Ten Rules for the Sale of a Business (Part Two)

Once a business owner has located a prospective purchaser of the business, whether that may be a business insider or an unrelated buyer, the business owner needs to undertake an inventory of the business. This is far more than simply counting supplies, inventory, desks, chairs and other tangible property. The owner needs to fully understand what is about to be sold or excluded from sale. This list typically includes many of the following items:

  1. Business goodwill, including all trademarks, logos, trade names, customer or client lists, lists of business contacts and referral sources, web-sites, phone numbers, photographs and other marketing data or customer information.
  2. Business records, including articles of incorporation, by-laws, operating agreements, financial, banking and tax records, contracts and billing records, personnel records, policy manuals, forms and correspondence (tangible and electronic).
  3. Intellectual property, including designs, copyrights, patents and trade secrets.
  4. Office equipment, supplies, furniture and decorations.
  5. Receivables.
  6. Inventory and Work-in-Process.
  7. Production equipment and tools.
  8. Customer and client contracts.
  9. Real estate, including leases and other property rights.
  10. Vendor contracts, service contracts and equipment leases.
  11. Insurance contracts and claims.
  12. Employment contracts.
  13. Bank deposits, and banking agreements.
  14. Licenses and permits.
  15. Software.
  16. Pre-payments, escrowed funds, utility and lease deposits.

Developing a thorough inventory of the business is useful for many reasons, but at a minimum it will help to avoid surprises for buyer and seller by forcing them to decide what the buyer is or is not purchasing. To the extent that a buyer will not be obtaining ownership of some part of the business’s property the seller will need to decide what to do with it after the sale closes. The inventory will also be helpful in identifying parties other than buyer and seller who will need to be contacted and may need to consent to the buyer’s assumption of the seller’s rights.

Part of the process of creating an inventory for pre-sale use by the business owner involves identifying aspects of the business which are difficult or impossible to transfer. Some of the most common examples involve customer and employee relations.

Particularly with service businesses, the personal relationship between a customer and an owner can be difficult if not impossible to transfer. It may take years for a customer’s trust to be earned by a new owner. This fact explains why so many sale-of-business deals envision the seller’s continuing involvement for years after the sale.

Of course employees can’t be sold but employment contracts, such as a covenant not to compete can be assigned if they specifically allow such an assignment. But even if a covenant not to compete is lawful and enforceable by the seller, it may become unenforceable by the buyer. This problem is easier to understand if we remember that if a business owner sells his business property (rather than stock or a membership or partnership interest) the owner will fire all of his employees who will likely be immediately rehired by the buyer. This process also points to the difficulties a seller will face if the business has an employee retirement plan in place, since termination of employees may trigger certain rights under such plans.

Another example of transfer problems involves the transfer of the seller’s unemployment tax experience rating which may be very favorable compared to the buyer’s rating. Depending on how the sale is handled the rating may prove to be non-transferable. This fact illustrates why each sale of a business needs to be evaluated carefully by the owner/seller in advance of actual negotiations with a buyer. Unless the seller understands what the buyer can expect to buy the seller may find it difficult to determine what price the buyer is likely willing to pay.

The complexity of the process described above illustrates one of the reasons it is preferable to sell to a business insider, who already has a grasp of the property he or she will be buying. But even in that situation the inventory is useful as a full-disclosure tool to avoid the sort of surprises that can lead to post-sale disputes. Developing the business inventory can also help identify matters which need to be “cleaned-up” or dealt with before selling or even pricing what is to be sold. In any case, the process normally is best handled by the owner/seller with the assistance of accounting, legal and insurance advisors.