Charles S. Wilson, CPA/CFF, CGMA, CBEC | CERTIFIED BUSINESS EXIT CONSULTANT | 281-993-4530 | charlie@wilsonaccounting.net
         

What Legal Agreements will your Exit Strategy Require?

 

[fname], whether selling, transferring, or otherwise exiting your business, legal agreements will be a necessary major step in a successful business exit strategy. Learning about these legal agreements today will save an exiting owner time and questions later, when he or she will have many other aspects to the exit to consider- including planning for the future.

 

Below I will examine the most common and universal legal agreements, and how they protect both the exiting owner and business successor.

Building an experienced and knowledgeable exit advisory team will be crucial in helping the exiting owner to comprehend and deal with legal agreements. A legal attorney specializing in the structure of business exits will be needed to deal with the specifics of your agreements, as well as drafting documents.

Some of the more common documents that an exiting owner will sign include:

1. Letters of Intent (to purchase the business)
2. Purchase and Sale Agreement
3. Non-Compete Agreements
4. Earn-out Agreements
5. Seller Financing Agreements

Letters of Intent:
 

In the sale of a business, a letter of intent (LOI) is a written document from a buyer or successor that encompasses the offer for your business, detailing the price, structure, and terms of the proposed transaction. The letters of intent (which should be obtained from all interested buyers) will outline the offer for the business so that the exiting owner can begin to identify the key points of the proposed transaction and begin initial negotiations. The LOI can help an owner to quickly determine whether he and the potential buyer have a strong possibility of reaching an agreement, or if the seller should move on to other prospective offers.

The selling owner will choose the LOI that best suits his/her financial and personal goals, taking into account all conditions and considerations specific to the offer. In transactions involving deferred payments, an owner will want to consider the credit worthiness of the potential buyer, as well as personal expectations following the transfer (i.e. if the exiting owner is expected to continue working, for what length of time, and at what salary rate).

Purchase and Sale Agreement:

 

This is the kingpin document in a business exit. The P & S Agreement, sometimes know as the Definitive Purchase Agreement, articulates the final agreement of the parties and allows for the legal exchange of ownership in the agreed upon shares (or assets) of the business. This is generally a very long and detailed document that is written by legal counsel, and will require the advice and expertise of an attorney on your Exit Strategy Advisory Team.

This document memorializes the transaction and will include all clauses pertaining to the transfer or sale of the assets or stock of the business. Your P & S Agreement will likely either be a Stock Purchase Agreement or an Asset Purchase Agreement. This is an important distinction, as the tax implications to each type of transaction can vary greatly (speak with your tax advisor about this important issue).

Non-Compete Agreement:

A business successor, whether an outside buyer or internal buyer, will naturally want to protect his or her new investment in your business. Of primary interest to this successor will be the role of the exiting owner in the business or industry following the transaction. Since the exiting owner typically plays a critical role driving value for the business, the transition of the business away from his or her control will be a risk factor that any buyer or successor will need to estimate.

The formal agreement that reflects your desire or ability to stay with or leave the business will be either an employment agreement (most typically utilized in traditional private equity group recapitalization deals) or a non-compete agreement where you are exiting the business and not continuing on after the close. In a traditional non-compete agreement, the exiting owner will consent to not work within the industry, or start a competing business for an agreed upon length of time – 3 years of non-competition is the norm.

Earn-Out Agreements:

Earn-out Agreements stipulate how certain payments will be made to an exiting owner after the closing, depending on how the business performs in the exiting owner's absence. While most exiting owners prefer to get more cash at the closing than to rely on contingencies that may ultimately pay more or less money, Earn-out agreements essentially provide built-in protection for the buyer. Most exiting owners also realize that they are going to lose control of the business–and its relative performance–once ownership changes, and are leery of tying their ultimate business pay-out to this uncertain end.

In addition, there is also the practical problem of monitoring the performance of the business after closing. In these cases, it is advisable to have a very specific formula and an objective manner in which performance can be measured, to help assure fairness in the process of determining an earn-out that is due an exiting owner. As a result of the uncertainty which can result for both the buyer and seller, the Earn-Out Agreement, as with all legal documents in the exit process, should be carefully worded to protect the wealth that will be due to the exiting owner in the future.

Seller Financing Agreements:

Seller Financing Agreements are an alternate form of deferred payment for the business owner, most often used when a family member or key employee is taking over control of the business. Under these agreements, the exiting owner will not receive cash at the closing, but will rather take back a note from the buyer or successor, agreeing to receive payments at a future date. The seller financing portion will usually include an interest rate that accrues against the amount due, typically at or near current commercial loan rates.

Seller notes may or may not be personally guaranteed by the buyer or successor, a point which can be negotiated in each transaction. As with considering multiple letters of intent, an exiting owner will want to see if some leverage can be created in the exit process to attract a buyer or successor who has deep pockets and is willing to support the payments of the notes either personally or against a corporation in a very strong financial position.

These legal documents can provide safeguards to both the exiting owner and his or her successor, not only memorializing their agreement but also providing a road map for sorting out any future issues between the exiting owner and the buyer. The legal language of these documents can prevent unnecessary future liabilities or lawsuits, and play a key role in a successful, and final, business exit for the owner. The proper structuring of the legal documents ultimately helps the exiting owner to both realize and protect his/her wealth.

 

As always if you need some advice, you're welcome to email me of call me here at the office at 281-993-4530.

 

Regards, Charlie

 

Charles Wilson, CPA/CFF, CGMA, CBEC

Charles Wilson, LLC

307 S. Friendswood Dr, Ste B-2
Friendswood, TX 77546
281-993-4530 (O)
866-567-3975 (F)
charlie@wilsonaccounting.net



 



 


   
 
         
   
         

         

Charles Wilson, CPA/CFF, CGMA, CBEC is a Certified Business Exit Consultant and is affiliated with Pinnacle Equity Solutions, Inc., an Exit Strategies Training and Solutions company.  Parts of the content in this email are taken from previous Pinnacle Equity Solutions, Inc's. newsletter library and website in accordance with Charles Wilson's certification in Pinnacle's Certification and Membership Program. All Copyrights are the properties of Pinnacle Equity Solutions, Inc. and Charles Wilson, LLC and their respective owners.