How lawyers can help entrepreneurs sell their start-up
For Australian business owners and entrepreneurs, the sale of their business or start-up is an important event both financially and personally.
Commercial Lawyers help business owners to sell their business by guiding them through the legal side of the process to ensure three key outcomes:
Both the Buyer and Seller are aware of what they’re buying and selling;
The underlying legal documents reflect the intentions of the Buyer and Seller; and
The Buyer and Seller actively consider and allocate risks in the business sale between them.
What am I selling?
Start-ups and businesses range in complexity. Some e-commerce startups may only be selling a website, social media accounts and a few key contracts with suppliers and service providers (those few assets may nevertheless be worth considerable value). In contrast, a long-established business in manufacturing will have a much longer list of assets to sell including real property, plant, inventory, vehicles and a wide range of business contracts that need to be transferred to the Buyer.
It's critical for the Seller to ensure they’re aware of all the assets and liabilities of their business before commencing the sale process to avoid any unwanted surprises which may scupper a sale, affect purchase price or lead to a claim from a Buyer post-sale.
Lawyers can help business owners conduct a pre-sale due diligence process. Basically, a company-wide review to capture, understand and price the business assets and liabilities. Undertaking pre-sale due-diligence will pay dividends in leading to a smoother and quicker sale process for both parties. If you need further advice, Our startup lawyers can help you sell your startup or business
How do I sell?
As business or start-up will have a range of assets and contracts that may need to be sold, lawyers will prepare a business sale agreement to effect the sale and transfer the business to ensure the Buyer becomes the legal owner of the business post-sale.
A key consideration is whether the Buyer will sell the shares in their company (a share-sale), or alternatively just sell the assets whilst retaining ownership of the company itself (which will in effect become a shell company) (an asset-sale). The decision on whether to undertake a share-sale or asset-sale is complicated and requires input from both legal advisors and accounting advisors.
Once the method of sale is decided, the lawyers will draft the business sale contract. Each such agreement is bespoke insofar as it needs to reflect the reality of the business that is being sold. However, they will need contain the below essential terms.
Price
Price may be determined between the parties in a number of ways, but is generally either agreed as a fixed number (which may be based on a separate valuation) or represented as a formula to reflect the business performance during an agreed period. As the sale process may take several months, it is usual for the actual business-value on the sale date (or completion date) to vary from the value at the start of the sale process. Therefore, lawyers will usually suggest the parties agree a mechanism by which they can ‘true-up’ the sale price once the business accounts are finalised post-sale. This helps to avoid a winner-loser situation if business performance changes in the lead up to the sale.
Depending on the nature of the business, a Seller might seek to tie part of the purchase price to performance post-sale. For example, part of the purchase price may be payable depending on profit results in the 18-months following completion.
Assets
In the event that the parties choose an asset-sale over a share-sale, a complete list of assets will need to be compiled and recorded in the business sale agreement. Usual asset classes include websites, social media accounts, goodwill, intellectual property, plant and equipment and real property. Certain of these asset classes (e.g. property and intellectual property) may require separate documents to be entered into to ensure the sale of those assets is legally effective. Lawyers will work with the client to ensure the assets are accurately described and any required exclusions are included.
Parties
Although it may seem obvious which parties will buy and sell the business, in reality this can often be a complicated question. If the Seller has a group of entities then special consideration will need to be had as to which entity should enter into the sale and a restructure may be required. Lawyers will work closely with a client’s accounting team as well as management to develop the most appropriate structure for the sale. At the same time the Buyer’s team will be developing a buying structure of their own. In an asset sale, a Buyer may often seek to join the shareholders of the Seller as parties to the business sale contract so that they may guarantee the performance of the Seller (otherwise they will be left trying to enforce their rights against a shell company with no assets). Likewise, if the Buyer is a special purpose entity that has been established solely for the purchase then the Sellers may insist on related parties guaranteeing the Buyer’s obligations
Key contracts
Throughout the life of a business it will have entered into a number of important contracts that are necessary to ensure it can operate. In particular, employment contracts, supply and sale contracts and service contracts will all need to be considered in the context of a business sale. In some cases, the third party to each contract will need to agree for the contract to be assigned to the Buyer (who will usually insist that the Seller ensures this occurs prior to completion). A Buyer may decide they don’t want to take the benefit of all the contracts (particularly if they in effect double up an existing service or resource the Buyer already enjoys) so the Seller will need to come to arrangement with the third party to terminate the relevant contract. This can be a sensitive process and lawyers can assist guide management through this process to try to reduce the number of disputes that can arise with third parties during the sale process.
How do I manage risk?
Any business will inevitably have risks to its successful performance. For a Buyer, there will be concern as to the nature of the assets it is purchasing and whether the business can continue to perform on the same trajectory it had pre-sale, especially where management and/or key staff may no longer continue to own or operate the business post-sale. For a Seller, where the purchase price is tied to post-sale performance, there will be concern to ensure the Buyer operates the business to a satisfactory standard to ensure performance goals are met.
Conditions precedent and conditions subsequent
A key way to manage risk is for the parties to agree to conditions precedent or subsequent i.e. certain things that must be completed either before or after the sale completes. Usual examples are for the Seller to assign key contracts set out above and regulatory approvals or third-party consents (including of any financiers) to be obtained. If these conditions are not met, then one or both parties may be able to terminate the business sale agreement without penalty.
Warranties and indemnities
A Buyer will normally seek a wide set of indemnities from the Seller in respect of the business and its assets: that the business information provided (including any valuation) is true and correct, that assets are free from defect, the key contracts are as described by the Seller, and so on. There can usually be considerable negotiation over the scope of the warranties to be provided, any caps on liability (or minimum amounts for claims) and the length of time that warranties will run. Carefully considering the agreed warranty coverage and establishing a fair process for warranty claims can help avoid costly disputes in court following the sale. The Seller may also seek warranties from the Buyer although these are usually narrower in scope and aimed at ensuring the sale can occur lawfully.
Related to warranty coverage, the parties will need to consider what (if any) indemnities should be provided. Indemnities are technical legal agreements / clauses to provide for special rules to apply when one party suffers a loss. Usually, they are appropriate to cover certain unique scenarios where the parties don’t want the standard contractual damages or limitations that a court would normally order to apply. For example, where a party is sued by a third party in respect to a claim for infringement of intellectual property.
Restraints
A key risk to any Buyer is where the Seller launches a new business post-sale that competes with the business they have just sold. To protect against this, Buyers will normally insist that the Seller agrees to a restraint of trade that limits their ability to compete with the sold business. Restraint of trade clauses may be considered unenforceable by the court if they are too broad, so careful consideration needs to be paid by lawyers when drafting the clause.
Termination
In rare circumstances, after the sale has completed one or both parties may seek to terminate the business sale contract and restore the parties to the pre-sale position. Obviously, this is a significant undertaking for both sides (and in some cases may be impossible), so termination rights under a business sale contract are usually restrictive and designed as a last resort. Considerable costs may be incurred so both parties will need to carefully consider their position before seeking to exercise any termination rights.
What next?
If you are considering selling your business (or already in the process of doing so) and want to speak with the legal team at Dexterity Law, please get in contact with us here or email pippin.barry@dexteritylaw.com.au directly.
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The above article was written by Pippin Barry (BA, JD - 2012, The University of Melbourne), an Australian Legal Practitioner, and Hyein Kim, paralegal.
