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
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
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).
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 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
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
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.
Charles Wilson, CPA/CFF, CGMA, CBEC
Charles Wilson, LLC
307 S. Friendswood Dr, Ste B-2
Friendswood, TX 77546