Business Sales Have Contingencies

When purchasing a business, the buyer will lay out a set of contingencies that must occur to their satisfaction prior to closing. If this set of contingencies does not happen (typically for any reason), then the buyer will have the right to withdraw from the deal. As a part of the withdraw or cancellation, the buyer will also receive back their deposit (almost always refundable in a business deal) from escrow. This sometimes confuses business owners who may be used to residential property transactions involving a much narrower scope of contingencies and where deposits are typically non-refundable. Business owners wishing to sell their business should be aware of the common contingencies of a business deal, and how they impact the business sales process.

Common Contingencies in Business Sales

When signing a purchase agreement or contract of a business sale, the contingencies (as set forth in the contract) must occur prior to closing.  While contingencies may be previously expressed in the Letter of Intent (LOI), the contingencies as expressed in the final purchase agreement are legally binding. Common contingencies in most business deals are the buyer’s completion of formal due diligence (to their own satisfaction), the assumption of the seller’s lease (particularly important in retail-related industries), and a seller’s affirmation that they are selling unencumbered assets. Buyers should specifically set forth the contingencies in as much detail as possible in the purchase agreement so there is no dispute or ambiguity.

Completion of Formal Due Diligence A Common Contingency

• The most important and time-consuming part of most business deals is the buyer’s completion of the formal due diligence process.
• Formal due diligence may start after an LOI or a purchase agreement is signed (usually accompanied by the buyer placing a refundable deposit into escrow), thus giving the buyer exclusivity over the business purchase for a period of time.
• Unlike preliminary due diligence, the formal due diligence involves the buyer being provided access to any available documentation that will help them assess the value of the business.
• This includes tax returns, detailed profit and loss statements, bank statements, payroll records, insurance documents, and company invoices and receipts.
• Sometimes, the buyer will want to have contact with company employees or suppliers as a part of the formal due diligence process.
• Other buyers may desire to ‘observe’ the business by physically being present in the business for a period of time.
• This may disrupt the seller’s confidentiality and adversely affect the operations of the business.
• It is thus critical that the buyer identifies the precise ways in which they intend to accomplish their formal due diligence in the purchase agreement.
• That way there will be no surprises and the parties may negotiate a mutually agreeable way for the buyer to conduct formal due diligence without disturbing the seller’s business.
• Lastly, sellers must be aware that the buyer has the sole right to determine whether due diligence is completed to their own satisfaction.

Assuming Lease A Common Contingency

For many retail-related business such as restaurants or beauty salons, the lease and location of the business is of paramount importance for the buyer. As such, the buyer will insist that the assumption of the lease be made a contingency of closing. A buyer is never guaranteed that they will be allowed to assume a commercial lease. The landlord typically qualifies the buyer (in the same way they qualify a new tenant) and may or may not approve. Further, some landlords may attempt to impose harsher terms upon the buyer (so long as it is allowable under the lease). It may also take several weeks of negotiation and delay for the landlord to assign the lease to the buyer, so both the buyer and the seller should start the lease assumption process as soon as a purchase agreement is signed.

Seller’s Affirmation A Common Contingency

In most business deals, it is common for the buyer to require the seller give certain affirmations as a contingency to close. Common affirmations include the seller’s right to sell the business and the accuracy (to the seller’s best knowledge) of the due diligence material. These documents are called the ‘seller’s corporate resolution to sell the business’ and a ‘seller’s certification statement’, and are given to the buyer by the seller at the closing. The buyer wants the legal assurance that they are receiving unencumbered assets without risk of future liens or lawsuits. Other closing documents, such as an ‘affidavit of no liens’ and a ‘bill of sale’ may also be provided to the buyer by the seller as a contingency to close. Of course, the buyer must fully fund the transaction through escrow prior to receiving such closing documents.

Seller’s Warranties Common Contingency for Service Businesses

In many service-related businesses such as healthcare companies or landscaping companies, there may be significant risk that the buyer (after the closing) will be subjected to warranty costs pertaining to services performed by the seller prior to closing. The warranty costs may come from refunds, extra service to correct previously conducted work by the seller, or even litigation pursued by previous customers. Even though the buyer will be doing business under a new corporate entity, the risk of liability from past actions of the seller may still exist. The buyer will thus insist upon the seller providing sufficient warranties for their previous actions (prior to the closing date) as a contingency to close.

Buyers who are obtaining external funding (typically via SBA-backed loans) will also include a ‘financing contingency’ which allows them to cancel the deal if financing may not be obtained.  Common contingencies to be found in most business deals are the completion of formal due diligence and lease assumption to the buyer’s satisfaction.  Further, most buyers expect the seller to warrant their business free from liens or future customer claims as a contingency to close. Both buyers and sellers of businesses should understand the common contingencies to close, and whether they will pose a problem to a successful transaction.

Give Martin at Five Star Business Brokers of Palm Beach County a call today at 561-827-1181 for a FREE evaluation of your business.