyer and his or her ability to succeed.

Third, just like the seller of a residential home, a serious Buyer with the financial ability to close the purchase is worth more than an unknown Buyer who may dangle a higher price or better terms, but may not have the ability or intention to deliver. There are many factors to consider in evaluating each prospective Buyer, including the Seller’s familiarity with the prospect (either by direct knowledge or reputation), the prospect’s background in the industry, the prospect’s access to capital, and the apparent level of motivation. If a prospect responds quickly and takes proactive steps to move the transaction forward, this is obviously a positive sign. But even an apparently “motivated” prospect may turn out to be incapable of closing the purchase, while another prospect who seems on the fence or slow to respond may turn out to be the right Buyer (and may have been moving slowly in order to raise capital, conduct due diligence, or research the business and its place in the market).

2. What are my risks before the sale ?

The purchase and sale of a business is a bit like marriage. The Buyer and Seller came together because they share the same goal of continuing the business, with new ownership. Also like a marriage, success requires both mutual commitment and mutual compromises on a host of questions, big and small. Sometimes, commitment is lacking or one or both parties find it impossible to compromise on important matters. Other times, there may be external factors that make the sale difficult or impossible (e.g., the sudden appearance of Covid-19).

Any number of factors may cause a Buyer to not sign the purchase agreement, or not close even after the agreement is signed. Thus, a Seller may never sign a purchase agreement, or may sign an agreement but never close the sale.

For that reason, every Seller must have the Buyer sign a confidentiality agreement early on in the process, before sensitive business or financial information is disclosed.  

3. What are my risks after the sale ?

A Seller’s highest priority is getting paid in full. Sellers understand there may be some credit risk relating to any post-closing portion of the purchase price, but they rely on their business attorney to either eliminate or reduce those risks (e.g., by front-loading as much of the purchase

payment as possible at closing, and for the unpaid balance, obtaining a lien on assets or personal guaranties from the Buyer or its owners). While negotiating the transaction, and before signing the purchase agreement, Sellers and their attorneys should repeatedly ask themselves “How will we ensure full payment by the purchaser, and what’s our recourse (or plan) if that doesn’t happen?” It’s important to note this does not just mean having the right “magic” words in the agreement. It is critical to think through the expense and distractions of litigation, the likelihood of success, and what mechanisms will have “teeth” to ensure the Seller receives full payment.. For example, Sellers should insist on dispute resolution provisions (including governing law, jurisdiction and venue) that are favorable to the Seller and make it difficult for the Buyer to evade or delay.

Sellers also need to think through and address possible claims by the Buyer after the closing. If the business under performs or suffers significant setbacks (e.g., loss of key customers), the Buyer may be tempted to blame the Seller – whether justified or not. Probably the most common post-closing dispute involves a claim by the Buyer that the Seller either failed to disclose, or misrepresented, important matters related to the business. It is human nature to look to fault others for our own setbacks, and sometimes it’s justified. Every day, courts hear cases to determine if a Buyer was misled or defrauded into buying a business or paying more than they would have, if all material information had been shared.

As a very general principle, Sellers have no obligation to protect Buyers from making mistakes or buying a business they may not be well-suited for. On the other hand, in a well-drafted purchase agreement, the Seller will have to make a large number of representations and warranties about the business.  Also called “reps & warranties”, these promises typically cover the full range of important aspects of the business, including recent balance sheets and financial statements, key assets and customers, any past or present disputes or lawsuits, among others. The Seller can be liable for monetary damages – and in cases of fraud, possibly even unwinding of the transaction – if any reps & warranties are later shown to be untrue.

Hence, it is imperative that Sellers understand exactly what their representations and warranties say. Before signing the purchase agreement, the Seller should carefully review them with their attorney to make sure each one is accurate and complete.

4. What are my obligations after the sale ?

Sellers usually have few obligations after the sale has closed. If the agreement requires the Seller to provide post-closing assistance as a consultant (or in some cases, a full or part-time employee), then naturally the Seller will have to fulfill whatever services or assistance as agreed. In addition, the Seller may have certain post-closing covenants, or obligations to take specific actions. These usually relate to tax and other government filings, or executing further documents to complete asset transfers. If the agreement includes a working capital adjustment or earn-out (see FN 2 above), then the Buyer will have post-closing obligations related to disclosures and calculation of those amounts, and the Seller will want to ensure those obligations are met. In the case of an earn-out, those obligations may extend for several years after the closing.

5. Will I be subject to a non-competition covenant ?   

Sellers are frequently required to accept non-competition restrictions that prevent or limit their ability to engage in competitive activities against the business for a certain period of time. These restrictions, sometimes referred to as a “non-compete” or a “restrictive covenant”, vary in terms of scope, duration and geography. As a very general rule, courts are most likely to enforce a non-compete in connection with the purchase of a business, since the Buyer just paid the Seller for the know-how, assets, market share, customer and vendor relationships, good will and other benefits – and it would be unfair and illogical to allow the Seller to then compete with the business the Seller was just paid for. That does not mean courts will enforce any non-compete. Generally, courts require that the covenant be reasonable in scope, duration and geography. Even in connection with a business purchase, courts would be less inclined to enforce a non-compete that barred the Seller from working in the same industry anywhere, ever again. But, for example, a restriction of one or two years, limited to the same industry in the same geographical region, would likely be enforced by most courts.