If you are a business owner contemplating the sale of your business, or an individual considering entrepreneurship through acquisition, you may be wondering “what are the steps in a purchase and sale of a business?” This article provides a high-level overview of the steps involved in a lower middle market ($5 million – $50 million annual revenue) business sale. For simplicity, I use corporate terminology throughout this article (e.g., “stock” rather than “membership interests” as in an LLC) but, with few exceptions, the concepts apply to other forms of business entities as well.

Preparation

There is a lot of planning that goes into preparing a business for sale. Business owners who reach out to their advisors (legal, accounting, broker, financial, etc.) early in the process will have time to assess any weaknesses in the business and address them prior to the sale.

Experienced advisors can find and clean up issues that may arise during the due diligence process which could delay closing, reduce the sale price, or sink the deal entirely. For example, business owners often favor running their business in a way that minimizes taxable income during the life of the business. This can result in financial statements and tax returns that reflect lower earnings than what might be achievable if the goal is to maximize earnings. However, once an owner begins to consider selling their business, higher earnings result in a higher sale price upon exit.

Listing

Business owners planning to sell their business may hire a business broker or investment banker to shop the business to prospective purchasers. A good broker will significantly increase the number of prospective purchasers that are aware of the business, act as a gatekeeper to keep tire kickers from wasting the owner’s time, and ultimately maximize the sale price and terms for the owner. The terms of the broker’s representation are included in an engagement agreement between the broker and the company. The broker’s engagement agreement should be reviewed by an experienced attorney to ensure that the broker and the owner’s interests are aligned. The vast majority of the broker’s fees should be contingent upon a sale. The broker will prepare a confidential information memorandum (“CIM”) to showcase the strengths of the business to potential buyers. The CIM will generally include details about the assets, operations, financials, management, and position of the business in its industry. Potential buyers are required to sign a nondisclosure agreement to protect the confidentiality of the CIM and any other materials shared about the business.

Letter of Intent (“LOI”)

Once a potential buyer has decided to make an offer, their lawyer will prepare a letter of intent to present to the seller. A letter of intent is a non-binding offer to purchase a business that outlines the key terms of the deal. The LOI is the buyer’s opportunity to “pitch” the seller and may include the buyer’s strategic plans, details about their financing, and anything else that might be important to the seller. Most LOIs cover (1) the structure of the transaction (asset or stock purchase), (2) purchase price, (3) payment terms (seller note, escrow/holdback, earnout, equity rollover, etc.), (4) working capital, (5) employment/transition assistance, (6) confidentiality, (7)exclusivity, (8) target closing date, and (9) any contingencies to closing, among others. The buyer and seller will negotiate until they are satisfied with the terms of the LOI. The LOI is signed, and the parties enter a period of exclusivity where the buyer has the sole right to pursue a deal with the seller.

Transaction Structure

The structure of the transaction will either be an asset sale, stock sale, or a merger (combination of two companies into one). The majority of sales of small and medium-sized businesses are asset sales. Stock sales are generally reserved for special circumstances where an asset sale would be impractical. A few examples of special circumstances where a stock sale may be appropriate include sales of (a) less than 100% of a business (as in the case of a strategic investment, or where the buyer requires the seller to roll over a portion of their equity), (b) government contractors, and (c) businesses that require expensive or difficult to obtain licenses. Although asset sales usually involve the acquisition of substantially all of the assets of a business by the purchaser, an asset sale allows the buyer to choose which assets and liabilities of the business that they want to acquire. As a result, the purchaser in an asset sale will generally have less exposure to known or unknown liabilities for prior acts or omissions of the business (e.g., unpaid taxes or withholding, lawsuits, employee benefit plans, etc.). In a stock sale, the purchaser acquires the entire business, including all of its assets and liabilities, known and unknown. The transaction structure also has tax implications for both buyer and seller. From a tax standpoint, asset sales are generally more favorable to the buyer, and stock sales more favorable to the seller.

Due Diligence

With a signed LOI in hand, the buyer begins due diligence by sending an initial due diligence request list to the seller. The due diligence request list is a combination Q&A and request for documents (e.g., financial statements, tax returns, contracts, leases, etc.). The buyer usually sets up a virtual data room for the seller to easily share the requested documents. If the seller is utilizing a broker, the broker should already have much of the buyer’s requested information organized and readily available to provide to the buyer. This can significantly reduce the seller’s burden and speed up the due diligence process. The buyer and their advisers review the seller’s responses and follow up with additional questions and document requests.

Purchase Agreement

While due diligence is proceeding, the buyer’s lawyer prepares the first draft of the purchase agreement and sends it to the seller’s counsel to review. The seller and their lawyer will review and propose revisions to the purchase agreement as necessary and send it back to the buyer’s lawyer. This back-and-forth may be repeated multiple times until the parties reach an agreement. Unless something unexpected is revealed in due diligence, the negotiation of the purchase agreement is normally limited to terms not addressed in the LOI. Items commonly left to be negotiated in the purchase agreement include indemnification, working capital, noncompetition, and any insurance requirements (e.g., tail policies, representations, and warranties insurance).

The purchase agreement will also contain representations and warranties (the “reps and warranties” or “reps”) of the company (and the seller in a stock sale). The reps and warranties of the company are affirmative statements about the company and its assets and liabilities. Reps and warranties cover a wide range of topics including financial statements, contracts, employees, real and personal property, taxes, and compliance. The company will prepare responses to reps that require disclosure of certain information, and any statement made in a rep that is not entirely true, correct, and complete. Collectively, these responses to the reps and warranties are called disclosure schedules.

Ancillary Documents

With progress being made on the purchase agreement and the disclosure schedules, the parties begin preparing all of the other documents that the purchase agreement requires to be delivered at closing. Depending on the terms of the deal, these documents may include: (1) seller note(s), (2) escrow agreement, (3) employment/consulting agreement(s) for the company’s principal(s) and key employees, (4) consents of the Board of Directors, stockholders, and third parties (5) director and officer resignations, (6) payoff letters, and (7) documents related to any rollover equity or reorganization of the company contemplated by the purchase agreement.

Closing

Assuming the parties have reached an agreement on sticky points like working capital, the closing date is set, the parties collect signatures for all of the closing deliverables, a flow of funds is prepared to direct the buyer where the cash payable at closing is to be wired (e.g., company/seller, creditors, advisers), and the deal closes. Congratulations to all!

Post-Closing Transition

After the closing, the buyer will launch into the task of becoming familiar with the business and transitioning the responsibility for day-to-day operations to their control. This transition period includes such tasks as updating authorized signatories on bank and other financial accounts, building trust with employees, providing any post-closing notices to third parties, and ultimately deploying their strategic plan to grow the business. Unless the seller has managed to remove themselves from the day-to-day operation of the business by putting an executive team in place prior to the sale, the seller usually remains on hand to provide transition assistance to the buyer for a period of 3 to 12 months.

​From listing to closing, the sale of a small or medium-sized business typically takes 6-12 months. However, depending on the financial and operational condition of the business, preparing the business for sale may take multiple years. Do not wait until you are burnt out and ready to quit. Selling a business and running a business are both full-time jobs. Sellers who wait too long to sell inevitably lack the motivation to put in the extra time, energy, and capital necessary to maximize the value of their business.

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