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Legal Forms for Selling a Business
By Quiet Light
Selling a business doesn’t need to be difficult, but it does require some thoughtful preparation and a clear plan for execution. Knowing all the right legal forms for selling a business is will put you one step closer to a successful transaction.
A successful transaction is one in which the terms are clear and each party completes their respective duties. When that happens, both the buyer and seller walk away on good terms.
Following the proper legal framework is an important element to ensuring a smooth transition when selling a business.
This article explains the legal forms involved in the sale of a business. It is not to provide an exhaustive list of all the due diligence steps that buyers should take. For a guide on that topic, check out this article.
Why Each Form Is Important
Before diving into each of the specific legal forms involved in the selling process, it’s important to understand why these forms are important. Together, the various documents establish clarity in several key areas, which include:
- Creating an organized framework by which the due diligence process takes place.
- Defining the scope, terms, compensation, included assets, and each party’s obligations.
- Protecting both the buyer and seller against fraudulent activity.
- Providing a process of remedy should any agreement violations occur.
Of course, legal documents can be expensive and tricky to draft. However, at Quiet Light Brokerage, we provide our clients with professional templates.
We always recommend that both the buyer and seller utilize their own attorney. However, our templates can certainly reduce the cost associated with drafting new legal documents.
Below, we’ve included all of the most common documents that you can expect to encounter as either a buyer or seller.
Letter of Intent
A Letter of Intent (LOI) is a document provided by one party to the other that establishes the relevant details and terms of a proposed transaction. It is also one of the first legal forms for selling a business that sellers encounter. While it is typically not a binding, formal contract, it does carry some legal weight. Typically, it’s used to create the Asset Purchase Agreement later in the process.
Some items that are often included in the LOI are:
- The purchase price
- List of transferable assets
- Deal Terms
- Exclusivity Period
- Expected closing date
- Confidentiality statement
Of course, the purchase price is one of the most critical numbers for buyers and sellers to agree on. If a potential buyer submits an LOI to a business owner, it will surely specify a proposed purchase price.
In addition to the purchase price, the LOI will usually include the terms by which the deal will take place. For example, a prospective buyer may require a month or two of training, or some form of seller financing. In many cases, an LOI will include a terms sheet that specifies key terms of the deal that both parties must agree to.
An LOI also usually establishes an Exclusivity Period. The Exclusivity Period is the length of time in which a purchaser can complete the due diligence process without needing to worry about competition from other buyers. Essentially, it’s how much time the buyer has to complete the due diligence process before the seller can consider other offers.
The period of exclusivity naturally determines the expected closing date. During that period, both parties are expected to work together to execute the Asset Purchase Agreement. The APA is usually a mirror image of the LOI that the parties agree upon.
Lastly, most LOIs include a confidentiality agreement that establishes that both parties will respect the privacy and confidentiality of the other.
In addition to these more common items, LOIs may include any number of additional items that either the buyer or seller will want to specify. Each deal is unique, so every translation includes its own set of terms and agreements.
Asset Purchase Agreement
Most online business purchase transactions are categorized as an asset purchase, as opposed to a stock purchase. In an asset purchase, the buyer purchases specific assets as defined in the Asset Purchase Agreement (APA).
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In this sort of transaction, the seller does not need to sell all of the business’s assets. For example, bank accounts, vehicles, or other physical property are usually not included in an asset purchase transaction. Also, a business purchase agreement doesn’t typically include business liabilities.
On the other hand, a stock purchase typically includes all of the company’s assets as well as its liabilities. Since online businesses usually don’t have stock, we don’t need to worry about this form of agreement.
The Asset Purchase Agreement is the full and binding agreement that governs the business purchase transaction.Click to tweet
Of all the legal forms for selling a business, the APA is the master of all documents. In other words, it’s the most important one that you will sign throughout the buying or selling process.
The APA is signed after the due diligence process has been completed and both parties are satisfied.
What Should an Asset Purchase Agreement Include?
Because the LOI establishes most of the deal terms, the APA will typically resemble that agreement, as long as the due diligence process doesn’t reveal information that is contrary to what the seller has represented.
The APA typically states:
- Who the buyer and seller are
- The purchase price
- The payment terms (due at closing, monthly installment payments, etc.)
- What assets the sale includes
- Other deal-specific terms or conditions
The APA should answer every question you can think of regarding the transaction and provide clarity between the buyer and seller.
As mentioned, the APA is usually based on the terms set forth in the LOI. It is legally binding and reflects the final agreement between both parties. Buyers and sellers should seek legal counsel throughout the process.
Promissory notes are relevant whenever one party loans money to another. Some common uses include real estate transactions, car loans, and student loans. During business transitions, they are used when seller financing is involved.
If a deal involves seller financing, the promissory note serves as a written promise that the buyer will pay the seller per the terms included in the note.
When Is a Promissory Note Used?
A promissory note is only necessary when seller financing occurs since that is the only time that one party will owe money to the other after closing. Therefore, there are many instances in which a promissory note isn’t used.
What Is Included in a Promissory Note?
The promissory note typically specifies the:
- Parties involved
- Amount owed
- Payment schedule
- Interest rate
- Collateral, if any
All promissory notes state who the lender and borrower are, as well as the amount owed to the lender. Seller financing deals also include an agreed payment schedule and interest rate, which are also specified in the promissory note.
Sometimes, a seller may require that the purchaser provide collateral, similar to a secured bank loan.
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If the buyer fails to make their payments, the seller has several options available. Each seller should consult with their attorney to determine the best way to handle their given situation. Some common options include written reminders, using debt collectors, or taking legal action.
Lastly, a promissory note should be tied directly to a purchase agreement to provide context and clarity.
The asset allocation is an agreement between the buyer and seller that specifies how both parties will report the transferred assets to the IRS. The asset allocation document is not complicated, but it carries significant implications when it comes to taxation.
When the buyer and seller prepare their taxes the following year, each will need to include a Form 8594, also known as an Asset Acquisition Statement. On the form, each party will need to classify each asset as belonging to a specific asset class.
Cash-like assets correspond to Class I, securities to Class II, accounts receivable to Class III, inventory to Class IV, and so on and so forth up to Class VII. Each asset class is taxed differently, so it’s important to speak with your tax account when determining the asset allocation.
It’s also essential that there is consistency between the buyer and seller’s Form 8594. Therefore, it’s necessary for both parties to come to an agreement on how each asset is allocated.
When a buyer purchases a business, they typically want some assurances that the seller won’t immediately start another business to compete with them. After all, a successful seller likely knows how to start another competitive business in the same market.
As the name implies, a non-compete agreement establishes that the seller will not compete with the business for a specified period of time after the sale.
In many ways, this agreement isn’t too different from an employment contract. Just as employers don’t want their employees to become their competitors, buyers don’t want to purchase a business and then deal with undue hardship caused by the seller’s competition.
While we include a non-compete agreement in our standard templates, many buyers and sellers choose to have their attorneys draft a customized agreement based on their unique situation.
Bill of Sale
Its primary purpose is to protect both the buyer and seller against any fraudulent claims. Of course, the bill of sale should only be signed when the closing funds and assets have been received by the respective parties.
Each acquisition is unique, so some deals will require additional legal forms for selling a business to clarify various aspects of the purchase and provide further protection for either the buyer or seller (or both).
It’s not uncommon for a buyer to seek consulting services from the seller. If such an arrangement is part of the deal, both parties will likely sign a consulting agreement to establish clarity and legal protection.
Just as your accountant and attorney answer questions about sales tax and formation documents during the founding stages, they can also be extremely valuable during the transition stages.
Although the legal forms for selling a business vary slightly from deal to deal, having a foundational legal understanding will help you navigate the process competently as a seller.
Have more questions about what the buying or selling process could look like for you? At Quiet Light Brokerage, our team of qualified advisors is always happy to discuss your situation or provide a free valuation of your business. Give us a call or send us an email today and we’ll get back to you quickly.